$SONO - SONOS Investment Summary:

The COVID-19 pandemic creating a great environment for home theater and home theater supply companies, due to people spending more time and money in/on their house because of the stay-at home orders.
- This was able to benefit audio companies like SONOS who provide home theater audio systems and sound bars to their customers.
Based off of the valuation techniques that I used to value SONOS, they are currently undervalued, and their current price represents a great buying opportunity.
By following the plan as outlined in the “Plan” section of this report, this investment idea has a potential upside between 31.34% - 34.33%.
- However, with every investment there are risks, these risks are outlined near the end of this report.

SONOS Company Overview:

$SONO - SONOS is a leading sound brand that is known for delivering unparalleled sound experiences, beautiful designs, and simplicity. The SONOS system is easy to set-up in any room of your home and their software is constantly being updated to enhance their product and improve functionality.

SONOS’ products include wireless and home theater speakers, their components, and accessories. Sonos is always looking for new ways to innovate their systems to increase functionality, improve their sound quality, and enrich their customer experience.

SONOS has partnered with many companies to provide services such as voice control, music streaming, internet radio, podcasts, and audiobooks to make using their speakers quicker and simpler.

Since SONOS was founded (in 2005) they have had 15 years of sustained revenue growth, selling their products through 3^rd party retail stores, select e-Commerce stores, and their own website.

Investment Information:

Macroeconomic Outlook:

Recently, the COVID-19 pandemic, and the associated stay-at-home orders that have come from COVID have greatly helped the home theater audio industry.

Firstly, COVID caused all movie theaters to temporarily shut down, meaning that there were no new movies or screenings coming out. This caused many streaming services, and entertainment companies to make their new movies available in people’s homes. As a result of this people were more inclined to spend some extra money to enhance their viewing experience, whether it be buying a better TV, better sound bar, or better seating, people were swilling to spend the extra money to improve their set-ups. This was good for SONOS as they provide home audio systems and soundbars that fit these needs.

Also, as a result of people spending more time at home, more people were inclined to spend money on upgrades to their home like a home theater. 82% of home theater integration companies reported that there were higher levels of interest for home theaters due to the pandemic. This is great news for companies like SONOS who provides sound systems for these theaters.

As a result of the pandemic, the home theater industry has been forecasted to grow at a CAGR of 14.6% over the next 6 years.

Sources:

CE Pro Home Theater Deep Dive 2021: Home Theater’s Big Comeback - CE Pro

Global Home Audio Equipment Industry (prnewswire.com)

SONOS Software:

SONOS believes that their software is the foundation of their business and helps them to differentiate themselves form their competitors. But what makes their software so good?

SONOS Radio: SONOS radio pools together over 60,000 stations from multiple streaming partners to deliver the most diverse and extensive range of songs and radio stations alike. This helps SONOS to cater to customers of all tastes/ages and makes it simpler to use.
SONOS S2: S2 is SONOS’ new app/OS that enables the next generation of SONOS products and experiences. This app includes new features, usability updates, increased personalization, and delivers a higher-quality listening experience.
Multi-Room: SONOS’ speakers come with the option to function individually, or they have the option to play together synchronously to a better audio experience and a longer range.
Smart Audio: SONOS has developed TruePlay and Automatic TruePlay technologies that use their paired devices speaker and the speakers of the SONOS device to analyze the room, speaker placement, and acoustics of the room to optimize sounds quality.

These are just some of the innovations that SONOS has made, that help to improve al aspects of the listening experience. It is features like these that help SONOS differentiate themselves and capture the attention of potential customers.

Growth Strategies:

SONOS has put forth a couple key factors and components of their strategy they plan to implement to continue growth. I was able to find these components in their SEC 10-K filing, I compiled the best 2 ideas out of the 5 they listed in the filing, which can be found below.

Expanding DTC efforts and building relationships with existing customers: In 2020, SONOS generated 21.4% of their revenue through their DTC channel (was 12% in 2019). SONOS’ DTC model is important because the margins on their DTC are the highest.
Expand Into New Geographic Areas: SONOS sees an expansion into a new geographic market as a way to drive sales and continue growth. SONOS needs to find the best strategic market to expand to in order to grow the quickest and set themselves up for future expansions. Keep an eye out for any news on a possible expansion as it will likely have a positive effect on their share price.

Intellectual Property:

Currently, SONOS holds over 1,000 patents, and is in the application process for 100’s more. These patents cover their technology, audio experiences, and other factors/aspects that are important to the SONOS’ operation.

These patents came into play in January of 2020, when SONOS decided to take legal action against Alphabet Inc., and Google LLC. For patent infringement of 5 of SONOS’ wireless audio patents. SONOS was able to win their lawsuit in Germany in Q1 2021 and reported this on their financial reports. By SONOS winning this injunction against Google, which may lead to Google’s products being banned in Germany. This is a win; however, it is a small win in the grand scheme of things as there are plenty more lawsuits Internationally that are yet to have reached a verdict. This win is still significant as it displays the strength of SONOS’ patent(s), and confirms SONOS’ ability to win in court.

If SONOS can win some more of their lawsuits in important Geographic areas (like the USA), these court wins will be huge for them, and there will likely be a positive effect passed onto their share price.

Financial Information:

Financial Performance (Good): SONOS increase their revenues by 5.2% YoY while only exhibiting a 2.85% increase in their cost of revenue (which is good because it helps SONOS to increase their margins), increased their gross profit by 8.46%, DTC revenues increased by 84.3%, they decreased their interest expense by 40.5%, and increased their Adjusted EBITDA by 22.39%. This is good to see as an investor, however there were some points of concern with their performance which will be discussed.
Financial Performance (Bad): SONOS reported an operating loss of $27.2M which is not ideal for investors (especially since they had an operating income in 2019), their net loss increased by 321.17% YOY which also is not good, and finally their operating expenses increased by 14.87% which is high compared to revenue growth.
Research and Development (R&D): SONOS increased their spending on R&D in 2020 by 25.4%, spending 214.6M on it. Although this is an increased expense, as an investor I do not mind SONOS spending this amount of money on their R&D. This is because their technology needs further innovations and upgrades for SONOS to stay relevant. Additionally, SONOS needs to spend money on R&D to acquire the technologies that they are able to patent, which they can use to protect their brand/company.
Long-Term Debt: In 2020, SONOS was able to pay off 6.6M of long-term debt (paid off 26.5% of long-term debt.) This is good to see as an investor, as more investors will be interested in SONOS the less debt they have. Also, SONOS has more than enough cash to cover this debt ($400M+ in cash and cash equivalents) which shows a couple of things. Firstly, they are not immediately paying off their debt which is good because they are likely using this debt to fund projects that will yield a higher return than their borrowing rate. Secondly, they are financially healthy and are able to meet their debt obligations as they come due.
Equity Incentive Plan: In 2020, SONOS issued 8,392,371 common shares through their equity incentive plans. The issuance of these shares caused a dilutionary effect on the existing shares of 7.66%. This is a decent amount of dilution, however it is not a lot compared to many other companies, to see the true effects of dilution we also need to factor in the repurchases.
Stock Repurchase: In 2020, SONOS retired some of their treasury stock, which essentially acted as a share buyback. SONOS indirectly repurchased 4,100,555 shares of common stock through their retirement of treasury stocks. This repurchase caused an inflationary effect on the existing shares of 3.74%. All said and done, between the incentive plan and the repurchase, SONOS’ common shares experienced a total dilution of 3.92%. Investors need to be cautious and recognize this dilution, however it is not a huge concern.

Competition:

In order to undergo my comparable analyses (seen later in this report), I had to find 4 other companies that I could compare to SONOS.

These companies have to operate in the same space, be of similar geography, be listed on the public markets, and be of similar market cap (not as important because there is not many audio stocks).

In an attempt to meet these criteria as closely as possible, I chose the following 4 companies to compare to SONOS: $SONY – Sony Group, $AVID – Avid Technology Inc., $DLB – Dolby Laboratories, and $HEAR – Turtle Beach Corp.

Valuation Information:

In order to value SONOS, I underwent a DCF model, and in this model, I used some information that I found myself, and from external sources. This section will highlight where I found this information from to give more credibility to the DCF model.

WACC:

I was able to find SONOS’ WACC through a website called “Finbox”. Finbox predicted that SONOS’ WACC is 7.75%, which I used in my DCF model.

CAGR:

I was able to find this figure myself by taking SONOS’ average annual growth rate of their normalized EBITDA. By doing this I arrived at a growth rate of 18.18%.

Interest Expense Decrease Rate:

To find this figure, I took the average decrease in SONOS’ interest expend over the past 3 years. By doing this I arrived at a decrease rate of 32.96%.

Tax Rate:

I also found this figure through Finbox, who estimate that SONOS’ effective tax rate for 2020 was 14%.

Valuing $SONO - SONOS' Stock:

In order to properly value SONOS, I decided to undergo a DCF model, and 3 comparable analyses to contrast/compare the results that I achieved.

DCF:

I conducted my DCF model using the information found above in the “valuation information” section of this report.

My DCF model concluded that SONOS has a fair value of $12.41/share, which would imply a 63.95% downside risk to this investment. However, there are a couple of reasons why this DCF is so low, and why it cannot be taken literally.

Firstly, the EBIT that I used for 2021 is their TTM EBIT. I used this because their 2020 EBIT was negative and their previous EBITs were sporadic and showed no cognisant pattern. This also made it hard to find a reliable CAGR for SONOS’ EBIT.

Secondly, the tax rate may not be accurate. Usually when I am finding the effective tax rates, I look through the companies SEC 10-K filings, so I know that the tax rate is accurate. However, this information was not disclosed in SONOS’ filings. As a result, I question the sources/legitimacy of the tax rate as estimated by Finbox.

Comparable Analyses:

EV/Assets:

By comparing SONOS’ EV/Assets multiple to that of their public competitors (found above in the “competitors” section of this report) I found that SONOS’ fair value is $42.08/share. This fair value implies an upside to such an investment of 22.18%. This contradicts the result found through the DCF model, so I decided to undergo more comparable analyses.

EV/Revenue:

By comparing this multiple, I found that SONOS’ fair value is $64.09/share, which implies an upside of 86.09%. This result is much higher than the result found through the previous comparable, so I decided to undergo a 3^rd comparable to get a better idea of SONOS’ true valuation.

P/E:

By comparing SONOS’ P/E ratio to their competitors, I found that their fair value sits around $31.14/share, which implies a downside risk of 9.58%. This is not consistent with the previous two results, so I decided to take the average result derived from each of the comparable analyses to find one fair value estimate.

Average Comparable:

By taking the average result of the 3 comparable analyses, I arrived at one, all-encompassing, comparable valuation of SONOS of $45.77/share. This implies that the upside to an investment into SONOS is roughly 32.90%

My SONOS Investment Plan:

As mentioned previously, I am not putting too much consideration into the result achieved through the DCF model. Thus, my plan will be constructed primarily from the results achieved through the 3 comparable analyses.

I see an entrance into a position in SONOS between the $33.50 and $35 as a great buy. By buying between these prices, you are limiting the downside risk of this investment, and still have a 30%+ potential profit.

If the price falls below this $33.50 price target, I would wait until the price falls to $30.20 before I would consider entering a position.

I would consider selling my position in SONOS between $43-45. I chose these levels because the $43 level is the current average analyst price target for SONOS, and the $45 level is the level I achieved through my comparable analyses.

Buying in between $33.50 - $34.44 and selling between $44 - $45 would yield an upside between 31.34% - 34.33%.

Risks to Investing in $SONO - SONOS:

Share Dilution: For the past 4 consecutive years, SONOS has experienced overall share dilution to varying extents. This past year, they experienced a total dilutionary effect of 3.92%. This is not a large amount of dilution; however, it is still something to look out for as an investor.
Financial Performance: SONOS’ financial performance was mixed during the fiscal year 2020. However, they experienced both an operating loss and a net loss, which is not favourable for the company/investors. If this kind of poor financial performance continues over the next couple of years, this will have big (and bad) effects on their share price. This type of financial performance also may scare off potential investors, reducing the amount of demand for their shares.
Lawsuits: As mentioned previously, SONOS is involved in some ongoing lawsuits and legal battles with Google over their wireless speaker technology. This might be a risk if SONOS loses because some investors might have just invested based off the fact that there is a lawsuit, and if this lawsuit is won, SONOS’ stock will go up. This is a problem because if SONOS loses these lawsuits there may be an abundance of investors who sell off their shares because it didn’t go to their plan. This would hurt SONOS’ share price.

Potential Catalysts for SONOS:

Share Buybacks: As an investor, it is music to our ears when we hear that companies are buying back their shares. This is because it makes the share, we hold slightly more valuable, however it also means that the company believes in their own future, and these people have the best idea of where the company is going and its potential. News of future buybacks (or reports on their statements) should help to combat the effects of inflation and boost the share price in the short term.
Financial Performance: As mentioned previously, this year’s financial report was pretty mixed. This year they increased their revenues, their DTC revenues, their margins, and their Adjusted EBITDA. Additionally, they were able to drastically decrease their interest expense. In the future, if SONOS can find a way to become profitable overall and in their operations, things will start to take shape and their stock price is likely to benefit from this.
Lawsuits: If SONOS is able to keep winning their various lawsuits against Google, especially in the USA, their share price should keep increasing. This lawsuit is a big deal and will be an example of how strong/valuable SONOS’ patents are. Furthermore, the revenue earned from these lawsuits will help to increase their share price.
Geographical Expansion: If the news breaks about SONOS expanding their operations into other strategic geographies, there should be more eyes and demand for their stock, which will help to drive their share price up.