Is It Time to Roll With Nvidia and Invest in SoundHound AI?

SoundHound AI (SOUN 10.18%) has disappointed a lot of investors since it went public by merging with a special purpose acquisition company (SPAC) in April 2022. The audio and speech recognition software company's stock opened at $8.72 and soared to its all-time high of $14.98 less than a month later. But earlier this month, shares were trading at less than $2.

Its stock stumbled as revenue growth decelerated, losses stacked up, and rising interest rates compressed its valuation. Many investors dismissed it as another overvalued SPAC listing that quickly lost its luster as the hype died down.

Image source: Getty Images.

But on Feb. 15, SoundHound's stock soared 67% after Nvidia (NVDA 1.23%) disclosed a $3.7 million stake in the company. That's essentially pocket change for Nvidia, which ended its latest quarter with $5.5 billion in cash and equivalents, but is the chipmaker's investment a vote of confidence for the out-of-favor AI stock? Let's see why Nvidia might be interested in SoundHound -- and if investors should follow its example.

Why would Nvidia invest in SoundHound AI?

This isn't the first time Nvidia invested in SoundHound AI. Back in 2017, the chipmaker's GPU Ventures arm joined Samsung and 10 other investors in a $75 million funding round for the start-up.

At the time, Nvidia and its fellow investors likely considered SoundHound AI to be a potential competitor for Alphabet, Microsoft, and Apple in the voice recognition software market. SoundHound's namesake app identifies, discovers, and plays music, while its Houndify developer platform enables companies to create customized voice recognition tools without locking themselves into a single tech ecosystem.

Nvidia only holds about 0.7% of SoundHound's outstanding shares, but the investment is still a vote of confidence in the company's abilty to grow in the shadow of its larger competiitors. Nvidia also likely believes the nascent market will expand and evolve as new generative AI tools -- which are mostly powered by its own data center GPUs -- make voice-activated chatbots even more capable.

But should you follow Nvidia's lead?

Nvidia's investment suggests SoundHound's service and technology hold promise, but investors should review its biggest issues before following Nvidia's lead. Over the past year, SoundHound's revenue growth has decelerated, its gross margins have declined, and its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) remained negative.

Data source: SoundHound AI. YOY = year over year.

It attributed that slowdown to the macro headwinds that drove many companies to rein in their software spending. However, management's fourth-quarter guidance calls for revenue to rise 68% to 111% year over year as its adjusted EBITDA finally turns positive. That outlook suggests SoundHound is out of its cyclical trough, and analysts believe its revenue rose 49% for the full year. That would put the company on track to deliver the 45% compound annual growth from 2023 to 2025 that analysts are expecting.

SoundHound's stock isn't cheap at 15 times next year's sales, but it might justify that premium by expanding its high-growth niche of the voice recognition market, which Mordor Intelligence expects to expand at a CAGR of 23% from 2024 to 2029.

Yet investors shouldn't turn a blind eye to SoundHound's glaring weaknesses. It already laid off half of its workforce last year, but it still isn't expected to turn profitable on a generally accepted accounting principles (GAAP) basis anytime soon. It ended its latest quarter with just $110 million in cash, which isn't a lot of liquidity relative to its net loss of $73 million in the first nine months of 2023. And its high debt-to-equity ratio could limit its ability to raise fresh cash at reasonable rates.

It might be worth a speculative investment

Nvidia's decision to make such a small investment in SoundHound -- instead of taking a bigger stake or buying it outright -- suggests the AI giant has its own qualms about the business.

It might be a promising speculative play for long-term investors, but its high valuation, high leverage, and persistent losses could limit its near-term gains. In other words, investors can follow Nvidia's lead and nibble on the stock, but they shouldn't assume the chipmaker's investment will set a firm floor under its volatile price.