Sprout Social: Margin Might Be Better Than Expected In FY23

Investment thesis

Despite worries about the justifiability of spending on Social in a more restrictive IT budget atmosphere, Sprout Social (NASDAQ:SPT) had a positive Q4 and offered robust FY23 guidance. This was driven by customers' ongoing emphasis on investing in Social media and SPT success in penetrating the up-market (SPT raised prices for new and existing customers). I think this is definitely positive as everyone is concerned about how resilient would SPT revenue stream be as it is dependent on social spending, which is tough in a tighter IT budget environment. Strong results in 4Q22 were also bolstered by contributions from the Salesforce partnership. On the point of price increase, an argument is that it discouraged customers from buying. While this may be the case for SPT at the high-volume low end of the market, growth among customers with >$10k and >$50k ARR remained strong at 35% and 59%, respectively, year over year.

Management also noted that the price increases and accelerated additions resulting from the Salesforce partnership were met with little resistance at the high end of the market. Management's guided to 33%+ ARR growth in FY23 is supported by increased exposure to enterprise customers, favorable pricing, and the contribution of partnerships. Looking at it from another angle, I believe the SPT can grow revenue of over 30% in the upcoming years thanks to its exposure to customers with higher lifetime value, who have greater potential for expansion and utilize the enterprise use cases beyond Marketing that are more advanced. I reiterate my position to invest in SPT.

Revenue/ARR/NRR

Strong increases in billings and cRPO are the key support for the FY23 revenue guide of $332–$333 million. Increased ACVs more than made up for the decline in new logos in December, leading to a monthly record in new business ARR. In my opinion, the momentum in FY23 brought about by larger customers and pricing tailwinds has the potential to drive ARR growth at a rate much higher than expected. On the flipside, NRR slowed to 109% in FY22 from 112% in FY21. I anticipate FY23 to be a turning point with regards to NRR as SPT experiences the full year's worth of annual price increase. More Enterprise and midmarket customers, who tend to have higher ARPU, should be beneficial to SPT as well. Management has previously stated that they anticipate the NRR to increase to over 120% by FY25, so I believe this to be in line with their expectations as well.

Margins

With an operating margin target of 0.5%, management sees a profitable year of operation in FY23. Considering initial targets for 100-300bps margin expansion, I see room for optimism in the outlook. It's crucial to remember that this forecast (100-300bps increase) was made before the expected annual price hike by SPT, and that the latter will have a tremendously positive effect on operating margin due to the nearly 100 percent incremental margins it brings.

Products

The Premium Module attach rates have increased 160bps sequentially, leading me to believe that the strategy of targeting more affluent customers is successful. Compared to 3Q, 4Q saw nearly 40% more new customers buy Premium Analytics and 2.3x more existing customers add the solution. Other indicators include demand for Social Listening increased by over 50 percent, and total Premium Analytics ARR nearly doubled year over year. It's promising that management is doubling down on expanded capabilities with the purchase of Repustate, which will speed up product innovation, which I expect to open up new monetization avenues.

Salesforce partnership

Notable progress also includes partnership with Salesforce (CRM). SPT's Q4 adds from the CRM partnership improved, with 175 new logos from Social Studio. This brings the total number of logos added from the partnership for FY22 to over 250. While it's encouraging to see total adds picking up steam, the opportunity is still in its infancy given that 250 total adds is a relatively small number compared to the opportunity's total of 4000 customers. Also, both the Service Cloud and Tableau integrations were made live in Q4. Even though it's still early, I find it encouraging that the CRM partnership and integrations are already producing additional high-quality pipeline for SPT.

Conclusion

In conclusion, SPT has demonstrated strong performance in Q4 and has offered robust FY23 guidance, despite concerns about the justifiability of spending on Social media in a tighter IT budget environment. The company's success in penetrating the up-market, raising prices for new and existing customers, and its partnerships, including the Salesforce partnership, have contributed to its growth. Additionally, the company's exposure to customers with higher lifetime value and its expansion into more advanced enterprise use cases beyond Marketing are positive indicators for future revenue growth. While NRR slowed in FY22, I anticipate a turning point in FY23 with the full year's worth of annual price increases and increased exposure to enterprise and midmarket customers. Overall, I reiterate my investment thesis to invest in SPT stock.