Don't Buy SoundHound AI (SOUN) Until This Happens

SoundHound AI (NASDAQ: SOUN), a leading developer of audio and voice recognition tools, went public through a merger with a special purpose acquisition company (SPAC) nearly 4 years ago. Its stock opened at $8.72 on the first day, but it now trades below $8.

That dismal performance might seem surprising relative to its explosive growth rates. From 2020 to 2024, its revenue grew at a 60% CAGR. From 2024 to 2027, analysts expect its revenue to increase at a 49% CAGR to $283 million, as its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) turn positive in the final year.

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With an enterprise value of $3.1 billion, SoundHound trades at 14 times its 2026 sales. It isn't a screaming bargain, but it also isn't that expensive compared to other hypergrowth stocks. However, investors shouldn't touch SoundHound's stock until one key metric improves.

Keep an eye on SoundHound's gross margins

Most of SoundHound's growth comes from Houndify, its developer-oriented platform for building custom AI-powered voice recognition apps. It's a popular option for companies -- including restaurants, automakers, and retailers -- that don't want to share their data with a tech giant like Microsoft (NASDAQ: MSFT) or Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google.

After completing its SPAC merger, it acquired the AI restaurant services provider SYNQ3, the online food ordering platform Allset, the conversational AI company Amelia, and the customer service AI company Interactions. Those acquisitions significantly increased its exposure to the restaurant industry and the booming market for voice-enabled customer service chatbots. That inorganic expansion also offset the slowing organic growth of its core business.

However, those acquisitions -- along with intense competition from larger tech companies -- reduced SoundHound's gross margin from 69% in 2022 to 49% in 2024. That's a grim trajectory for an unprofitable company expected to remain in the red for the foreseeable future.

How does SoundHound plan to expand its gross margins?

SoundHound's declining gross margins indicate its high growth rates aren't sustainable yet. It's trying to stabilize its gross margins by scaling its business, streamlining cloud costs across its acquired companies, replacing third-party software solutions with in-house solutions, and increasing the mix of higher-margin subscription and royalty-based revenues.

But at the same time, it's increasing its headcount, ramping up data center spending, and possibly considering even more acquisitions. In other words, we shouldn't expect its gross margins to improve anytime soon -- and its stock won't be worth buying until that happens.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Microsoft, and SoundHound AI. The Motley Fool has a disclosure policy.