There are no two ways about it: SoundHound AI (SOUN 2.24%) stock has been on fire.
Part of the attraction is the obvious ties to artificial intelligence (AI), which has lifted many stocks in the space over the past year or so. Then, in mid-February, a regulatory filing revealed that Nvidia owned a small stake in SoundHound AI, and the stock was once again off to the races, soaring 295% in the weeks that followed. Furthermore, investors cheered SoundHound's fourth-quarter results, as revenue grew 80% year over year while the company slashed its losses by nearly half.
While all that might seem like good news, there were other, more troubling revelations suggesting SoundHound AI investors should be careful. In fact, I wouldn't touch SoundHound AI stock with a 10-foot pole. Here's why.
Image source: Getty Images.
The initial catalyst for concern
A short report was released on March 19 titled "Lies, Damned Lies, and Cheeseburger 'AI'." The report suggested that SoundHound AI was a "failing company peddling lies and deception" and it issued a stock price target of $1.
The report took exception to a number of aspects of SoundHound's business, saying the company is "misleading investors about their AI capabilities," often returns incorrect information, and has become a "commodity service." As evidence, the report suggests that "SoundHound has admitted as much by removing claims about the superiority of their product from their recent 10-K." A quick look through SoundHound's two most recent 10-Ks (annual reports) shows that it did remove a table that purported to show a number of ways that SoundHound AI's voice AI was superior to the competition.
Another allegation is that SoundHound AI is "hiding the fact that it has lost some of its biggest customers," including Mercedes-Benz, Deutsche Telekom, and Netflix. The report suggests that to hide client defections, SoundHound "removed all customer names from the 2023 10-K." A review of the past several 10-Ks does indeed show that SoundHound removed a list of global customers. To be fair, there are a number of reasons SoundHound could have taken this action. That said, the omission does seem curious, particularly given the list of customer-centric announcements included in its quarterly earnings press release.
The report also alleges that Sound disclosed a retention rate of 80% in 2022, a "statistic that is mysteriously absent from the 2023 10-K." This was also verified from a review of the respective 10-Ks.
There were many more allegations, and I didn't take the time to go through every one. However, the specific items I did check seemed to be based in fact.
NASDAQ: SOUN
Key Data Points
A rare double downgrade
Just one day after the short report was issued, analysts at Cantor Fitzgerald downgraded SoundHound stock to underweight (sell) from overweight (buy) while simultaneously lowering its price target to $4.90, down from $5.80. The analysts posit that the current valuation is "difficult to justify" given the company's nascent business.
Curiously, the analyst lists many of the exact same concerns laid out in the short report, including:
- Decelerating organic growth.
- Loss of customers.
- Lack of capex spending.
- Growing competition from big tech.
The analyst also cited the "opaqueness" of SoundHound's operating model, which smacks of a lack of clarity about how the company will make money going forward or how it reports certain metrics. In my experience, you rarely see seasoned analysts taking cues from a short report -- that is, of course, unless there is some basis behind the concerns expressed.
Big red flags
I have previously raised other concerns about SoundHound AI.
In its annual report, the company admitted that it had "identified material weaknesses in its internal control over financial reporting," which resulted in the restatement of a number of SoundHound AI's financial statements. The company noted that in the future, this could result in "material misstatements of the company's consolidated financial statements." I'm a certified public accountant (CPA) by trade, and this raises a serious red flag for me, as it can be an indicator of more serious financial irregularities or be a precursor to more financial restatements down the line.
Then there's the issue of SoundHound's backlog. In the fourth quarter, SoundHound reported that its "cumulative subscriptions & bookings backlog of $661 million represents a 2x increase year over year." Unfortunately, that statement comes with a big asterisk. In the fine print, management notes that the company has "updated this metric." While the amounts in its backlog were derived from "committed customer contracts," the subscriptions backlog is another matter entirely. This refers to "potential revenue achievable," with a laundry list of management assumptions baked in.
Combining the two metrics muddies that water as to what amounts are contractually obligated and what amounts are based on management assumptions. This may well have been the "opaqueness" cited by the analyst.
Where there's smoke, there's fire
While I normally take short reports with a grain of salt, this one raised a number of justifiable concerns, including SoundHound's customer defections, mounting financial losses, and accounting irregularities, to name just a few. Taken together, these issues significantly raise the risk of owning SoundHound AI stock.
To be clear, I've been wrong before, and I will absolutely be wrong again. That said, I wouldn't touch SoundHound AI stock with a 10-foot pole. I would respectfully submit that investors would do well to avoid this stock altogether or at least ensure that any holdings are a small part of a well-diversified portfolio.
It could turn out to be much ado about nothing. But I'm not willing to take that chance.
