Summary

• SoundHound's stock surged over 1,000% in 2024, driven by NVIDIA's investment, strong Q3 earnings, and growing interest in voice AI technology.

• Despite impressive revenue growth and new deals in the automotive and restaurant sectors, SOUN remains unprofitable and cash flow negative.

• SoundHound's competitive edge lies in its superior voice AI technology, which management claims surpasses competitors in speed, accuracy, and complex language processing.

• The stock's valuation appears unsustainable; investors should wait for profitability or cash flow improvements before considering a buy.

Sundry Photography

After opening 2024 at a stock price of $2.13, SoundHound (NASDAQ:SOUN) got on investors' radars after NVIDIA (NVDA) announced an investment in the company in February and SoundHound issued a press release in March announcing NVIDIA DRIVE will enable SoundHound Chat AI Automotive, an in-vehicle voice platform. On March 14, the stock hit an intraday high of $10.25 before returning to around $4 in the middle of April. The stock flatlined for much of the year after the pullback until exploding higher in November. It is now up over 1,000% for the year.

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A combination of the company releasing excellent third quarter 2024 earnings results on November 12, 2024, several investor conferences early in December boosting confidence in the company, a realization among investors that voice AI could be a killer app, the announcement of rollout of its AI Smart Ordering product with Torchy's Taco and Church's Texas Chicken, showing that the company's voice technology product may be gaining traction in the restaurant marketplace, explosive revenue growth this year and the expectation of near triple-digit revenue growth in 2025 likely caused short covering into the end of the year.

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However, this company is currently unprofitable and has a negative cash flow. The stock's recent price movement has also likely raised the valuation to unsustainable levels. This article will discuss SoundHound's AI voice technology and review its third-quarter 2024 results. It will also examine its valuation, risks, and why I believe the stock is a Sell.

SoundHound's Voice AI is a massive opportunity

Voice is becoming the preferred way for users to interact with billions of devices and is finally meeting the science fiction quality expectations. Users are adopting it enthusiastically and product creators can embrace it with just a small inexpensive microphone and a partner like SoundHound

Source: Chief Executive Officer ("CEO") Keyvan Mohajer on third quarter 2024 earnings call.

SoundHound November 2024 Investor Presentation.

SoundHound cites a 2020 Juniper Research estimation of the voice market that estimates that Conversational AI has a +$140 billion total addressable market ("TAM") today and will exceed $160 billion by 2026. Market research company IMARC is less optimistic and estimates the global conversational AI market size at $13.6 billion in 2024, growing at a compound annual growth rate of 29.16%, reaching $151.6 billion by 2033. However, even using IMARC's numbers, the market is still immense. At the end of the third quarter, the company only had $67.30 million in trailing 12-month revenue, about 0.5% of its 2024 TAM estimated by IMARC. Using Juniper's estimation, SoundHound's market penetration is infinitesimal in 2024. So, this company has significant room for growth.

SoundHound November 2024 Investor Presentation.

As the above image shows, multiple industries encompass its TAM. However, the three areas management discusses the most on conference calls are automotive, restaurants, and customer service.

SoundHound November 2024 Investor Presentation.

The company partners with car manufacturers to integrate SoundHound Chat AI voice technology into vehicles to answer questions like "What's the weather?" and enable drivers to have "hands-free control" of various vehicle functions such as locking/unlocking doors, making phone calls, and controlling climate settings by using voice commands. The company's technology connects to multiple third-party data sources to provide real-time information on topics such as weather, traffic information, news, sports, stocks, flight status, restaurants, and other knowledge vehicle occupants might have an interest in. It combines this data with several large language models ("LLMs") like ChatGPT to provide accurate and timely answers. CEO Mohajer said the following about the company's LLM-enhanced chat technology on the third quarter 2024 earnings call:

We continue to show momentum with Stellantis in various markets, but more importantly, seven of their brands have now rolled out our Generative AI enhanced digital assistant, SoundHound Chat AI with Lancia in Europe being the latest. This technology was the first of its kind solution, leveraging the strength of Generative AI to delight drivers and increase the usage of voice technology within the car. This has been driving strong usage growth over the past two quarters now. Our technology has broken through and we are seeing tremendous interest with other brands that we hope to announce very soon.

Stellantis (STLA) owns the car brands Chrysler, Dodge, Jeep, Ram, SRT, Alfa Romeo, Abarth, Lancia, Maserati, Opel, Peugeot, Vauxhall, Citroën, and several others. With four signed deals, the company is also gaining traction with electric vehicle (EV) manufacturers. Two of those EV manufacturers are already incorporating SoundHound technology on the road. The CEO of SoundHound announced on the earnings call that it has made significant progress in emerging markets by signing a significant EV brand in the Middle East in the third quarter, partnering with a leading Chinese software automotive supplier, DaYin Tec, partnering with what SoundHound's CEO calls "one of the largest Chinese multinational technology companies in the world," and partnerships with Kia and VE Commercial trucks for this technology in India. SoundHound supports 25 different languages and can even understand heavy accents, which is how it can attract international customers.

SoundHound November 2024 Investor Presentation.

SoundHound has a growing presence in the restaurant industry. The most popular applications use voice AI for drive-thru orders, phone orders, mobile app integration, customer service, and an employee assist function. CEO Mohajer briefly discussed how voice AI has helped restaurants gain a greater 'upsell per order' and increase ordering efficiency on the earnings call. He also said the following:

We power the AI drive-thru for Panda Express in dozens of locations in multiple states and continue to add new locations. We also just went live with Church's Texas Chicken and the feedback from the restaurant staff is incredible. They are delighted with how much faster they're able to accept orders. We continue to expand in more locations with White Castle. Our earliest drive-thru customer is also our largest deployment. Last quarter we implemented innovation related to speeding up the hardware deployments that we believe can help us scale even faster going forward. Because of our tech and ability to navigate different languages and acoustic variations, we already have drive-thru locations in three continents and we're just getting started.

Mohajer also briefly discussed phone ordering and mobile apps:

The demand for our phone ordering continues to accelerate. We just recently signed yet another top 10 QSR (quick-service restaurant) brand in pizza and that makes for three of the top pizza brands globally that we now have as customers. Of late, we are also seeing demand from brands to power their mobile apps.

The CEO also name-dropped wins and expansions with several prominent customers: Firehouse Subs, Five Guys, Panda Express, Beef' O' Brady's, Applebee's, Chipotle (CMG), Casey's General Stores (CASY), California Pizza Kitchen, Jersey Mike's, Habit Burger, Noodles & Company (NDLS), MOD Pizza, Corner Bakery, Blaze Pizza, McAlister's Deli, Schlotzsky's, Café Zupas and Blake's Lotaburger.

Customer Service in all industries is another rapidly growing application. Mohajer said the following about customer service (emphasis added):

I'm very pleased with the way we have grown this business over the course of this year, winning new logos organically, expanding with existing customers, growing our ecosystem of partners and making smart acquisitions. We have now expanded our enterprise customer brands deep into some major industries like financial services and healthcare among others. And we see opportunities in our pipeline for new verticals such as energy and going deeper into retail.

SoundHound works through several companies acting as system integrators for its technology in several industries. These companies include Deloitte, Epic, EXL, Fujitsu (OTCPK:FJTSF), General Dynamics (GD), Jack Henry (JKHY), Kyndryl (KD), NICE (NICE), Oracle's (ORCL) Cerner and ServiceNow (NOW). I emphasized smart acquisitions in the above quote because one of the rationales behind its August 08, 2024, acquisition of Amelia is accelerating customer service expansion into new verticals. While this acquisition should significantly benefit the company in the long term, the acquisition could make near-term fundamentals look ugly, which I will discuss later in this article.

Why are so many customers flocking to SoundHound? Management says in its investor presentation that the company has "Best-in-class voice AI technology surpassing competitors in speed, accuracy, and complex language," which is the core of SoundHound's competitive advantage. The technology behind the company's ability to understand and respond to complex language prompts includes a new LLM Polaris and data processing techniques that require substantial investment in Research and Development ('R&D'), data acquisition, and infrastructure, which are barriers that make it difficult for new entrants to compete effectively. The company's 2023 10-K states:

Our market position is strengthened by the technical barriers to entry in the Voice AI space, which tend to discourage new market participants. Furthermore, our technology is backed by significant investments in intellectual property, with over 155 patents granted and over 115 patents pending, spanning multiple fields including speech recognition, natural language understanding, machine learning, monetization, and more.

SoundHound November 2024 Investor Presentation.

The number and quality of customers the company has attracted are evidence of its differentiated technology.

Company fundamentals

SoundHound's third-quarter 2024 revenue increased by 89% over the previous year's quarter to $25.1 million, beating analysts' estimates by $2.07 million. Investors like seeing growth reaccelerate after decelerating revenue growth in 2023. The company has also significantly derisked by diversifying its revenue sources from 72% from one customer in the third quarter of 2023 to only 12% of revenue from its largest customer in the third quarter of this year. It also increased its diversification by industry. Last year, 90% of its revenue came from the automotive industry, which hurt the company since autos were in a slump in 2023 and have yet to recover fully. This third quarter, automotive, restaurants, financial services, healthcare, and the insurance sector each contributed 5–25% of revenue.

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SoundHound's third quarter 2024 GAAP (Generally Accepted Accounting Principles) gross margin was 49%, shrinking 24 points year-over-year. Chief Financial Officer ("CFO") Nitesh Sharan attributed the gross margin decline to "the impact of the business mix from recent acquisitions, which we expect will deliver significant value over time." Although Sharan didn't specify, his commentary suggests that recent acquisitions like Amelia have different cost structures or product pricing that pull down the company's gross margin.

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SoundHound's non-GAAP gross margin, which eliminates the amortization of intangibles and stock-based compensation ('SBC'), dropped 14 points to 60%—the amortization cost results from gradually reducing the value of intangible (non-physical) assets from an acquisition. The company did not record amortization costs in the third quarter of 2023, and SBC was similar to last year.

CFO Sharan also said the following on the third-quarter earnings call about the recent acquisition's adverse impact on gross margin (emphasis added):

While the acquired businesses weigh on our margins, they provide deep customer relationships and essential enterprise grade data assets. We anticipate margin recovery as we realize synergies from cloud data center migration, tech stack integration and cost rationalization. Additionally, meaningful reductions in inference costs provide a favorable tailwind for our deployments.

The first sentence in the above statement is SoundHound's management's way of saying that the acquisition strengthens the company's long-term competitive advantages. One of the things that makes it difficult for competitors to catch up to SoundHound is its enormous data advantage. By adding a company such as Amelia, the company gains another immense data source that adds to the company's competitive advantage. Additionally, if SoundHound retains its acquisitions' customers, it will add another source of loyal customers, making it difficult for competitors to peel them away in the future. Establishing loyal customers is key to scaling the business at this point. The company anticipates the long-term benefits from the Amelia acquisition are worth the short-term impact on gross margins, which management expects to recover as it integrates its new acquisitions.

SoundHound Third Quarter 2024 10-Q

SoundHound's operating expenses increased 112% to $58.86 million, mainly due to the impact of the acquisitions on R&D, sales and marketing (S&M), and general and administrative (G&A). Amortization of intangible assets added $2.4 million in operating expenses.

CFO Sharan said about G&A on the earnings call, "The increase (in G&A) is primarily due to acquisitions, in particular, related to transactional costs that are one-time in nature." Although R&D increased 53% year over year, this increased investment should pay off in the long term in better products and increased revenue. The CFO said the following on the earnings call about R&D:

We are committed to delivering innovative products that exceed our customers' expectations and that enhance their experiences. Our focus includes advancing our voice AI engines, integrating leading LLM architectures to elevate our offerings and investing in high impact innovations such as the Polaris initiative which as Keyvan mentioned is an exciting breakthrough not only for SoundHound but for the industry as a whole. With efficient model training as a priority, we are well positioned to pioneer next generation solutions that push boundaries and deliver measurable results.

The company's third-quarter S&M increased 87% year over year, with a focus on restaurants and automotive. CFO Sharan said about S&M, "Our emphasis continues to be in demand generation, lead generation, and improving close rates with speed and efficiency."

SoundHound's third quarter 2024 GAAP operating margin was negative 135%. Its third-quarter 2024 GAAP net loss was -$21.8 million, and its earnings-per-share (EPS) loss was -$0.06, beating analysts' estimates by $0.01. Non-GAAP EPS loss was -$0.04, beating analysts' estimates by $0.03.

SoundHound Third Quarter 2024 Earnings Release.

SBC was $9.1 million or 36.10% of revenue. Amortization and depreciation were $5.4 million, or 21.50% of revenue. Some investors may avoid the stock due to its high SBC. Non-GAAP adjusted EBITDA losses increased to $15.86 million.

SoundHound's trailing 12-month (TTM) cash flow from operations (CFO) was negative $89.63 million. The company's digestion of recent acquisitions negatively impacted the CFO. Although its top line is impressive, increasing cash flow losses could make the market nervous—expect the stock price to be volatile.

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At the end of the third quarter, the company had $135.61 million in cash and short-term investments and $39.69 million in long-term debt. Its debt-to-equity ratio was 0.134, which means it relies more on equity than debt to finance its operations.

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The company's balance sheet debt has a roughly 15% annual cost, so management is considering paying the debt down soon. CFO Sharan believes "there are economic savings to achieve." In early November, SoundHound filed a Form 8-K announcing a new at-the-market (ATM) equity program, meaning it can issue new stock shares for debt reduction, funding operations, or acquisitions. Management emphasized that SoundHound doesn't need additional capital to stay afloat until it breaks even.

SoundHound November 2024 Investor Presentation.

Management's prior annual guidance for 2024 was over $80 million; for 2025, it was over $150 million. So, the figures in the above image represent raised guidance. If SoundHound hits the midpoint of the revised 2024 guidance, revenue will grow 82% year over year, and if it hits the midpoint of the 2025 revised guidance, revenue will grow 97.60%. The company did not provide profitability guidance, which may turn off some investors.

Valuation

SoundHound's price-to-sales (P/S) ratio of 109.22 looks extreme compared to where it traded earlier in 2023. Despite the accelerating revenue growth, profitability is abysmal and going in the wrong direction. The company's median P/S ratio over the last three years is 15.54. If SoundHound drops back to a P/S ratio of 15.54, the stock price would be $3.41. The market may be overly exuberant about AI, driving a high valuation.

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Since the company has no earnings or cash flow, the best way to value the stock is through its one-year forward P/S ratio, as this metric considers its estimated forward revenue growth rates.

Cerence and Veritone are the closest publicly traded pure plays that compete with SoundHound's audio solutions. Cerence specializes in AI voice assistants for autos, and Veritone is an AI company that does some audio, video, and text recognition. Microsoft and Alphabet are large, diversified tech companies with AI audio applications. A P/S-to-Growth ratio lower than 1.0 means that for every dollar of sales growth, investors pay less than a dollar for the company's market value, which is generally considered desirable. However, investors will also factor in profitability, cash flow, and other factors like the strength of the balance sheet into this equation.

On a relative valuation basis, I don't believe SoundHound should trade higher than Alphabet on a P/S-to-Growth basis because SoundHound's revenue growth doesn't make up for its negative 139% TTM operating margins, representing a high risk that its revenue growth is unsustainable long term. Alphabet's revenue growth may be lower, but it is far more likely to have long-term sustainability. So, even considering SoundHound's higher estimated revenue growth, the market likely overvalues the stock's one-year forward P/S ratio of 53.95 because positive investor sentiment may currently be overruling the risk of revenue growth lacking sustainability.

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Take all attempts to assign an exact valuation or price target to this stock with a massive grain of salt. The stock will trade in line with investor sentiment towards the company, AI, and the U.S. economy. If the sentiment remains positive, the stock could continue trading at the current valuation or higher, even if people think it has a valuation that is too high. If sentiment turns negative, it could drop 50% within a month, despite some investors liking the stock's future growth prospects. It's a speculative stock with multiple risks.

Risks

SoundHound's negative return on invested capital ("ROIC") of -53.84% means it is destroying value. Although ROIC has improved over the last year, it only means that the company is destroying invested capital at a slower rate. Investors' hunger for AI investments has likely increased the stock price over the last several months. Still, if SoundHound consistently generates a negative ROIC, raising additional capital will eventually become increasingly difficult.

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The company will eventually have to prove it can control costs and improve profitability. Management's ability to execute its strategy, achieve profitability, and improve ROIC is crucial for investors to achieve upside in an investment in this stock. It's only a matter of time before investors become impatient and increase the pressure on the company to produce profits and cash flow. If SoundHound fails to meet Wall Street's profitability expectations, the market will likely sell off the stock.

SoundHound's reported revenue growth has accelerated, and its diversification efforts improved significantly following its acquisition of SYNQ3 in December 2023, which diversified SoundHound into restaurants, and the acquisition of Amelia in August 2024, which diversified its business into customer service. Since the company didn't include its organic revenue growth rate in its latest earnings, investors may find assessing its ability to produce revenue growth aside from its acquisitions challenging. If SoundHound fails to prove it can grow revenue organically, investors may become disenchanted with the stock.

Last, the AI Voice market is highly competitive. The company's 10-K states:

There are a number of companies that develop or may develop products that compete in the Voice AI market. The market for SoundHound's products and technologies is characterized by intense competition, evolving industry and regulatory standards, emerging business and distribution models, disruptive software technology developments, short product and service life cycles, price sensitivity on the part of customers, and frequent new product introductions, including alternatives to certain of SoundHound's products from other vendors which may be offered at significantly lower costs or free of charge. Current and potential competitors have established, or may establish, cooperative relationships among themselves or with third parties to increase the ability of their technologies to address the needs of SoundHound's current and prospective customers. Furthermore, current or prospective customers may decide to develop competing products or to establish, strategic relationships with SoundHound's competitors.

SoundHound's data advantages and potential high switching costs in some of its verticals protect it against some smaller competitors. The most worrying competition comes from large hyperscalers like Microsoft, Google, Amazon (AMZN), and Meta Platforms (META), which have the resources to match or exceed SoundHound's data or technological advantages. Competition may adversely impact revenue growth and profitability.

SoundHound is a Sell

The company's lack of cash flow and profitability will likely make the stock price volatile. Unless these factors improve, most investors would be better off avoiding buying it at its current valuation.

Seeking Alpha

Prudent investors interested in this stock should wait for it to pull back. The big question is, how much of a pullback should people wait for before buying? That all depends on an investor's aggressiveness and risk tolerance. A more cautious investor may wait for the stock price to hit analysts' consensus price target of $12.36, which has a 48.39% downside from the December 27 close. A more aggressive investor may only wait for a 20% pullback from the December 27 close, representing a stock price of $19.16. Investors must also assess the reason for the pullback. An event that damages the company's long-term prospects may be a reason to avoid buying on a pullback. Still, a shift in market sentiment or the company missing estimates in an earnings report may be a reason to buy.

Short-term and long-term investors should consider taking profits on the massive gains over the last several months. However, if you are a speculative investor who believes Voice AI is the next big thing and has significant growth potential, consider holding at the current valuation. I rate SoundHound as a sell for most investors, and only investors willing to speculate should keep it.