SoundHound: Buy The Dip

Interest rate fears have pummeled the markets in the month of September, hitting especially hard on small-cap tech stocks. Though ~5% risk-free interest rates are certainly appealing, it's also not a bad time to exchange some cash for low-valued growth stocks at an excellent discount.

One company I've been eyeing over the past month is SoundHound (NASDAQ:SOUN), a relatively lesser-known AI stock. The company is up more than 40% year to date in sympathy with other AI-related names, but since peaking above $4.50 in June, the company has shed more than half of its value.

I wrote a bullish note on SoundHound a month back when the stock was trading in the mid-$2s. Since then, two things have happened: the company has inked a major new deal with a restaurant SaaS platform, and the stock's valuation is also dramatically lower. In other words, I remain bullish on this stock, and I am advocating buying on the dip.

The bull case for SoundHound is bright

As a reminder for the many investors who are unfamiliar with this relatively unknown company, SoundHound provides a voice-AI technology whose classic use case is in restaurant drive-throughs, but also has applications in automobiles and advertising.

The full long-term bull case for this stock is below:

The Olo opportunity

On September 28, SoundHound announced a major new business development deal: an expanded partnership with Olo (OLO). See the press release here.

Olo is one of the major brands for restaurant SaaS software. This public company generates more than $200 million in annual revenue, and is still growing at a >20% clip (it's more than 4x the scale of SoundHound).

Olo serves more than 600 well-known restaurant brands, including household staples from Denny's, Nando's, P.F. Chang's, Portillo's, Wingstop, Qdoba, Five Guys, and Cold Stone Creamery. Across these brands, Olo software is deployed in more than 77,000 locations.

As of September, SoundHound is now part of the Olo Connect marketplace, meaning its AI features can natively integrate with a restraint on Olo software.

I view this deal as a major step forward for SoundHound, which is already at a tremendous growth pace (in Q2, the company drove 42% y/y revenue growth, coming in ahead of Wall Street's expectations). Often, the biggest challenge for new SaaS companies is scale: because they have very limited capital to hire sales headcount to fulfill market expansion activities. Adopting a reseller agreement like SoundHound has done with Olo immediately positions SoundHound's brand to the hundreds of high-profile restaurants that Olo serves, accelerating its go-to-market progress.

It's worth noting that Wall Street is expecting SoundHound's revenue growth to accelerate in FY24, with consensus calling for 62% y/y revenue growth to $74.1 million in revenue (data from Yahoo Finance). Large-scale partnerships like the new deal just inked with Olo help to justify that expectation of acceleration and deliver confidence in SoundHound's ability to beat it.

Valuation underestimates SoundHound's potential

With the latest slide in SoundHound shares, the company has become even more of a bargain play. At current share prices just under $2, SoundHound trades at a measly $455.2 million market cap. Netting off the $115.8 million of cash and $66.4 million of debt on SoundHound's most recent balance sheet gives us an enterprise value of $405.8 million.

This positions SoundHound's valuation at 5.5x EV/FY24 revenue, based on consensus' expectations for $74.1 million in revenue next year. To me, for a company that is expected to see growth leap to >60% y/y next year (which I believe is more than supported by strong recent business development efforts, including and especially the company's deal with Olo) this is quite a bargain multiple.

We note as well that SoundHound's $115 million of cash provides an ample cushion against its current burn rate: in the first half of FY23, SoundHound's operating cash burn was -$33 million. Assuming burn rates hold, SoundHound has about two years of liquidity left on its books - giving it time to keep expanding its scale until it reaches profitability, which is more than reasonable to expect with SoundHound's amazing ~80% GAAP gross margin profile.

Risks and key takeaways

With new business development efforts paving the way for acceleration in growth, plus a modest valuation that has been decimated by a recent stock market rout, there are many reasons to go long on SoundHound now.

There is certainly execution risk, of course, in investing in a small-cap company that is at a small revenue scale. I'd argue, however, that SoundHound's top-tier list of customers ranging from the largest automakers to broad-spanning restaurant platforms like Olo will help the company expand its reach.

Stay long here and use the dip as a buying opportunity.