Smith Micro Software: Death Spiral
Is it over?
Disclaimer: I’m not an investment advisor. Nothing I have written in this article should be taken as investment advice. Everything I have written here could be inaccurate. Trust nothing you just read. I’m part of the Seeking Alpha Affiliate program which means I have a financial relationship with Seeking Alpha.
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It’s tax loss selling season. A time of year to look at horribly performing stocks YTD that people are selling for tax purposes. This year the effect of the tax loss selling is even more drastic than usual especially in the US because of the overall strong market performance people will be selling their losing positions to reduce their capital gains taxes for the next year. I’m on the lookout for beaten-down stocks that have the potential to turn-around like Smith.
Smith Micro Software is a software company founded and still led by William Smith. It’s also a micro-cap. They named the company correctly in 1982, knowing these three things wouldn’t change.
Source: https://ir.smithmicro.com/presentation/SMSI-Investor-Overview-November-2024.pdf
They have 3 products and they white-label these products to other companies. Meaning their customers will rebrand Smith’s products, market them and have revenue sharing agreements with Smith.
Safepath=Family safety app Smith white-labels to wireless carriers for them to rebrand and sell. Their main revenue generator and centerpiece of the investment thesis. This product is the ultimate helicopter parent. It tracks everywhere your child goes, what he/she does online, what websites they have access to, controls screen time and they can’t delete it. It’s a great app. Allthough I don’t have any personal experience using it or other similar apps.
Viewspot=Retail management solution
Commsuite=Advanced Messaging solution
Smith has been around for a long time.
Source: Google
And now we are sitting at close to all-time lows. The exact all-time low was 0,55$ which was hit a couple of months ago and I don’t know why it was up 15,9% yesterday. This stock can be erratic.
The company has a market cap of 15,42 million USD and no debt.
Their TTM revenue is 24,2m USD and they are burning cash, but are saying that will change in 2025. Their gross margin is 70-90%.
February 21st, 2020 Smith acquired Circle Media Labs for 13.5m USD
April 19th, 2021 Smith Acquires the family safety business from Avast for 66m USD
This is already starting to remind me of another company. Send me a fax If you know what other company I’m thinking about.
The integration of Safepath with Circle and Avast plus the R&D spending over the years means Safepath has easily gotten +100m USD of investment.
February 27th, 2023 Verizon terminates its contract with Smith to build its own family safety app.
April 3rd, 2024 Smith announces reverse split to stay listed on Nasdaq.
October 3rd, 2024 the company raised 6,9m$ which included 3m$ investment from the CEO and Founder William Smith.
November 19th, 2024 European tier one carrier Orange launches Safepath in Spain.
There was some starting information. Now let’s move on to my history with this stock.
Mongolian history
Source: Seeking Alpha Premium+My edits
This is my history with the stock. In Autumn 2024 the remaining small position had plummeted and an insignificant sum was left. I was thinking about whether to take the tax loss or buy the dip. I did not have a strong view on Smith, because I had not done proper due diligence on the stock. I had surface-level knowledge and was focusing more on other stocks. So end of this summer and autumn was the first time I started doing proper due diligence on this stock to make up my mind on what to do with this calamity which was long overdue because I had a position since 2022. Shouldn’t wait for 2 years before starting due diligence.
Source: Almostmongolian, Substack notes
Sometimes I write Substack notes. Follow me on the Substack App for these.
This August I made the decision and 5x the position then recently added some more now having 6x the position and got my cost-basis down to 1,96$. It’s still my second smallest position(slightly bigger than Eco Atlantic). Shows how small the position had gotten that I could 6x it and it would still be the smallest position. I wouldn’t make this a big position even now. Maybe a mid position, but It’s still one of my riskier picks. The current price is 0,88 so now I need 123% to break-even. Which I think has a high chance of happening.
What went wrong in 2022-2024?
The original thesis in late 2022 when I first got involved was this. Smith has Safepath and they got the top 3 wireless carriers in the US as customers Verizon, T-Mobile, and AT&T. Massive companies. Massive subscriber base to market Safepath to. If these companies start pushing the app and ramping up marketing Smith will grow massively and there were all sorts of arguments about why they would do this. “Marketing Safepath is a win-win for both Smith and the Carriers.” Safepath grew very fast with Sprint(previously 4th biggest US mobile carrier) which was acquired by T-Mobile. This is Safepath growing with Sprint.
Source: Picture from this article. Another write-up about Smith from june 2023
Imagine if you could do this kind of ramp with one of the 3 carriers that all have way more customers than Sprint. They just need one carrier to do what Sprint did to succeed. The product has also been vastly improved since the Sprint ramp with new features, new offerings, and integration with the Avast Family safety product and the Circle family safety product.
Source: https://www.statista.com/statistics/199359/market-share-of-wireless-carriers-in-the-us-by-subscriptions/
What ended up happening:
Verizon terminated its contract with Smith in order to build its own family safety app.
T-Mobile merged with Sprint and while this provided Smith with a bigger potential opportunity because of T-Mobile’s much larger customer base the merger turned out to be a disaster for Smith because while T-Mobile kept using Safepath they were not as motivated to market their Family Safety App as Sprint was.
AT&T launched its upgraded version of Safepath in August 2023 and there was going to be a marketing push with that. The “we only need one” thesis was still in play and shareholders had faith in it. “If AT&T ramps like Sprint the Verizon loss will feel like a mosquito bite”
Also, the other smaller parts of Smith’s business their products Commsuite and Viewspot experienced declines.
This is what happened with the top 3 carriers.
There is going to be some positive stuff later.
Revenues went down:
2022=48.5m
2023=40,9m
TTM(trailing 12 months)=24,2m
And the company kept burning cash despite cutting costs. Cash from operations is the same as FCF for Smith because they have no CAPEX and an immaterial amount of other investing activities in the cash flow statement.
Source: Seeking Alpha Premium
In Q4 2023 Verizon terminated their contract, but Smith had a launch with AT&T in Q3 2023 which was expected to coincide with a heavy marketing push from AT&T and this growth would offset this revenue loss somewhat as well as their launch with a European tier one carrier in the summer of 2025. So things did not seem too bad.
Then AT&T did not really push Safepath that much and the Launch of the European tier one carrier was delayed to November of 2024. It has now finally launched.
Because of all this underperformance and delays the stock has been in something I call THE DEATH SPIRAL.
What is the death spiral?
A death spiral can occur when growth stocks do not deliver. These stocks have high valuations when the market believes in the story. They usually burn cash (investing in growth) but can raise cash from the market using their high valuation, because the market believes in the growth story.
But when the company does not meet market expectations. The stock price falls. They need to raise money at a lower valuation meaning more dilution. Doesn’t meet expectations again. Stock falls. Raises money and again it dilutes more than last time because of lower valuation. And so forth
The stock has a 100m market cap. They raise 5m$ and dilute 5%. If the market cap falls to 50m$ now 5m$ raise is a 10% dilution. If the market cap drops to 10m$ the 5m$ raise is a 50% dilution. This is not accounting for warrants that would be usually included with the raise.
As this keeps happening market will start expecting it and the stock falls in anticipation of the next raise which will dilute more because of the lower valuation. This is what happened to Smith. Their last raise diluted about 50% instantly and around 100% with Warrants.
If a cash-flowing stock falls in price the stock is just cheaper and pays a higher dividend yield or the company can buy back stock cheaper. With a growth stock that needs to tap the market the stock price fall by itself can be a negative fundamental event because raising money becomes so much more dilutive to existing shareholders.
The death spiral can end in 2 ways. The valuation starts rising so raising money is gets less dilutive or the company gets profitable and doesn’t need to raise money anymore. After this happens or if you project this happening it’s time to buy and reduce cost-basis and you can’t be thinking about the prices in previous years where you bought in originally. The dilution has been so heavy after a death spiral that returning to those prices is unlikely. It has to be treated as a new investment. Seems like the CEO of Smith Smith understands this with his recent 3 million dollar investment at 1,165$.
It’s noteworthy that the last time Bill Smith made a large investment in the company was before the big ramp-up with Sprint which led to a big stock price rise. Now he makes a big investment and they have just launched with Orange.
Source: Q3 2027 Smith earnings call
Smith stock multibagged after this.
Getting back to the dilution after a death spiral. In late 2022 Smith's stock price was 18$ and the market cap was 131 million.
Smith’s current stock price would have to rise 21x to get to that same price and because of the dilution, the market cap at the current diluted sharecount would be 460m USD. So this is very unlikely. Maybe if everything lines up perfectly. But returning to the 131m market cap is very possible and even likely if they can get to profitability and consistent growth again. Considering last time they were at that market cap, they were not even growing or profitable, but market believed they would be in the future.
Buying when you think the death spiral is over is similar to having your stock go bankrupt and you buy the post-bankruptcy business. If you want to make money you need to buy the dip and lower your cost-basis dramatically and understand the stock will likely not get to your original pre-spiral purchase price.
This death spiral reminds me of another stock. Send me a carrier pigeon if you know what stock I’m thinking about.
Now that I’m making up terms let’s talk about a life spiral which is the opposite of a death spiral Aduro is a good example of a life spiral which is another stock that needs to raise money and I have been also holding it since 2022. When a stock like this meets market expectations or exceeds them the company can keep raising money and raising the same amount of money becomes less dilutive over time because the valuation is going up.
Source: Google+My edits
Red spots mark when Aduro raises money,
These spirals are very important. Always predict the spirals. Also, predict everything else. Correctly. Very important for investing success.
The Smith investment case at this price is that they are exiting the death spiral.
They have no debt. They have 6,9m USD from their last raise if they can stop burning cash before the money from the last raise runs out they are out of the death spiral. I would say that alone would provide 2-3x return from here.
The last raise also included a warrant for every share. These warrants will be exercisable from the 3rd of April 2025 and at the price of 1,04$. So if the stock is above that price by that time this will also provide the company with more cash giving them more time to become profitable. This would also be quite dilutive, but considering the price is 0,88$ there is already a considerable 17% return before that dilution.
Then if they can return to consistent growth and start having strong earnings, this would return the stock to a more typical Nasdaq software growth valuation. Potentially 70-140m USD. 3-6 times revenue With the current market cap being 15,42m USD.
Reaching profitability
Smith needs a mid-7m$ revenue range per quarter to breakeven according to the management
Scott Searle
Maybe to dig in a little bit further, I think at the midpoint of guidance for December, you're looking at about a $500,000 sequential uplift. I wonder if you give us an idea of where that comes from. It sounds like the European carrier is part of that, but who else is providing a positive trajectory on that front and contributing to that increase?
Bill Smith
Yes, I don't really want to get into the name by name on the thing, but it's coming from a collection of activities with current customers, as well as new customers. And so we feel very comfortable with it. And I think the other part to keep in mind is you add that growth to the fact that we're going to continue to reduce the overall expenses will allow us to narrow the losses that we will see in Q4 and lead us to a trend that will take us to profitability in ‘25.
Scott Searle
And just to clarify that in terms of the new break even, Jim, it sounds like we're in the ballpark around $7 million or so is kind of the break-even level?
Jim Kempton
Hey Scott, how are you? As far as the break-even, it's probably you know in the mid-7 range when you take into effect cost of sales.
Quotes from the Q3 earnings call
In the fourth quarter of 2024, we expect consolidated revenues to be in the range of approximately $5 million to $5.2 million. This anticipated growth in revenues as compared to the third quarter is driven in part by a projected increase in Family Safety revenues.
From 5m to 5,2m in Q4 to mid-sevens might seem like a big jump, but this company has a very jumpy revenue. This would not require much to happen.
Since Q3 2023 every quarter has been a Q-O-Q decline in revenue. Q4 2024 would break this trend if they have 5m to 5.2m of revenue as they say. I do trust Smith management’s short-term revenue and cost predictions from my experience they have been accurate in the past.
And if they keep up Q-O-Q growth we will also get Y-O-Y growth next year. This would improve how the stock screens and change the sentiment around the company. This coupled with their prediction of being profitable next year would make it a profitable growth story which would completely change the valuation, but I can’t just take their word for it. Let’s see how they could get to that point and how likely is it.
“In other words, we anticipate that our total quarterly non-GAAP operating expenses and cost of sales will decrease by $2.4 million to $2.8 million, when comparing first quarter 2024 costs to the fourth quarter of 2024, based on the cost reduction activities executed this year.”
excluded the following items from GAAP earnings calculations: stock compensation, intangibles amortization, depreciation, fair value adjustments, amortization of debt issuance costs and discount, goodwill impairment, personnel severance and reorganization activities, and adjustment for non-recurring items.
The non-GAAP costs are all cash costs. In Q1 their cost of sales+GAAP operating expenses were 13,3m if we take out the midpoint of that prediction 2.6m
Then we have 10,7m then we take out non-cash costs like amortization and stock-based comp(these are about 50/50) which is roughly 3m then we get 7.7m that is basically a cash flow positive point. Stock-based comp is of course a real cost, but at this point, it’s most important to get the cash flow breakeven to stop the death spiral.
Smith has also delivered on cost reduction so I’m inclined to believe they will deliver on that front going forward. The revenue has been the problem.
At roughly 7,7m cast costs(including cost of sales) and 5,1m revenue(midpoint of the prediction) they would burn 2,6m of cash. They received the 6,9m on October 3rd. Assuming they would not improve their revenue or reduce their costs any further than Q4 and that the stock doesn’t go above 1,04$ for the warrants to provide them more cash this raise would sustain them to around the start of summer 2025 with the warrants possibly to the end of 2025.
This would be the bear case. Even a conservative prediction would include some revenue growth for the next quarters, because of certain activities I will talk about soon, but I think a conservative estimate would be that Smith would have reduced burn and this cash would last them to the latter part of 2025.
The moderate bull case is that they will stop burning cash before the cash from the last raise runs out. To do that they will have to grow revenue.
Revenue drivers
I’m pretty confident Smith will deliver on costs, but to get to profitability Smith also needs higher revenues so let’s see what negative revenue drivers have been causing lower revenues and are those factors going to keep causing further declines and what positive revenue drives there are and what are the projected and potential positive revenue drivers.
This was around 40% of this article. The remaining 60% is behind a paywall. This will be about the revenue drivers and my ending thoughts. The significant clients, Commsuite and Viewspot, new offerings, new marketing agreements, growth opportunities in US and Europe, Why I think the European carrier launch is different from Verizon, AT&T and T-Mobile and more likely to yield results.
If your name is Mark Gomes, Brian Perles or Aaron Warvick send me a message on Substack or Twitter. I will comp you so you can read the whole write-up for free. I would be interested to hear your thoughts.