Description

Short SPT

Sprout Social (NASDAQ: SPT) is a social media management platform that trades at >10X NTM Sales with a market capitalization over $3bn. We think those statements do not belong in the same sentence, especially as we head into 2023. Borrow is GC, ADV is ~$30mm and SI is HSD.

SPT was founded in 2010 and its core offering aggregates clients’ social feeds (e.g. Twitter, Facebook, Instagram, etc.) onto one integrated dashboard for easier management. Customers can then access tools for Engagement, Publishing and Analytics, among others. Engagement is for responding to/receiving messages across social media accounts; Publishing is for coordinating the publishing of content; Analytics includes features like competitor reports and campaign analysis to measure effectiveness. In recent quarters, SPT has increasingly focused on the rollout of premium add-ons (i.e. Social Listening) as they push upstream to capture Enterprise customers that yield significantly higher ACVs. Most recently, roughly 2/3 of ARR came from Enterprise/MM names and 1/3 from SMB type names.

SPT has thus grown at a mid-30s% clip since going public in 2019 and hit ~$270mm in ARR in the latest quarter. This execution helps explain the premium multiple SPT has been granted.

In the most recent earnings call, management made several comments that caught our attention:

1. SPT is targeting a 30% CAGR through 2025
2. SMBs are increasingly expensive to acquire, harder to retain and not mature enough to fully monetize down the road
3. SMBs are seeing noticeably slower expansion activity and lengthened conversion cycles
4. Management will more than double the pricing for new customers across plans going forward

Management has buoyed up the growth thesis by citing an increasingly larger addressable market through the years. At IPO, the figures mentioned were a $25bn SAM and a $50bn TAM. Most recently this has been revised to a >$44bn SAM and a $100bn TAM by 2025. What is suspect is the calculation behind both. SAM and TAM are calculated as management’s estimate of [total applicable businesses in each segment (SMB, Agency, Enterprise)] * [the average ACV or the top 10% of ACV, respectively]. A sellside note from Needham replicated this so-called analysis in support of its bullish note: the total number of “relevant” US firms is 2.3mm. This 2.3mm count includes all businesses that have more than four workers. Does your average small business with five employees really need a SaaS platform to coordinate its social media accounts? The quoted ACV figures are also based on peak spending in the later stages of a bull market. In what fiction do these businesses ramp to anywhere near the 90th percentile of relative spending?

Most SMBs are not relevant to SPT in terms of potential ACV spend given their small size. At double the current price point, we are highly skeptical that SPT will be able to grow the customer count and ARR contribution from its SMB segment anywhere near historical rates/what they are extrapolating through 2025. This is especially true heading into a recessionary environment.

Then we have the Enterprise/Middle Market segment. Keep in mind that achieving that 30% topline target implicitly requires Enterprise growth to compensate for SMB’s slower growth/higher churn going forward. The push for Enterprise clients has been driven by the rollout of premium add-ons, namely Social Listening. Social Listening tracks candid conversations on major online forums (Facebook, Twitter, Instagram, Youtube, etc.) for a better understanding of target customer responses. Excluding the recently announced price hikes, this add-on is priced at $999 annually per organization, while the core plan ranges from $99-$249 per user per month. Management disclosed that Social Listening had hit $9.2mm in ARR through Q3FY19. Given the success in the Enterprise segment/popularity of this add-on, we think the add-on’s growth has outpaced the consolidated CAGR and we would not be surprised if Social Listening currently represents ~10% or more of total ARR.

Twitter has lost over 3/4 of its employees across all functions, though most of them represent support roles/back-office types. We are led to believe SPT’s contacts within Twitter are gone and Musk has full say in determining where API pricing goes from here. Seeing how he intends to further monetize Twitter (shouldn’t come as a surprise to anyone), we think API pricing will be hiked significantly and that SPT/peers would not be able to push back. Reading between the lines in the recent 10Q affirms these concerns: a new key risk disclosed involves “access to third-party APIs and data on favorable terms.” In another scenario, we think Social Listening becomes less popular with new and existing clients as Twitter loses its value in terms of tracking real time sentiment. Consider that a sizable percent of clients that signed-on during 2020/21 were those forced to rapidly adopt an online social presence in the wake of COVID. Marketing budgets are being slashed across the board.

An additional line in the recent 10Q also piqued our interest. Management noted “increasing consolidation among competitors in the space”, as opposed to the “highly fragmented landscape” described earlier in the year. SPT namely competes with Khoros and Sprinklr (NYSE: CXM), along with various point solutions. Khoros and CXM have both focused on the Enterprise segment historically, while SPT’s legacy focus was around SMBs.  

The sellside has given SPT the full benefit of the doubt and is projecting a 30% CAGR – this is where the opportunity exists. Between the competition, weakness in SMBs, and budget cuts among clients, we think SPT decelerates to a mid-20% topline grower with potential margin degradation if Twitter re-negotiates pricing  terms. SPT's inbound funnel has largely worked for SMBs (lower CAC), but we believe the cost structure will need additional spend for a continued pivot towards Enterprise names. The market should recognize the cyclical nature of SPT’s business (+ the pull forward from COVID), acknowledge the blow to management’s credibility, acknowledge that the real TAM is much smaller than projected, and note the worsened structural profitability.

Where do we think SPT goes from here? Consider CXM, which grows at a ~20% clip and has the same gross margins, but is trading at ~2.5X NTM Sales. We think a similar re-rating will catalyze once management/sellside expectations converge with what is already occurring in most pockets of the high-flying software landscape. 30-40% in downside over the NTM is not unreasonable here. We think the risk/reward spread is favorably skewed given where it’s trading today and how the market has responded to similar high flyers that miss on expectations.

Catalyst

Earnings/guidance