(TIVO) Where Did I Go Wrong With SoundBite Communications?
It’s been about two months now since I advocated selling your full position, if you had one, in SoundBite Communications (NASDAQ: SDBT), a provider of on-demand customer contact solutions.
In those couple of months I’ve had time to reflect upon what went wrong with my investment thesis in SoundBite, what I learned from the debacle, and how I can apply those lessons going forward.
My hope is that by sharing these insights with you, you can also strengthen your investing parameters and better understand what goes into my criteria for selecting companies for inclusion into the PeakStocks.com portfolio.
The bottom line is that I goofed with SoundBite, but it doesn’t have to be a lesson lost, and one that we can all benefit from in the long run to become better investors, regardless of your investing objectives or experience.
New to the SoundBite story?
SoundBite Communications is a provider of on-demand automated voice messaging (AVM) solutions that are delivered through a Software as a Service (SaaS) model.
What Went Wrong With SoundBite Communications?
Steep Price to Pay for Not Following My Instincts
SoundBite was a cheap company, with great growth prospects in a small niche field.
They had recently come public, and I had watched their stock price steadily decline, in spite of their impressive seemingly great and improving fundamentals, and wonderful business model.
So I did some digging around.
What I found out should have given me pause, and in retrospect, it sure does thinking about it now, but I was too focused and blinded by the “cheap” valuation, and the fact that as their only quarter as a public company, SoundBite beat and raised guidance to such a degree as to seem like an unbelievably cheap stock compared to any comparables that were available at the time.
There was trouble in the water however, and while difficult to spot, I did have warning signals going off inside my head that I should have listened to.
Here are the reasons why my investment thesis in SoundBite was wrong, and the warning signs that I should have paid more attention to:
- Industry that I didn’t understand well enough: We’ll start with the easy stuff and work our way down.
The Automated Voice Messaging (AVM) market is not what I would consider a complex industry to understand.
Pretty much every business on earth has some sort of voice mail system, message tree, or other system for routing customer calls, and staying in contact with them via direct dialers, or other systems.
What I didn’t realize was that this industry was becoming largely commoditized, and that regardless of the offerings that SoundBite staked their claim to, when it is all said and done, the end game is always about saving money.
When companies wish to contact their customers for debt collection, for payment reminders, for surveys, for security alerts on their accounts, etc., they are looking for the most cost-comprehensive solution, not necessarily the most comprehensive solution.
Further to this point is the very fact that the majority of SoundBite’s revenues were derived from the collections industry (84% in 2008), and even though SoundBite’s management team assured investors that in a declining economy their business would thrive because that’s when debt collectors get more charged off debt to collect, they didn’t foresee, and neither did I, that they would be dead wrong.
Instead of increasing volumes of debt collection, by the very fact that people were losing jobs, their homes and because of a lack of credit availability, most folks were having trouble paying day-to-day bills, let alone even thinking about paying old debt that they could not afford to pay.
As a result, SoundBite’s revenues, profit, margins and guidance, which had looked so unbelievable just a few months back, tumbled and along with it, the stock price and my investment thesis.
It’s funny how it turns out that there really aren’t any “recession proof” businesses, or ones that do better when times are bad.
Debt collecting is no different.
Lesson learned: Do more homework on an industry that you don’t understand. Don’t ever take management’s word for it that things are going to be fine, and that a recessionary market is going to be good for business, even when it appears that the argument makes intellectual sense.
- Miss guidance once, shame on you. Miss guidance twice, shame on me: This one isn’t as cut and dry as it appears.
I sincerely believe that SoundBite’s management team was as caught off guard by the decline in their industry as much as we were.
That being said, management took guidance down heavily after Q1/2008 earnings.
At the time, in conversations with the management team, I was told that they took guidance down so heavily as a result of wanting to control expectations and put in a natural buffer just in case things got worse, and finally, because they never wanted to have to lower guidance again.
Oops…
When SoundBite reported Q2/2008 earnings, expectations were not just cut again, but SLASHED, with growth targets going from the 35-40% range to now just break even to 10% sales growth!
In retrospect, I should have known that if a company has to restate their expectations to such a high degree the first time around, odds are they’re going to do it again, and it’s not going to be pleasant, especially if that company just came public and has no track record to speak of.
The good news was that as a result of SoundBite’s Q1 earnings miss and guidance reductions, the stock really didn’t decline much more when they lowered their guidance after their Q2 earnings release for the rest of this year and for the next few years, because the stock was already trading for around cash value.
My theory was that with the stock already off about 60% from where I cost-averaged in, an earnings miss or forward guidance revision, wasn’t going to affect the stock price as a percentage of my loss by any great margin.
While that held true, the greater lesson was to not ignore deteriorating fundamentals in a still nascent industry where the management team didn’t even understand their own perilous situation.
Lesson learned: Ignore deteriorating fundamentals at your own peril. When a certain industry, sector, or company shows initial weakness that catches both management and Wall Street off guard to such a degree, it would be unwise to ignore that deteriorating state from an investment perspective. In addition, without a prolonged track record of success, early trouble with a newly minted public company should set off extreme warning signals.
- Management that was not passionate about their business: This is a bigger factor than you might imagine.
Whenever I spoke to management on the phone, or listened to their conference calls, I never got the sense that they were passionate about their business and what they were doing.
It was no secret that the CEO/CFO and other members of the management team were brought in to replace founding members, but this is one warning that is more subtle and less obvious than other investing factors.
Is the CEO/CFO/COO, et. al., passionate about their business and what they do?
Do they look forward to coming to work each day?
Are they looking at this as just a payday?
Look, not everyone is passionate about the Automated Voice Messaging market.
Therefore, it would behoove us as investors to make sure that, no matter how quirky and strange they might be, having a founder at the helm that LOVED the smell of fresh voice messages in the morning would be in everyone’s best interest.
That was not the case with SoundBite’s management team.
Lesson learned: Passionate management is a must. Those who work because they choose to, not because they have to, can lead and inspire others and see opportunity where no one else has before. Passionate and great leaders of companies would work for free. If you ignore this tenet, you are treading on hot coals hoping not to get your feet burnt.
- Lack of founding members within the company: This is similar to the lesson above.
It is more than a little disconcerting to look around at the management team in place at a company, and not see anyone that founded it.
This isn’t always a 100% requirement, as founders leave for one reason or another, but with a company as small and as new as SoundBite was, I believe this was another warning sign that goes along with a passionate management team.
Lesson learned: When dealing with small and micro cap stocks, an original founder with a large personal stake in the company that is passionate about his business, is a 100% must-have. There can be no compromise when entrusting your investment in a company that has yet to prove itself with a management team that was merely brought in to take the company public, with no other personal interest to see it succeed.
- Management that couldn’t explain their competitive advantages: I recall speaking to management and asking them what they believed their competitive advantages were.
After bumbling about for a few minutes with rhetoric, and double-speak, I got something that resembled a competitive advantage.
Looking back on it now, and further analyzing my investment thesis, it is clear that while SoundBite may have thought they had some sort of competitive advantage, all they really had was a pig dressed up with lipstick on it.
The AVM market is intensely competitive and basically serves the needs of 1st and 3rd party customers to fulfill debt collection and early stage bill payment servicing.
Sure there are a myriad of other uses like keeping in contact with your customers, sending them special offers via SoundBite’s new text messaging offerings, etc., but when it all comes down to it, companies are looking to save money, and collect more of the money they are owed.
In the end, who can do that the cheapest matters more than who has an extra layer of bells and whistles that they claim is a competitive advantage.
What’s more, when you talk to management, and they have trouble explaining CLEAR competitive advantages to you, there’s something wrong there.
Lesson learned: When researching a company, make absolutely certain that you understand that company’s competitive advantages in detail.
Furthermore, when analyzing whether those advantages are rock solid moats around the business, or whether they are merely up-selling features on a commoditized product are crucial to understanding the full investment thesis, and backing out of a potential dead-on-arrival investment.
While no competitive advantage lasts forever, if the company you are thinking of investing in doesn’t continue to execute and differentiate themselves for the timeframe of your investment thesis, then you can bet that any advantage that they did have, will be long gone before your thesis pays off.
- Commoditized industry becomes a feature instead of a business: This was a slight concern of mine going in, but I should have been more aware of the declining market and the fact that most companies in this industry want to save money and collect money, not spend more money to collect less money.
It is a natural progression with most industries that competition drives down prices and hurts the bottom line unless you have a clear competitive advantage, of which SoundBite had none that were worth a premium pricing structure to which they had become accustomed.
As more and more companies get into the AVM business, these offerings are going to become a featureset of other product offerings, instead of stand alone products.
Think of this as akin to TiVo (NASDAQ: TIVO) and their DVR service which can now be found on virtually any and all cable or satellite set top boxes, and is known now as a feature (the ability to record shows and pause live TV), rather than a stand-alone business of selling set-top boxes with cool features.
The same thing was happening, or was going to happen, to SoundBite and their technology.
Eventually, the services that SoundBite offered would be either offered by many other companies, or offered as standard features by companies that already dealt with the AVM market such as Avaya and Premier Global Services (NYSE: PGI).
Lesson learned: When looking at a niche technology, and a stand alone company within that niche, make sure that technology is a sustainable long term as a business, not just a product.
While it is sometimes difficult to tell, if I would have combined this observation with the fact that SoundBite had no real competitive advantages, I could clearly discern that it would only be a matter of time before SoundBite would find itself in the exact position that it is in today.
- Not listening to my instincts: To me, this is my #1 lesson learned.
Instincts are merely past experiences resonating within your subconscious.
You can ignore them at your own peril, and unfortunately, I did.
Through my various conversations with management and due diligence that I performed on SoundBite from top to bottom, I never got a “gut” instinct that this was an amazing company that I needed to be invested in right now.
Over time I convinced myself through my research and through the ridiculously cheap valuation of the stock at the time, that there was something here that Wall Street was missing.
My years of experience and travails dealing with these sorts of companies was already resonating deep within me telling me that something was amiss, and to stay away.
I should have listened.
Lesson learned: Don’t discount your instincts. It’s better to be wrong and go with your gut, then be wrong when ignoring it. Of course, you have to make sure that your gut is reading the right signals, and that this feeling is from years of experience in dealing with what you are about to make a decision on.
Bottom Line
Learn and move on
I hope that by passing on some of the lessons that I learned when looking back on my mistake with regards to investing in SoundBite, you can glean some information that will help you when analyzing and making your own investment decisions.
In this business, you are apt to be wrong about the same amount of times you are right.
If you manage to pick 6 times out of 10 correctly, I guarantee that you will be a success.
The devil, however, is in the details.
With the diligence, research and expertise that I have gained over a decade of analyzing and researching stocks, these lessons serve as valuable reminders that no matter how far along in the game you are, you ALWAYS can learn something new, and whether you like it or not, you will continue to learn more from your failures than you ever will from your successes.
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*Variables You Should Know About SoundBite Communications (Nasdaq: SDBT) |
|
|---|---|
| Current Recommendation: |
SELL |
| The Company: | SoundBite Communications is a provider of on-demand automated voice messaging (AVM) solutions that are delivered through a Software as a Service (SaaS) model. |
| Why Sell Now: |
|
| Market Cap: |
$38.92 |
| Revenue (TTM): |
$43.34 |
| Cash/Debt: |
$39/ $0 |
| Current Price: | $2.50 |
| Risk Rating (?): | 10 (Highest Possible Risk!) |
| Position Size (?): | 1/4 (2-1-08), 1/2 (2-13-08), 1/4 (5-1-08), SELL FULL POSITION (8-7-08) |
| Buy Around Price (?): | $6.00 (2-1-08), $5.50 (2-13-08), $4.00 (5-1-08), SELL FULL POSITION (8-7-08) |
*As of 10-3-08. Except share price, all values in millions.
View original at: PeakStocks.com
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