Lowering Stem’s Fair Value Estimate to $8 as We Await Further Scaling of Software Revenue

We reduce our fair value estimate for Stem STEM to $8 per share from $10 following the company’s fourth-quarter results and 2023 outlook. Our decreased fair value is a result of reducing our long-term gross margin forecast as we expect gross margin improvement to be more gradual than our prior forecast. Our no-moat rating remains unchanged. We view Stem shares as fairly valued.

With Stem previously indicating 2022 results were going to be weaker than expected, our focus was on the company’s 2023 guidance. Positives include expected booking growth of 40% year on year and reiteration of achieving breakeven adjusted EBITDA in the second half of 2023. However, non-GAAP gross margin guidance of 15%-20% for the full year is in line with original 2022 guidance, showing limited improvement year on year.

Stem’s long-term strategy remains around its Athena software, but we think its transition from a hardware-dominated business to one with sizable software revenue is going to be more gradual than our prior expectations. As such, we now incorporate a more subdued gross margin improvement into our forecast. We now assume the company does not meet its 15% adjusted EBITDA target until 2026, a year later than its analyst day projections. We would like to see management execute against its 2023 guidance and further scale its software revenue prior to becoming more constructive on shares.

In addition to margin improvements, we are watching Stem’s ability to turn cash flow positive given its somewhat constrained balance sheet. Stem ended the quarter with $250 million in cash and approximately $450 million in debt. The resulting net leverage position has us agreeing with management’s laser focus on achieving adjusted EBITDA breakeven (even if it comes at the expense of revenue growth).