In our view, Sprout Social (SPT) presents an interesting investment opportunity due to its deep moat in the social media management space. Alternatively, we also view Sprout Social as a social media CRM (Customer Relationship Management) play. Founded in 2011, the company has expanded its offering and acquired a strong brand reputation globally over time. In this first coverage, we take a closer look at Sprout Social’s competitive positioning and revenue model, in conjunction with its go-to-market.
The strong brand name gives Sprout Social a defensible moat and an edge against its peers. There is a massive TAM behind the social media management space, given the overlap with the competitive CRM (Customer Relationship Management) and contact center spaces, in which we see many well-capitalized players like Salesforce (CRM), Hubspot (HUBS), or Zendesk (ZEN).
Over the last decade, however, the space has evolved and become more specialized. The evolution of the space has further presented opportunities for players like Sprout Social, Buffer, or Hootsuite to differentiate themselves and establish defensible moats.
(Source: Sprout Social)
Having been a user of some of these tools as well, we conclude that Sprout Social and Hootsuite have the most comprehensive offerings and stronger brand names in the space, even against the more well-resourced peers like Salesforce, Hubspot, and Zendesk. With that in mind, we believe that Sprout Social is well-positioned to extract the highest-valued opportunities from the large and evolving social media management space.
Sprout Social has high growth and high-quality revenue. Sprout Social should continue to benefit from its strong brand reputation globally. It has 24,000 customers worldwide and primarily leverages its self-serve free-trial model to drive conversions. In our view, the combination of a strong brand reputation, differentiated offering, and a highly efficient go-to-market have resulted in high growth and high-quality revenue.
(Source: Company’s earnings call slide)
Sprout Social has a +30% revenue growth with a +$120 million ARR, in which 99% of it is subscription-based. The subscription revenue figure is the highest among other SaaS stocks we have covered so far. Furthermore, the company would have had a 41% YoY organic revenue growth in Q1, if it excluded the revenue from Simply Measure, a company it acquired in 2017. Overall, revenue grew by 31% YoY in Q1, even despite the reportedly heavy headwinds in March. As such, we see an upside from here on out. As the company conservatively forecasts a full-year ~25% growth with ~30% organic growth due to the COVID-19 uncertainty, we expect growth to also reaccelerate beyond 2020.
While the high-quality revenue provides predictability and also sustainability, we expect Sprout Social to continue reinvesting back to the business to expand its TAM. As such, we do not foresee the company to be profitable in the near to medium term.
(Source: Company 10-K)
So far, operating margin and FCF (Free Cash Flow) have been negative, driven by the high expenses. Marketing has historically been the largest expense as a percentage of revenue. This year, we expect Sprout Social to continue spending ~45% of its revenue on marketing, which is already an improvement from ~53% in 2019.
We believe that Sprout Social has solid fundamentals and moat in the social media management space, driven by its differentiated offering and strong brand reputation. The growth story is attractive considering the massive TAM and Social Sprout’s strong positioning.
(Source: Company’s earnings call slide)
Despite the heavy investments to-date, there is a path to cash flow and operating profitability longer term considering the company’s high subscription base and organic revenue that provide it with visibility. Therefore, we think that Sprout Social is fairly valued at ~11x P/S, despite the 25% growth expectation. The company expects revenue of ~$128 million at the end of FY 2020, down from the previous ~$133 million, which assumed a 30% growth. We believe that the stock can easily reaccelerate to +30% beyond 2020, in which we expect the stock to trade at ~12x-14x P/S, driven by the long-term catalysts discussed. We maintain an Overweight rating on the stock with a price target of ~$34.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.