SONO - Sonos: A Mixed Bag

2023-11-03 10:39:07 ET

Summary

• Sonos, Inc. has experienced significant pressure on sales and margins, leading to a decline in realistic earnings.
• Despite a strong product lineup, product superiority has not translated into superior financial performance.
• The company's net cash holdings have decreased substantially, and the outlook for sales and margins remains weak.

In the spring of this year, I believed that the fundamentals for Sonos, Inc. ( SONO ) were deteriorating with the business seeing substantial and continued pressure on both sales and margins. With realistic earnings largely evaporated, while M&A efforts and buybacks depleted net cash holdings in a major way, I was cautious.

Despite a strong product lineup, this product quality did not translate into superior financial performance, as has been the case for years now. The current share price is quite low, certainly if we adjust for the sales base and net cash balances. While a positive view could be warranted, despite near term headwinds, I am cautious to get too optimistic given the volatile performance in recent years, as Sonos operates in a very cyclical and competitive business.

The Sound Of Sonos

Sonos went public in the summer of 2018, following the likes of other consumer hardware companies like GoPro and FitBit, both of which have not translated into decent long-term investment opportunities as well. Sonos went public at $15 per share, granting the business a $1.3 billion valuation as more than five years ahead of time first-day investors have seen substantial losses.

All this was based on a consumer sound business which posted sales of around a billion at the time, although accompanied by a small operating loss, despite the popularity of the products.

Post the outbreak of the pandemic, shares rose to the $40s in 2021, driven by optimism on consumers boosting discretionary spending. 2020 sales grew modestly to $1.33 billion, still accompanied by a $27 million operating loss. The real achievement was seen in 2021, with revenues up 29% to $1.72 billion with strong operating leverage resulting in operating profits of $155 million.

The company guided for a 14% increase in 2022 sales to $2 billion, with EBITDA seen up modestly between $280-$325 million, which at the lower end of the range meant that EBITDA was seen flattish compared to a $279 million EBITDA number in 2021.

During 2022, it became clear that the results would come in far softer than expected, with full year sales reported flattish at $1.75 billion, as the company posted revenue declines in the fourth quarter (as well as losses) as net cash balances came down following an M&A move and some share buybacks.

The company guided for 2023 sales flattish between $1.7 and $1.8 billion, with EBITDA seen down from $227 million in 2022 to $145-$180 million, indicating that relative no, or relative low earnings were seen. Following a soft second quarter earnings report the company cut the full year sales guidance to $1.65 billion, with EBITDA seen at just $153 million.

With shares trading at $15 in May of this year, the company commanded a $1.9 billion equity valuation, a number which included a $295 million net cash position. The resulting $1.6 billion enterprise valuation was equal to about 1 times sales, but the issue was that of very low to no realistic earnings. This comes as Sonos is facing real margin pressure and competition, despite the demand for its products, making it an easy avoid for me.

Coming Down Further

Since May shares have fallen from their mid-teens to levels around the $11 mark, after shares have even traded around the $10 mark in recent weeks.

Activity on the corporate front has been relatively limited, other than the third quarter earnings report being released in August. Third quarter revenues came in flat year-over-year. That was about the good news as the company posted GAAP operating losses of $21 million, compared to a seven million dollar profit number in the year before. The company posted adjusted earnings of $21 million, but this excludes an $18 million stock-based compensation expense as well as $15 million in legal and transaction related costs, which is quite a recurring item given the pronged IP battles which the company faces.

The company maintained the full-year guidance, with sales still seen at a midpoint of $1.65 billion and EBITDA around $153 million. This comes after the company posted adjusted EBITDA of $147 million in the first nine months of the year, as the fourth quarter is seasonally softer. With GAAP operating earnings posted at $8 million so far this year, and the fourth quarter being seasonally softer, it is very clear that realistic profits are simply quite modest to non-existing this year, depending on which adjustments one is happy to accept and which not.

And Now?

The 133 million shares of Sonos value the firm around $1.4 billion here at nearly $11 per share. This number includes a $268 million net cash position, revealing that the business trades below 1 times sales here. The issue is not that much of the sales multiple but the lack of (sustainable) margins as this causes real concerns among investors in a fiercely competitive operating field. Furthermore, consumers across the globe are hurt by the burden of inflation and higher interest rates weighing on discretionary income and likely spending categories like the ones catered by Sonos.

Moreover, Sonos furthermore had to swallow a painful loss in court as it lost a high profile court case versus Alphabet/G oogle ( GOOGL ) , although the positive might be that this might result in a reduced legal bill over time as well. The company has furthermore cut 7% of its workforce over the summer in order to cut its operating expense base, something which is badly needed here.

Given all the moving elements, I think that Sonos is preparing for a soft fourth quarter, as discretionary spending is under pressure in this environment, in what is already a seasonally softer quarter for Sonos. This is clearly the negative, but on the positive side is a low sales multiple, still a resilient balance sheet , a strong brand name, and the fact that operating expenses are being cut.

Amidst all this, the risk-reward is improving, notably given the declines in the share price. While such an argument would favor a speculative long position, it is the continued disappointments in the structural performance which make me cautious to have conviction on Sonos, Inc. shares here.

For further details see: