Sprout Social Stock: Positive Secular Themes But Returns Limited (NASDAQ:SPT)

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investment thesis

Sprout Social (SPT) is establishing itself as a major player in SaaS for social media management, but current expectations are for limited returns due to a combination of persistent high investment costs and an average level of net revenue retention. With stocks trading at a 0.1% free cash flow return for fiscal 2012/22 with slowing sales growth, we think stocks are unattractive and trending lower on stocks.

quick primer

Founded in 2010, Sprout Social is a real-time SaaS social media management platform. This platform allows companies to gain data-driven intelligence, listen to social media messages and use them to analyze consumer sentiment, brand health, improve awareness and boost user engagement. SaaS is integrated into core social networks such as Facebook (FB), Instagram, Twitter (TWTR), LinkedIn, Reddit, YouTube and Glassdoor (GDOOR) – does not include more international platforms such as TikTok (BYTE) and LINE (OTCPK: Yahoo). Listed in 2019, the company has more than 30,000 customers worldwide and the key market segments are travel and hospitality, computer and software, retail and higher education. Approximately 28% of revenue was generated outside the US for the fiscal year 2012/21 third quarter to date, and 99% of sales were by recurring subscription.

Main financial data

Key financial data and consensus forecast for Sprout Social

Main financial data

Company Refinitiv

Our goals

In this article we want to evaluate the following:

  • Sprout Social showed accelerated year-over-year sales growth in FY 2012/2021, and showed a flat dollar-based net retention rate over the past two years (110% in FY2012/2020 and FY12/2019 for all clients including SMEs ) which indicates fairness but not great success with clients. What is the outlook for sales growth and margin improvement?
  • The outlook for generating free cash flow in the medium term.

We will take each one in turn.

Growth rates are set to slow down

FY12/21 third quarter results highlighted positive KPIs, demonstrating Sprout Social winning new clients as well as increasing sales from existing groups. Third quarter sales grew solidly 46% year over year but was in line with market expectations. Annual Recurring Revenue (ARR) grew 44% year-over-year to $204.6 million, providing a consistent backdrop for growth in the 2012/2022 fiscal year. The company recorded three consecutive quarters of positive free cash flow demonstrating the potential for value creation. The number of clients grew to 30,705 with 20% year-on-year growth and the annual contract value grew by 20% year-on-year with higher initial deal volumes and larger account winnings.

These encouraging metrics contrast with the expense profile. Sales and marketing expenses (including stock-based compensation expenses) accounted for 43.5% of third-quarter sales, indicating that the product needs a significant upfront investment cost to drive demand and revenue. Research and development expenditures accounted for 21% of sales showing that the company’s product offering areas are still in the development stage and not fully mature (which may explain average NRR levels). The reading here is that margin optimization will remain a challenge for some time to come.

Perhaps these spending levels are a prerequisite for building a successful SaaS business, and it can be considered industry practice to spend 40% of sales on promotional activity. As the volume of business increases with recurring income, it should be a matter of time until profitability is achieved on an ongoing basis. The question is how long that will take and only consensus forecasts estimate a break-even situation for the 2012/2023 fiscal year. Another area of ​​concern is the actual net revenue retention rate (for larger clients) declining year-over-year, dropping to 117% in FY2012/2020 from 120% in FY2012/19. Despite some success in winning larger business, customer success has previously been declining.

High growth rates are a key factor in justifying investment costs and management has driven 37% year-over-year sales growth for the fourth quarter of the 2012/2021 fiscal year. This is still at a high level but is likely to signal a peak in growth. Even if the guidance is set conservatively, we believe sustaining the level of growth seen in the third quarter (at 46% yoy) will be difficult given its high base. There is likely to be a slowdown in growth with limited margin improvement, making the stocks less attractive.

Next we look at the forecasts for generating free cash flow.

Not generating value

Sprout Social’s operating cash flows became positive for the first time as of the first quarter of fiscal 2012/2021 with stronger working capital management. Since this was due to a sudden rise in accounts payable, we do not view this as a major change factor in the company’s underlying performance.

Despite very limited capital expenditure requirements, current consensus forecasts estimate only incremental improvement in free cash flow generation through fiscal year 2012/2024. This indicates expectations of limited improvement in profitability in the future.

The company revealed a medium-term framework that aims to improve its adjusted annual operating profit margin by about 1% to 3% each year until at least the 2012/2025 fiscal year. This underscores the continued need to invest upfront for what is still a project still in development. Theoretically (based on a consensus 2012/2021 operating margin of -5.6%), on an unadjusted basis, the company could remain in the red within four years, or generate a maximum operating margin of just 6.4%. This doesn’t sound like a high-return business from our point of view, so the odds of converting free cash flow are low. Despite running a SaaS model, Sprout Social appears to be limited in generating revenue from its core offerings and needs to ramp up additional and premium services in order to maximize the potential for higher free cash flow. The results of these endeavors are uncertain and will take time to materialize in our opinion.

balance sheet

The Company remains well capitalized with cash and cash equivalents of $175.0 million available in the third quarter of the 2012/2021 financial year. This gives a current ratio of 2.6x indicative of high liquidity, and indicates a relatively low medium-term funding requirement despite the limited free cash flow generation potential.


The stock is trading on a 0.1% free cash flow return for the 2012/2022 fiscal year – that’s a very low and unattractive return coupled with slow sales growth. Despite what appears to be a market with high secular growth prospects, currently estimated returns in SaaS social network management are low and the stocks do not appear to be undervalued in our view.


The upside risks come from significant growth in new customer acquisition and increased net revenue retention, which results in sales growing much faster than anticipated and leading to increased operating leverage.

The integration of a wide range of social platforms will make this platform more attractive as a comprehensive social media management solution for potential clients.

The downside risk comes from continued upfront investment costs as the company continues to prioritize new clients and product development. The lack of material improvements in profitability will weaken the outlook for future earnings.

Social media management is another type of business intelligence software. Companies based in the data analytics industry may actively enter this sub-market segment with solutions based on more traditional tools such as Domo (DOMO).


We believe there is value in extracting business intelligence and data insight from social media – especially for companies operating in the consumer sector. Sprout Social is establishing itself as a major player in social media management, but current expectations are for limited returns due to a combination of continuous investment and average level of net revenue retention. With stocks trading at a 0.1% free cash flow return for fiscal 2012/22 with slowing sales growth, we think stocks are unattractive and trending lower on stocks.

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