Reasons Why I Wouldn’t Invest in SoundHound AI Stock.

Reasons Why I Wouldn’t Invest in SoundHound AI Stock.

There are no two solutions: AI SoundHound (NASDAQ:SON) the stock caught fire.

Part of the appeal is the obvious connections to artificial intelligence (AI), which has sent many stocks in the space soaring over the past year. Then, in mid-February, a regulatory filing revealed that Nvidia had a little bet in SoundHound AI, and the stock raced again, climbing 295% in the weeks that followed. Additionally, investors praised SoundHound’s fourth-quarter results, as revenue grew 80% year-over-year while the company cut its losses by almost half.

While all of this may seem like good news, other, more troubling revelations suggest that SoundHound AI investors should be cautious. In fact, I wouldn’t touch the stock SoundHound AI with a 10-foot pole. Here’s why.

Reasons Why I Wouldn’t Invest in SoundHound AI Stock.

Image source: Getty Images.

The first catalyst for worry

A short report was released on March 19 titled “Lies, Damned Lies, and Cheeseburger ‘AI.” The report suggested that SoundHound AI was a “bankrupt company that peddled lies and deception” and had set a stock price target of $1.

The report takes issue with a number of aspects of SoundHound’s business, saying the company “misleads investors about their AI capabilities,” often returns incorrect information, and has become a “commodity service.” As evidence, the report suggests that “SoundHound admitted this by removing claims about its product’s superiority from its recent 10-K.” A quick look at SoundHound’s two most recent 10-K (annual reports) shows that it did remove a chart that purported to show a number of ways SoundHound AI’s voice AI was superior to the competition.

Another allegation is that SoundHound AI is “hiding the fact that it lost some of its biggest customers,” including Mercedes-Benz, Deutsche TelekomAnd Netflix. The report suggests that to hide customer defections, SoundHound “removed all customer names from the 2023 10-K.” A review of the latest 10-K indeed shows that SoundHound has removed a list of global clients. To be fair, there are a number of reasons why SoundHound could have taken this step. That said, the omission seems curious, especially given the list of customer-centric announcements included in its quarterly earnings press release.

The report also alleges that Sound disclosed an 80% retention rate in 2022, a “statistic mysteriously missing from the 2023 10-K.” This was also verified from a review of the respective 10-Ks.

There was a lot other allegations, and I haven’t taken the time to go through them all. However, the specific items that I did the check appeared to be based on facts.

A rare double downgrade

Just a day after the brief report was released, analysts at Cantor Fitzgerald lowered SoundHound stock’s rating from underweight (sell) to overweight (buy) while simultaneously lowering its price target to $4.90, compared to $5.80. Analysts say the current valuation is “difficult to justify” given the company’s nascent business.

Oddly enough, the analyst lists many of the same concerns expressed in the short report, including:

The analyst also cited the “opacity” of SoundHound’s operating model, which reflects a lack of clarity on how the company will make money in the future or how it communicates certain indicators. In my experience, you rarely see seasoned analysts drawing inspiration from a short report – of course, unless there is some basis to the concerns expressed.

Big red flags

I’ve raised other concerns about SoundHound AI before.

In its annual report, the company admitted that it “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 in the Company’s consolidated financial statements.” I’m a Certified Public Accountant (CPA) by profession, and this raises a serious red flag for me, as it may be an indicator of more serious financial irregularities or be a precursor to more financial restatements in the long run term.

Then there’s the issue of SoundHound lagging. In the fourth quarter, SoundHound reported that its “cumulative subscription and booking backlog of $661 million represents a 2x year-over-year increase.” Unfortunately, this statement comes with a big asterisk. In the fine print, management notes that the company has “updated this metric.” While the amounts in its order book came from “committed customer contracts”, the subscription order book is a completely different matter. This refers to “potential achievable income”, with a long list of built-in management assumptions.

The combination of the two measures blurs the lines as to which amounts are contractually committed and which amounts are based on management assumptions. This could well be the “opacity” mentioned by the analyst.

When there is smoke there is fire

While I usually take short reports with a grain of salt, this one raised a number of legitimate concerns, including customer defections from SoundHound, increasing financial losses, and accounting irregularities, to name a few -ones. Taken together, these issues significantly increase the risk of owning SoundHound AI stock.

To be clear, I have been wrong before and I will absolutely be wrong again. That said, I wouldn’t touch the stock SoundHound AI with a 10-foot pole. I respectfully submit that investors would do well to avoid this stock altogether or at least ensure that any holding constitutes a small portion of a well-diversified portfolio.

This could turn out to be much ado about nothing. But I’m not ready to take that risk.

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Danny Vena has positions in Netflix and Nvidia. The Motley Fool holds positions and recommends Netflix and Nvidia. The Motley Fool has a disclosure policy.

I wouldn’t touch the stock SoundHound AI with a 10 foot pole. Here’s why. was originally published by The Motley Fool

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