Stay Away From Sprout Social Which Can’t Seem to Get Profitable

Sprout Social (NASDAQ:SPT) is one of a few billion-dollar software companies that has a problem with profits. SPT stock is going to suffer as a result … unless the company can get profitable, it may have a limited upside.

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The company is a $1.7 billion market capitalization company that runs a social media management cloud-based software tool. It helps companies manage their public relations in social media.

But it seems to have a perennial problem with making money.

Sprout Social Can’t Seem To Make a Profit

Sprout Social has never made a profit. Most software and cloud-based companies its market cap size are profitable. But Sprout Social lost $5.8 million on a non-GAAP basis during the quarter. It produced revenues of $31.4 million.

Granted, revenue rose 27% on a year-over-year basis. But its net income non-GAAP losses were worse than the $5.5 million in the prior-year quarter.

And to make matters worse the company does not seem to have a real plan to get profitable anytime soon. For example, Sprout Social said its Q3 revenue will only be slightly higher at $33 million than the Q2 revenue of $31.4 million.

Moreover, it can’t even make operating profits. As of Q2 Sprout Social made an operating non-GAAP loss of $5.9 million. This was again higher than last year. And it projects that its Q3 operating loss will be even higher between negative $6 and $6 million.

To make matters worse, nine analysts polled by Yahoo! Finance have average estimates of negative earnings per share for 2020 and 2021. Their projections for 2020 are for a loss of 50 cents per share and only slightly better at negative 38 cents per share for 2021.

So something is really off here. Or another way to look at it is, maybe SPT stock is not worthy of a $1.7 billion market capitalization.

Recent Capital Raise Lifts Its Cash Balance

So far there are plenty of believers in the stock. In fact, in mid-August, the company closed on the sale of $43 million in new shares for the company and $145 million in shares from insiders. They sold shares in a secondary offering at $27.50 per share.

So far the stock is holding steady above that level at $34. This is despite the obvious point that the sale was for insiders who were cashing out at a high price. To me, that is not a good sign. Moreover, insiders have been selling stock even after that secondary offering.

Nevertheless, Sprout Social now has an estimated cash balance of about $174 million, after having raised $43 million in new shares in mid-August. This will allow the company to finance its continuing losses.

For example, the company seems to have burnt only about $4.5 million to $5 million in each of the past three quarters. This means it can last a good many years.

And maybe that is the problem. If the company knew that its cash was running dry, maybe they would find a way to run its operation for the shareholders and for a profit. But, instead, they seem secure knowing that they have enough cash to continue growing revenue without regard to profits.

I find this happens a lot with much smaller companies, like those in the $100 million to $500 million market cap range. But not with companies that have a $1.7 billion market capitalization. So, again, something feels off here with management.

How To Properly Value SPT Stock

Maybe I am being too harsh on the company. After all, Hubspot (NASDAQ:HUBS) is a somewhat similar company with a $12.3 billion market value that is barely profitable. It trades for an astounding 291 times this years’ expected earnings and 206 times next year’s EPS.

However, HUBS stock trades for 15 times this year’s sales and 13 times next year’s expected sales. By contrast, SPT stock is trading at 14 times this years’ expected sales and 11 times the next years’.

In other words, at least in regard to this measure, the two companies are not that far off in terms of valuation. For example, even if we project out 12 times next years’ sales, SPT stock should be only 16.6% higher.

So, at best, my target price for SPT stock is $37.67, up 9.7% from today’s closing price of $34. That is not that great an expected return, especially given that the company is so unprofitable. In other words, SPT stock does not have a great margin of safety, but it is possibly slightly undervalued.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.

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