SoundHound Stock: Strong Prospects But Don’t Chase Now (NASDAQ:SOUN)

Investment Thesis

Since Microsoft (MSFT) announced a multi-billion dollar investment in OpenAI, the creator of ChatGPT and Dall-E, AI has become the latest buzzword in the investing world. Investors are now searching for companies that could potentially become the next OpenAI.

A lot of companies got bid up and SoundHound (NASDAQ:SOUN) is the one that caught my eye. Unlike a lot of others that skyrocketed purely because of hype, its fundamentals are actually very solid. The company has useful technologies with a blue-chip customer base. It also has huge market opportunities and is showing strong growth. However, the valuation is starting to look expensive after the huge run-up and it is also burning quite a lot of cash with profitability deep in negative territory. Therefore I rate the company as a hold.

Why SoundHound?

SoundHound is a US-based company that specializes in voice AI technologies. Its platform is able to process complex speech and interpret its meaning just like the human brain. It is sort of similar to Siri and Alexa, but they are strictly limited to the Apple (AAPL) and Amazon (AMZN) ecosystems while SoundHound can be embedded anywhere.

Traditional voice AI technologies are also slow as it needs to first translate speech into text through ASR (automatic speech recognition) and then translate that text into meaning through NLU (natural language understanding). Through proprietary technologies, SoundHound is able to do both steps simultaneously and achieve Speech to Meaning directly which increases speed.

It currently processes 1 billion queries annually and supports over 25 languages. This provides them with a lot of data for training which continues to improve the accuracy of the platform. The company already has 120 patents granted with 144 currently pending. This provides a strong moat and prevents disruption from other competitors.

Unlike big-tech companies, SoundHound offers white-labeled solutions that give brands the ability to have their brand-owned voice experiences that drive loyalty. Despite being a small and emerging company, its technologies have successfully attracted multiple blue-chip customers. This includes Mastercard (MA), Netflix (NFLX), Qualcomm (QCOM), Mercedes-Benz (OTCPK:MBGYY), and more.

Market Opportunity

The market opportunity for SoundHound is massive. According to the company, its TAM (total addressable market) is estimated to be over $160 billion in 2025.

The growth is driven by the increase in connected devices as digital transformation and IoT (internet of things) continue to advance. The number of connected devices is expected to grow from 15.4 billion in 2015 to 75.4 billion in 2025, representing a nearly 400% increase.

The increase in these devices will increase the demand for conversational AI as it is able to vastly improve devices’ ability to interact with users which adds a lot more value to the product. Consumers also tend to prefer products with conversational AI as it improves efficiency.

Automotive and restaurants are two strong growth drivers. According to Navigant Research, conversational AI is projected to be embedded in nearly 90% of new vehicles sold globally by 2028. Voice assistant is a key part of in-car user experiences, as it enables drivers to access navigation, music, news, etc while driving. It is currently used by notable brands such as Honda (HMC), Hyundai (OTCPK:HYMTF), and Jeep (STLA). The company has been winning deals from competitors like Cerence (CRNC) and it expects to double the customer unit base by 2026.

Paul Choo, Hyundai Director, on SoundHound’s platform

“Sophisticated voice recognition and AI integration are core to effectively providing drivers with the massive content and data that future connected vehicles have to offer.”

More and more restaurants are now technology driven and voice AI is a very important piece of it. For example, voice-AI-enabled digital kiosks or apps are able to boost efficiency and process more orders at the same time. Voice assistants are also able to deal with basic customer services while providing better consistency. This allows restaurants to reduce operational costs as they can now hire fewer employees and let the machines do all the ordering. I believe the adoption rate of voice AI will continue to increase.

Profitability Is A Problem

SoundHound continues to see strong traction as demand for its products remains strong. In the latest quarter, the company reported revenue of $11.2 million, up 178% YoY (year over year) from $4 million. The cumulative bookings backlog was $302 million, up 239% YoY. Gross margins increased significantly from 59% to 77% as it benefits from economies of scale. Monthly queries also more than doubled to roughly 180 million.

The top line was very strong but it continues to struggle with profitability. Operating loss further widened by 57% from $(17.2) million to $(27) million. This is mostly caused by R&D (research and development) expenses which increased to $19.4 million. S&M (sales and marketing) expenses were also up over 450% from $1.2 million to $6.7 million. Considering minimal cash on hand, the company will likely require ongoing financing which should weigh in the near term as rates are quite high currently.

Investor Takeaway

After the 100%+ run-up in share price, SoundHound is now trading at a PS (price to sales) ratio of 13x which is quite expensive. The company has strong prospects and is growing revenue explosively, but the current valuation is priced to perfection that a slight drop in growth will trigger a huge downward revision in multiple. I do not think the risk-to-reward ratio is attractive at current levels. Profitability is another issue the company has to face and despite the management team re-assuring its path to cash flow positive, no sign has been shown just yet. There is no need to chase the stock now and investors can just be patient and wait for a more attractive entry point. Therefore, I rate the company as a hold.