Prediction: Fed Rate Cut Could Actually Hurt This Artificial Intelligence (AI) Stock

In theory, companies looking to raise money just got a big boost. That’s because the Federal Reserve just lowered the federal funds rate by 50 basis points. Debt interest rates, as well as the cost of equity capital, should be more affordable for almost every business. Markets generally see this as a good thing. But there is one artificial intelligence (AI) stock that could actually be weaker following the rate cut.

Expect the AI ​​competition to heat up even more

AI spending has gone gangbusters. According to data from Statista, the total size of the AI ​​market has already gone from $93 billion in 2020 to around $184 billion today. That means the market has close doubled in just five years. But things have only just begun. By 2030, the market size is expected to exceed $800 billion — about 5 times its current level.

From critical hardware components like GPUs to the software models themselves, there’s an arms race for AI infrastructure right now, and everyone — from big tech to small start-ups — is spending huge resources to compete. This is great for AI innovation in the long run, and the Fed’s latest rate cut will only accelerate this momentum. That’s what it means even more resources being used in innovation, especially from the biggest competitors who can afford the most. If you like IBM, Appleand Alphabet were spending billions a year on AI before, imagine how much they will spend now that capital is even cheaper. This is especially true given that the Fed has signaled that even more tapering is on the way.

SoundHound might be a loser for that reason

In general, innovation in the AI ​​sector will only accelerate following rate cuts. But this is actually bad news for competitors like SoundHound AI (SOUND -0.80%) who have proven unwilling to invest heavily in research and development.

SoundHound specializes in voice AI. Virtually anywhere a consumer has a voice conversation—say with a vehicle’s entertainment system or a fast-food drive-thru—SoundHound can insert its AI technology to mimic the experience of talking to a human. The company has an impressive portfolio of AI patents supported by a growing client list. But it’s a relatively small player, with a market cap of just $1.7 billion and a revenue base of just $55 million.

Capital constraints have been a serious challenge for SoundHound, especially as it posted its biggest loss in years. Consider its ability to increase R&D spending over the past three years. As of early 2022, the company was spending around $60 million a year on research and development. Today, this figure has fallen to about $55 million, even though its sales grew by about 155% during that time frame.

Let’s compare SoundHound’s reduction in R&D spending to that of its major technology competition. Google’s Bard, Apple’s Siri, and IBM’s Watson already compete directly with SoundHound’s AI platform, and spending on innovation from these tech giants will have a direct result on the company’s long-term competitiveness. Since the start of 2022, IBM has increased R&D spending by about 8%, while Google and Apple have increased spending by 42% and 28%, respectively. While not all of this spending growth went to AI, it creates a stark contrast to SoundHound’s capital allocation strategy.

Another way to see this contrast is to look at each company’s R&D spending as a percentage of its total sales. IBM, Google and Apple all increased their R&D spending even as sales continued to grow. SoundHound, meanwhile, has decreased its expenses related to sales growth.

SOUN Research and Development Expenditure (TTM) data by YCharts.

What do these data tell us? That big tech — arguably SoundHound’s biggest long-term competitors — has been willing to aggressively ramp up R&D spending even at high rates. As rates fall and capital becomes cheaper, expect this innovation spending to become even more aggressive. And while SoundHound could also increase its R&D budget, any growth will pale in comparison to what the big tech giants will be able to manage.

In a silo, perhaps SoundHound is a beneficiary of rate cuts. His cost of capital will come down and maybe he can finally increase his budget for innovation. But its technologies compete with very well-funded peers that have proven willing to invest aggressively even at high rates. Now that rates are falling, SoundHound may not be able to invest aggressively enough to keep its technology competitive over the long term.