Sonos: Uncertain Prospects in an Uncertain Environment (NASDAQ: SONO)

Company presentation

Sonos, Inc. (NASDAQ: SONO) is an American audio product developer and manufacturer, best known for its multi-room audio products and portable speaker systems. Sonos has sound systems for every purpose, from living rooms to outdoor events. Their products can “seamlessly” connect to each other using Wi-Fi and generally get good reviews.

Sonos completed its IPO in August 2018, raising around $250 million at a valuation of around $1.5 billion. Year-to-date, Sonos’ stock price has significantly underperformed the market, having more than halved year-to-date. Meanwhile, the S&P 500 over the same period was down only -20.2%. The company’s market capitalization currently stands at nearly $2 billion.

Disappointing results and advice

Sonos had a below-par third quarter of 2022 (reported August 10, 2022), including its substantial deceleration in revenue growth. The company reported -2% year-on-year revenue growth in the third quarter, which on an inflation-adjusted basis results in a negative decline. That’s significantly lower than the level of growth seen in the same quarter last year, when the company posted 52% year-over-year growth. Management cited “weaker consumer demand” and “supply chain issues” as reasons for minimal revenue growth – two factors that are expected to persist for the foreseeable future. The company also significantly lowered its full-year guidance, forecasting 1%-2% year-on-year growth for fiscal 2022, down from its previous projection of 14%-16% year-on-year growth. annual. The significant downward revision is substantial in our view.

Intense competition

Sonos operates in a highly competitive industry from companies that sell high-end audio products and smart speakers. Sonos claims to hold 2% of the global audio market. With countless players ranging from Sony, JBL, Amazon, Apple, Bose, Bang & Olufsen, and more, Sonos operates in a saturated market and a consumer base that has plenty to choose from. As smart speakers become more popular, Amazon and Apple – two tech giants – will have more of a say in the audio market in the future.

Although Sonos tries to differentiate its product line by emphasizing connectivity and other connected features, we believe there are many compelling substitutes for the product in different dimensions, from brand prestige to design. Therefore, we view the saturated industry and formidable competition as major headwinds for the company’s future prospects.

Recession risk

We believe Sonos is sensitive to the high risks of a deteriorating economy. In the most recent results, Sonos has already indicated that the drop in consumer demand has had an impact on the company’s performance. As the economy deteriorates in the United States and abroad, we are likely to see a continued deterioration in demand for Sonos products, because quite simply, audio products are consumer discretionary and, for some, a luxury good to buy when disposable income is high. . Upgrading speaker setups and buying nicer speakers will likely be pushed back as consumer sentiment weakens further and people struggle with higher rates of inflation.

Assessment uncertain

The company expects its “long-term” financial goals to be $2.5 billion in revenue, with an adjusted EBITDA margin of 15-18%. In the most recent results, the company extended the timeline “beyond FY24” citing “an uncertain and evolving macroeconomic backdrop.” Assuming the company achieves this goal through fiscal 2027 over the next five years, this sets Adjusted EBITDA in 2027 at $375 million to $450 million. Using an EBITDA multiple of 8x and taking the midpoint of EBITDA margin estimates, this represents a valuation of $3.3 billion in 2027. Discounting this to today’s dollars using a 10% discount rate gives us a valuation of $2.0 billion today, which is not far off from current levels. Therefore, we do not believe that the risk investors would take would be sufficiently rewarded given the many cyclical headwinds the company faces.

Conclusion

We recommend a “HOLD” on this company due to the fact that there are still many unanswered questions about the company’s short and medium term prospects. The valuation remains reasonable based on the company’s own financial objectives and guidelines, and we would like to see growth return to the company. Our “HOLD” thesis is not without risk, as stronger than expected performance in Q4 or a better than expected recovery in the US and global economy could alter our conservative thesis.