American Virtual Cloud Technologies (NASDAQ:AVCT) is a company in the cloud computing industry. According to the firm’s self-description, it is a “premier global IT solutions provider” which offers cloud, cybersecurity, and connectivity services among other features. Its premier status is up for debate, however. AVCT stock is trading for less than $1.50 per share, likely as a result of the company’s underwhelming financial results in recent quarters.
American Virtual Cloud’s journey began as a special purpose acquisition company (SPAC) launched in 2016. This SPAC, Pensare, would merge with Computex in 2020 and change its name to American Virtual Cloud Technologies.
In late 2020, the firm would make another big move. It acquired a cloud communications platform named Kandy Solutions. In theory, the combination of these two businesses might launch a solid firm into existence.
The Bullish Argument For AVCT Stock
American Virtual Cloud’s investor presentation makes a reasonable argument for the business. It starts with the overall addressable market for cloud communications services, which is expected to grow from $58 billion to $100 billion annually by year-end 2025.
The company sees three pillars to support increasing demand. These include globalization, mobilization and virtualization. The pandemic caused people to reimagine work. There’s more gig economy and part-time jobs, more remote work, and a sharing economy where people borrow rather than purchase items. All these trends rely on ubiquitous cloud communications to operate seamlessly.
American Virtual Cloud has a management team that has prior experience at other publicly-traded companies. Plus, is has some contracts and partnerships with well-known firms. In theory, American Virtual Cloud might be able to build a decent business. Actual operating results, however, have been deeply underwhelming.
American Cloud’s Unfortunate Operating Results
Over the past 12 months, American Virtual Cloud generated $109 million of revenues. That’s a fairly significant number; the company has a real and sizable line of business operations. That puts it well ahead of many of its penny stock peers.
Unfortunately, this is not the sort of high profit margin business you might associate with a cloud or software-as-a-service company. It turned those $109 million of revenues into just $30 million of gross profit, amounting to a 27% ratio. Many software firms, by contrast, have gross margin ratios closer to 70% or 80%. It appears that much of American Cloud’s business is more of a lower-value add commodity style of product rather than something that generates premium pricing.
While the company has low gross margins, it hasn’t been able to maintain a lean cost structure. Last year, it spent more than $69 million on sales, general, and administrative costs (SG&A). Throw in other line items such as R&D and interest on its debt, and the company ran a massive loss. All told, AVCT stock lost $98 million over the past 12 months while bringing in those $109 million of revenues. That’s a dreadful ratio.
The company tells shareholders that it anticipates significant revenue growth going forward. And it has raised fresh capital to try to continue executing on the business plan. At the company’s pedestrian levels of profitability, however, it will need to generate a ton of additional revenues to offset its heavy operational expenses.
The Cloud Sector Is Plunging, So Buy Quality
It’s a total bloodbath in the cloud computing sector right now. The Global X Cloud Computing ETF (NYSEARCA:CLOU) ETF has plunged to new 52-week lows in 2022. Shares are down a quick 30% from their November 2021 peak.
The Cloud Computing ETF is full of big name holdings such as Akamai Technologies (NASDAQ:AKAM), Zscaler (NASDAQ:ZS), Workday (NASDAQ:WDAY), Netflix (NASDAQ:NFLX) and Five9 (NASDAQ:FIVN). If a basket of industry-leading companies such as these can fall 30% in two months, it gives you a sense of the complete chaos in the tech market today.
In this sort of environment, it pays to stick to more established operations. Companies like Netflix and Five9 have slid 40% off of their highs. Those are high-quality companies with proven business models, positive earnings, and credible management teams.
Maybe if the stock market were at all-time highs, it’d make sense to roll the dice on a small-cap struggling firm such as American Virtual Cloud as a value pick. But right now, the industry-leading firms are on deep discount. So don’t bother trying to pick through penny stocks.
AVCT Stock Verdict
American Virtual Cloud has several of the troubling signs you generally find at struggling penny stocks. There’s a shifting business strategy. A history of sizable operating losses. Ongoing stock dilution. The list goes on.
It’s possible that a company like this can stage a comeback. However, most of the time, companies with these sorts of red flags end up disappointing their investors. And in a market like this, there’s no need to reach for riskier investments. The highest-quality cloud and software-as-a-service stocks out there are in freefall. Given that, just say no to third-tier players in the industry.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a sizable New York City-based hedge fund. You can reach him on Twitter at @irbezek.