SPT - Sprout Social: High Growth Trajectory And Potentially The Next Big SaaS Company

2024-01-18 07:08:00 ET

Summary

• Sprout Social's revenue has grown consistently well (CAGR +40%), as Management has executed an aggressive go-to-market strategy, underpinned by a quality platform.
• Management is continuing to innovate and is supplementing this with M&A. We consider AI and ML to be key opportunities to transform the quality of its offerings.
• SPT is also benefiting from industry tailwinds, contributing to large customer wins. With both ARR and ACV growing at ~30%, we see an impressive decade ahead.
• The Company is widely recognized as a leading business within the industry. Management estimates its current SAM to be ~$55b, with a current revenue of $310m.
• SPT is not cheap, but we believe this is due to the strong growth ahead. If we consider its long-term potential, we see considerable upside.

Investment thesis

Our current investment thesis is:

• SPT is showing signs of being the next great SaaS business. It is operating in a relatively young vertical, Social Media Management, with a quality product that is underpinned by reviews and market recognition.
• It is rare to see a business of this size boast the clients it does and the growth in ACV it has achieved. This implies considerable value offered to its clients, which we think will accelerate with the incorporation of AI and ML.

Company description

Sprout Social ( SPT ) is a Chicago-based software company. It specializes in social media management solutions, offering a platform that enables businesses to manage their social media presence, engage with audiences, and analyze performance across various social channels.

Share price

SPT's share price has been volatile since the company was listed, returning over +600% at its peak, before declining to ~+250%. Investors are still attempting to understand the long-term trajectory of the company as Management executes its strategy.

Financial analysis

Presented above are SPT's financial results.

Revenue & Commercial Factors

SPT's revenue growth has been impressive, with a CAGR of +40% since FY17. This trajectory broadly continues, with 35% growth in FY22.

Business Model

SPT offers a suite of tools for social media management, including post-scheduling, content curation, and analytics. These tools enable businesses to efficiently manage their social media accounts from a centralized platform.

The platform integrates with all of the key social media channels such as Facebook, Twitter, Instagram, LinkedIn, and others.

SPT has expanded aggressively globally, a natural development given the inherent nature of social media. The company caters to businesses of all sizes, including agencies, although is now seeking to target higher-value customers in the Enterprise segment.

SPT provides robust analytics and reporting features, allowing businesses to track the performance of their social media campaigns. Insights into engagement, reach, and audience behavior, all of which support businesses making data-driven decisions.

SPT focuses on customer engagement through features like social listening and response management. Businesses can monitor conversations about their brand and engage with customers directly from the platform.

SPT is increasingly utilizing AI and ML (expertise acquired through M&A) to hone the accuracy of its analysis and actionable insight from large data sets.

The platform facilitates collaboration among team members involved in social media management. Features like content approval workflows and task assignments enhance team efficiency and coordination. This is critical as businesses increasingly build out dedicated social media teams that are required to operate as a standalone function.

SPT integrates with customer relationship management ((CRM)) systems, providing a unified view of customer interactions across various channels. This enhances customer understanding and relationship management.

Financial KPIs

SPT currently has over 30,000 customers across ~100 countries. The company's revenue is generated through a subscription model, the most superior form of revenue generation due to its recurring nature and scope for up/cross-selling.

As of Q3'23, the company had an ARR ("Annual recurring revenue") of $360m, representing a CAGR of +36% since Q3'20 (vs. revenue growth of +31%). This puts the company just below the famed " Rule of 40 ", which states a SaaS ("Software as a Service") business should target (and maintain) a growth rate + FCF margin of 40 (this can be defined slightly differently). Given SPT's growth is remaining sustainable in the 30-40% range while its FCF margin is stepping up ( discussed later ), SPT may find itself within this elite cohort.

ARR growth has been materially driven by customer growth, as we would expect for a growth business in a growing industry, as SPT has expanded its footprint across a range of industries. This said, volume-driven ARR growth is restricted long-term as competition increases and penetration moves toward maturity.

For this reason, scope for price-driven ARR growth is critical. This means higher value customers, opportunities to up/cross-sell, and the ability to execute price increases. Despite this being the secondary focus for a growing SaaS business, SPT is progressing exceptionally well, with ACV ("annual contract value") growing by +26%.

SPT offers different plans based on the needs of businesses and users. This adaptability allows businesses to choose a plan that aligns with their budget and requirements while allowing SPT to benefit from growth in its clients.

This has contributed to a compounding acceleration in the number of customers generating ARR of >$10k / >$50k. We suspect this will continue to grow as tailwinds drive growth in the social media industry and SPT becomes more regarded in the industry, contributing to higher value wins.

Key customer wins include: Harman ( OTCPK:SSNLF ), Kraft Heinz ( KHC ), Honda ( HMC ), Hormel Foods ( HRL ), University of Michigan, BT ( OTCPK:BTGOF ), MercadoLibre ( MELI ), Universal ( CMCSA ), Danaher ( DHR ), Activision Blizzard ( MSFT ).

Competitive Positioning

We consider the following competitive advantages:

• All-in-One Solution - Businesses prefer all-in-one solutions that streamline their operations with minimal complexity. SPT's platform, offering a range of tools from analytics to engagement, fulfills this need.
• User-Friendly Interface - Further, our analysis of customer reviews has stated its platform has a user-friendly interface, making it accessible to a broad audience.
• Effective Analytics - The analytics and reporting features address the need for businesses to measure the impact of their social media efforts. SPT's platform currently provides market-leading insight following years of innovation.
• Adoption by Diverse Industries - SPT has developed its platform to be adaptable across diverse industries.
• Integration - SPT platform integrates with a range of related software solutions utilized by its clients.

• Scalability - The platform's scalability allows businesses of various sizes to use its services effectively, creating long-term relationships.
• Continuous Innovation - SPT continues to invest heavily in innovation to maintain its competitive advantage. R&D expense has grown at a CAGR of +29% while Management is also now undertaking M&A to bolster its capabilities.

Social Media Software Industry

SPT competes with Hootsuite, Sprinklr ( CXM ), Buffer, HubSpot, BrandWatch, and Socialbee.

The growth trajectory of this industry is difficult to assess, although it is clear that the opportunities are vast. ~4.5b consumers are using social media, with penetration only increasing. Further, the industry is directly correlated with economic development, as growth leads to increased spending potential, leading to increased advertising value.

Management estimates the current SAM ("Serviceable available market") of the industry to be ~$55b, while the TAM ("Total addressable market") is forecast to be ~$120b in 2025. This implies <1% penetration, representing an impressive scope for growth.

Competitive dynamics are currently centered around:

• Features and capabilities of the social media management tools.
• Pricing structures and scalability.
• Quality of insight provided and value proposition.
• Customer support and user satisfaction.

SPT is currently extremely well-regarded. The company was recognized by G2 users as the 3rd highest-ranked company and the top-rated platform in its category. The industry is large enough for a number of players, with SPT clearly among the top cohort.

SPT sees itself differentiated by the following.

Opportunities

We see the company's opportunities as the following.

• AI and ML Integration - Leveraging artificial intelligence and machine learning for improved social media insights.
• Global Expansion - Tapping into emerging markets with growing social media usage.
• New Feature Development - Staying ahead by introducing innovative features.
• Product diversification - Launching and/or acquiring related services to broaden its ecosystem.

Notable threats

We consider the following to be key commercial risks:

• Platform Dependence - Vulnerability to changes in algorithms and policies of social media platforms.
• Cybersecurity Risks - Potential data breaches and security concerns.
• User Engagement Challenges - Keeping users engaged in a rapidly evolving digital landscape.
• Relative maturity of the industry - This industry (Supporting social media marketing) is still young and so susceptible to innovation and rapidly changing conditions.

Economic & External Consideration

Current economic conditions are not conducive to growth. With elevated rates and inflation, we are experiencing a slowdown in spending and growth, contributing to financial constraints by consumers and businesses. This is contributing to reduced advertising spending and operational investment. Nevertheless, SPT's trajectory alone has allowed it to maintain growth.

Looking ahead, we suspect rates will decline in 2024, although in the context of a looming recession. We do believe SPT could experience a step down in growth but in the context of a 5-year period with rates declining, we are broadly bullish on growth.

Margins

SPT's margins have gradually improved as scale has increased, with the company EBITDA-M positive when adjusting for SBC. The company's limited FCF improvement is likely the reason for its share price softening, as investors are unconvinced by progress.

We would argue this is due to increased investment in marketing (S&A% of revenue stepped back up in FY22) and R&D (again, stepped up again as a % of revenue), which has been done to improve its long-term trajectory.

Quarterly results

SPT's top-line growth has been incredibly consistent, boasting +30.8%, +31.0%, +29.1%, and +31.0% in its last four quarters. In conjunction with this, its Adj. EBITDA-M was 2.2%, 3.7%, 2.6%, and 1.6%.

The company continues to develop well. Some have suggested focus must switch to margins but at a revenue level of ~$300m and a SAM of ~$55b, we believe the focus should absolutely remain on growth, with sufficient cash flows to fund opportunistic M&A and its organic growth efforts.

Balance sheet

SPT is currently in a negative net debt balance while positively generating cash. This limits any downside risk, although investors should be prepared should Management decide to conduct a transformative transaction that requires financing.

Outlook

Presented above is Wall Street's consensus view on the coming years.

Analysts appear to align with our view of the company. Growth is forecast to be strong (+25% CAGR into FY26F), alongside slow margin improvement but accelerating FCF. We wholly concur with this trajectory, as it will be critical to the long-term success of the company. This said, naturally the actual results will likely vary given the complexity and uncertainty involved with a growth business.

Valuation

SPT is currently trading at 10.5x LTM Revenue and 8x NTM Revenue. This is a discount to its historical average.

SPT is clearly not cheap at 8x NTM Revenue, however, this must be contextualized by its strong growth trajectory, which will contribute to a contraction in multiples over time. Due to the size of the company and its potential, it is difficult to apply standard metrics to assess its valuation.

By 2028, Management is expecting a GM% of ~80% and an FCF margin of ~21%, which would imply a revenue valuation at the time of >6x. This of course implies substantial value but materially reflects execution risk over the coming years.

Finally, given the growth potential of the industry and the lack of mature players, SPT represents an attractive takeover target for a SaaS player looking to gain exposure to the industry. This protects against downside risk.

We see sufficient progress thus far, underpinned by quality product development, to suggest upside toward its long-term goals.

Key risks with our thesis

The risks to our current thesis are:

• Intense competition impacting market share and margin development.
• Adverse changes in social media policies affecting functionality.

Final thoughts

SPT is showing considerable potential in our view. The company has achieved impressive growth, is working toward the Rule of 40, has an impressive product offering, and is operating within an industry benefiting from tailwinds.

The company remains a high-risk bet given the developments required in the years to come, although we are not concerned given the execution thus far and the quality of its offering.

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