Sprout Social Stock: Steadfast To Capture Share (NASDAQ:SPT)

Investment thesis

I recommend investing in Sprout Social (NASDAQ:SPT). I believe the business has strong value proposition to existing businesses that need to adapt to the social media world. SPT has structured its software solution (using a single code) that can be deployed across organizations of all levels, which significantly increases its ability to capture more share. While valuation is high on absolute terms, I believe it is justified given its high growth.

Business overview

SPT offers businesses online social media management tools. In addition to reporting and analytics services, the Company provides communication tools, contact management, and lead generation.

Social media has become the way people connect with each other

The original purpose of social media was to facilitate communication and knowledge sharing amongst users. People were able to more easily reach out to their networks of loved ones, acquaintances at work, and people with similar interests thanks to the availability of such mediums. With the rise of social media, forward-thinking companies realized the platform’s potential as a means of reaching a large number of people with their marketing messages. With the advent of social media, a new form of advertising emerged, and businesses scrambled to build an audience there. With over 4.33 billion users, social media has drastically altered both business and interpersonal interactions.

While some businesses have adapted by creating a social media presence and incorporating these platforms into their marketing strategies, I believe that further adjustments are required to stay competitive and pertinent in the face of this disruption, and that these changes will necessitate new technology solutions, workflows, and strategies. First, companies have to accept the fact that social media is more than just another platform for promotional material. Marketers, publicists, salespeople, relationship managers, service technicians, product testers, business intelligence analysts, and strategic planners have all felt the effects of social media’s expansion. Rather than being an independent marketing strategy, social media should be viewed as an additional layer over current business operations. In order to keep up with the ever-growing influence of social media, businesses must make fundamental changes to their operations to keep up with the times. It necessitates readjusting and retooling on a similar scale to that which was necessary when email and telephones were introduced.

Large TAM

The number of people using social media has surpassed 4.33 billion. Organizations now have access to a plethora of business intelligence thanks to the widespread use of social media platforms, allowing them to better communicate with and learn about their target demographic. Despite this, only a small fraction of businesses have implemented centralized social media management software. Management estimates that SPT and its direct competitors only take home 1% of this massive TAM. But I think businesses are starting to realize the importance of social workflows and analytics, and are looking for a single tool that can handle both, while also being easily integrated with other analytics and BI systems. From my perspective, this presents a great chance for market leaders in social media software like SPT to rapidly expand their share of a very large TAM.

SPT comprehensive solution

The SPT platform unifies all facets of social interaction into a unified service. All aspects of a customer’s social media activity can be managed in one place, from initial interaction to content publication and analysis of results. Moreover, it can be utilized with minimal effort. The importance of simple implementation and intuitive operation grows as the influence of social media permeates more and more levels of an organization. A typical customer can begin using the product immediately after beginning the trial; no professional services or alterations are necessary. SPT platform is created to be intuitive, allowing even inexperienced users to quickly adopt and benefit from it, while also providing the advanced features required by the most discerning business users.

Established relationship with large social media platforms

SPT has built strong partnerships with every major social media network since its inception. My opinion is that data sources are less of a differentiator between vendors for social media management than they once were, now that most vendors have access to the APIs provided by social media platforms. However, I worry that stricter privacy regulations around the world will make it so that only the most trustworthy third-party vendors have access to user data from social media platforms. As a company with established ties to every major media outlet, I think SPT is in a good spot.

Penetrating the enterprise space

Since its inception, SPT has used an inbound marketing strategy centered on increasing website visitors in the hopes of converting them into paying customers through the provision of free trial accounts. Recently, the company has had rising levels of success in breaking into the enterprise market. This is crucial for SPT’s long-term growth prospects, as I anticipate that spending per enterprise customer will rise significantly as they gain the ability to add on more modules. To put things in perspective, SPT has clients who annually spend over $200,000 with the company.

Free trials have been a major factor in enterprise adoption, but I think SPT is just getting started building up an outbound enterprise sales force to really break into the market. It’s safe to assume that the outbound salesforce and the associated increase in S&M spending will take some time to reach full productivity. However, I anticipate that the more comprehensive approach to penetrating the enterprise segment will aid in driving larger deal sizes and maintaining revenue growth. Furthermore, as I mentioned before, gaining traction in the enterprise sector ought to permit a more robust cross-selling motion of supplementary modules, which could drive appreciably larger deal sizes. Finally, I believe that SPT’s offering stands out from the competition due to the low level of customization required, which allows for rapid deployment and a short time to value. When compared to its contemporaries, SPT has among the best usability ratings.

Competition

I think the SPT platform has been well received by businesses of all sizes because it is built on a shared code base and provided as a service. SPT’s impressive organic revenue growth over the years is proof of this. Although SPT has some down-market competitors, I think it generally outperforms them in terms of usability, integration, speed of implementation, and quality of analytics provided (refer to screenshot above). In addition, the SPT platform has seen robust adoption across SMB, mid-market, and enterprise, all of which are served from a common code base, in contrast to competitors who typically focus on a subset of the market. In my opinion, this places SPT in a prime position to increase its market share.

Valuation

My model suggests SPT is worth $73.36, if it trades at 9x forward revenue multiple in FY23.

Model walkthrough:

1. Revenue to follow management full year guidance in FY22. Unlike other software companies that I have covered, I believe SPT is set to continue growing strongly given the large TAM, its ability to cross-sell, and its penetration into enterprise segment.
2. While SPT is trading at a high valuation on absolute terms, I believe this is justified given its high growth.

Risks

Competition

SPT may find it difficult to maintain above-market growth in the face of rising competition from well-funded private vendors and may be forced to make additional investments to keep up with the industry’s rapid pace of change.

Rely on social media platforms for data

There is a chance that social media platforms may alter the terms and conditions under which their APIs make data available to outside parties in the future. The business model of SPT could be significantly affected by these alterations.

Conclusion

In my opinion, the company offers a great deal of value to established companies that are struggling to keep up with the rapid pace of social media change. By designing its software solution (with a single code) to be deployable across organizations of varying levels, SPT has greatly increased its potential to capture more market share. The valuation is high relative to other industries, but I think it’s fair given the company’s rapid expansion.