Monday, September 26, 2022

Sonos: The Sound Of The Message (NASDAQ:SONO)


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In April, I thought that the sound of Sonos, Inc. (NASDAQ:SONO) was slowly getting better. The company has been a beneficiary of the pandemic and while 2022 was becoming a bit tougher, results were still seen way ahead of the pre-pandemic performance.

Liking the business, I feared a post-pandemic reversal, as I was not involved with shares at the time, with shares trading in the low twenties at the time.

Some Perspective

Sonos went public in the summer of 2018, as shares made their debut at $15 per share. I was a bit fearful of Sonos at the time, fearing a similar outcome and fate as the likes of GoPro (GPRO) and Fitbit, not having been decent long term investment opportunities.

A resulting $1.3 billion enterprise valuation at the time was applied to a business which generated a billion in revenues, with operating losses posted at $16 million that year. Shares have been lagging in 2018 and 2019 while modest growth was guided for, as the business was not profitable despite the popularity of the products. This combination was a dangerous set-up for sustainable long term returns.

After trading in the low teens ahead of the pandemic, shares rallied to a high of $40 in the first half of 2021, having retreated to $23 in April of this year. To put these moves into perspective: Sonos did post $1.26 billion in sales in 2019, on which it reported EBITDA of $89 million, but just $5 million in operating earnings.

The company saw very modest growth to $1.33 billion in the pandemic year 2020, on which it lost $27 million on an operating basis, yet the real acceleration was seen in 2021. Revenues rose 29% to $1.72 billion as EBITDA rose to $279 million, with real operating profits posted at $155 million, and earnings at $1.13 per share. At the same time, the company operated with $640 million in net cash, equal to another $4-$5 per share. The company guided for 2022 sales to rise 12-16%, just shy of $2 billion, with EBITDA seen between $280-$325 million.

After posting its first quarter results in the spring of this year, and announcing a $100 million deal to acquire Mayht Holdings in April, I believed that situation was slowly getting more compelling. Trading at $23, the pro forma cash holdings of some $4 per share resulted in a non-demanding valuation if earnings could come in around a dollar in 2022. With the pandemic momentum clearly on its retreat, I saw risks to the full-year guidance, certainly as component shortages and tougher comparables made me cautious, even as the company has not been a pure pandemic play like the names of Teladoc (TDOC), Zoom (ZM), or Peloton (PTON).

Disappointments Have Arrived

Fast forwarding to August, shares are now back to $17, basically having traded around the $20 mark since April as investors have been fearing and anticipating some bad news. Third quarter sales fell 2% to $378 million as EBITDA margins fell a percent to 11.3% of sales, with GAAP earnings posted at the flat line. This was in part the result of a one-time expense, yet operating profits of $9 million were very modest, otherwise revealing just a few pennies in profits.

Net cash is down to $40 million following some dealmaking, equal to $3.50 per share with 128 million shares outstanding. High inflation has resulted in pressure on consumer spending. All of this and a stronger dollar have created huge headwinds here, as the company cut the guidance in a major way.

The company cut the midpoint of the sales guidance from $1.975 billion to $1.742 billion, a very meaningful cut as 14-16% growth is basically cut to 1-2% This is certainly the case as the cut has been announced so late in the fiscal year, with basically just one quarter to go. While gross margins are seen largely equal, EBITDA is set to fall from a midpoint of $300 million to $222 million, a substantial cut given that the gross margins guidance has been left unchanged.

With D&A charges and stock-based compensation coming in close to $120 million here, that suggest that the bridge from EBITDA to adjusted EBIT shows roughly $100 million in operating earnings. With no interest expenses and statutory tax rates, earnings only come in at $0.60-$0.70 per share, far below the >$1 per share number a year before.

In the meantime, the share have fallen to $17, and after backing out net cash, operating asset valuation have fallen to $13.50 per share. Based on the full year earnings guidance, even as they have been cut by approximately a third, resulting multiples “only” comes in at 20 times earnings.

What Now?

Right now it is clear that Sonos has been seeing softer demand and softer momentum. This comes amidst softer demand from consumers, while supply chain issues and inflation hurt margins on top of that as well. The surprising resignation of the CFO does not help either to instill confidence at this uncertain point in crime.

In the meantime, the company, even though recognized as a strong brand with great quality, is facing competition as well as notably Jabil (JBL) is turning out to be a stiff competitor in some segments. That observation and the focus on sound quality means that the company over time could become an IP house as well. For now, this remains largely a consumer sound play as these are the times to get more upbeat, yet the situation is still very volatile with no immediate recovery in sight.

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