Sonos hopes to bring music to investors’ ears: Takeaways from its IPO filing

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By Rohit Kulkarni, SharesPost

With sales quickly approaching $1 billion, wireless speaker maker Sonos has filed to go public. According to its updated S-1 filing, the company expects to price between $17 and $19 a share, implying a market cap of up to $1.9 billion and a 1.9x EV/Revenue multiple.

Earlier media reports indicated that the company was targeting an IPO valuation as high as $2.75 billion. However, private investors have plenty to cheer about Sonos IPO as the IPO valuation of $1.9 billion implies a 180 percent premium above the company’s Series D post-money valuation of $682 million set in June 2012.

Sonos plans to raise up to $105 million, and its selling shareholders plan to offer shares worth up to $159 million. The Santa Barbara company faces a tough market as a pure-play consumer business; hardware companies have continued to struggle in an increasingly competitive market.

Category Killer

Founded in 2002 by John MacFarlane, Craig Shelburne, Tom Cullen and Trung Mai, Sonos revolutionized the speaker category with popular wireless audio systems like Play, Sonos Beam and Playbar.

The company integrated Sonos One, its latest product, with Amazon’s Alexa voice assistant. With an estimated value of $2.75 billion, Sonos is one of the largest consumer electronics companies to go public over the past 5 years, after Fitbit and GoPro. Like other unicorns, Sonos is hoping to ride the booming IPO market this year, but faces stiff competition from the tech giants Amazon, Apple and Google, as well as peers such as Bose and JBL.

Despite the company’s well-defined brand and technology, history has not been kind to pure-play consumer hardware companies. Since its IPO, Fitbit’s valuation has plunged to $1.6 billion from $6.1 billion, while GoPro’s market cap fell to less than $1 billion from $3.9 billion. Since Sonos generates nearly all of its revenue from one-time sales of hardware, the company could meet a similar fate.

The Upside Scenarios

  • Early-mover advantage in the wireless and multi-room speaker market. Known for its innovative design and technology, Sonos was the first company to introduce wireless, multi-room audio speakers to the market. Products such as the Sonos Playbar and Play provide seamless wireless integration and deliver excellent audio quality. Thanks to these products, Sonos today boasts a customer base to 6.9 million, about 7 times more than what it had in 2013. Over 50 percent of Sonos’s customers live outside the United States, and 61 percent of customers own more than one product.
  • Strong tailwinds from the music streaming industry. Streaming services have transformed the way we consume music by allowing listeners to play music on demand without the need for devices to store audio files. Sonos’s product strategy complements the growing demand for these services by allowing listeners to wirelessly stream music directly to Sonos speakers. The company was quick to partner with Spotify, Apple Music and Pandora and we expect to see more such alliances in the future.
  • Consistent Gross and EBITDA marigins. Sonos has generated consistent gross margins of about 46 percent on average for the past 5 years, even though revenues have been growing only at about 9 percent on average year over year. The company has also been able to maintain a positive cash flow and an EBITDA margin of about 4 percent on average for most of the past five years. In the most recent six-month period, Sonos boasted a better-than-average EBITDA margin of 7.7 percent, thanks to efforts to reduce operational expenses, especially in sales and marketing.
  • Vast and growing patent repository. Sonos has amassed 630 patents, with 570 more patent applications pending in wireless audio technology. The company ranked second in electronics patents last year. Although Sonos does not disclose licensing revenues, we expect licensing to grow as more players enter the wireless audio space.
  • Integration with Alexa and Apple AirPlay. The emergence of voice-assisted speakers from Amazon and Google have challenged pure-play speaker companies. Unlike its peers, Sonos quickly partnered with the big tech companies to integrate their respective technologies. Sonos One and Sonos Beam, released in October 2017, feature Amazon’s Alexa voice assistant. The company has also partnered with Apple to integrate AirPlay into its speaker products for iPhone users.
Positive EBITDA for the past five years. Source: SharesPost Research, Sonos S-1 filing.

The Downside Risks

  • Increasing competition from the tech giants and peers. Although Sonos tops the market for high-quality audio systems, the market is shifting toward smart-assistant-powered speakers, such as Amazon Echo, Google Home and Apple Homepod. The tech companies use smart speakers as just another product to complement their myriad services and support their overall brands. That makes it tough for pure-play hardware makers such as Sonos to effectively compete with them. Peers such as Bose and JBL are also quickly catching up, building up the overall competition in the wireless speaker segment.
  • Maturing revenues and flattening product sales. Sonos has been releasing products at a regular pace, but revenues have not kept pace, partly because of increased competition from Amazon and Google. Despite advanced, voice-assisted integrated speakers, such as Sonos One, the company has posted tepid revenue growth of about 10 percent for the past three years. New product launches have not significantly boosted sales either. Over the past three years, the company averaged a lower than expected 9 percent growth in the number of products sold.
  • Non-diversified and non-recurring revenue stream. That Sonos’s revenues come from just speaker sales, which are typically one-time sales with no recurring revenue, should worry investors. Given the high price of Sonos’s products, ranging from $149 to $699, consumers are less likely to refresh their products on a regular basis. To ramp up revenues, the company should use its audio expertise and expand its product portfolio beyond home speakers. Headphones and car audio seem like ideal adjacent markets for Sonos to expand into.
  • High interest expenses. The company signed a $40 million loan agreement with Gordon Brothers Finance Company at a high interest rate of 11.2 percent. The loan has resulted in high interest expenses, which we expect to continue into 2021. We’re not even sure if Sonos will generate a profit by then. We believe Amazon’s and Google’s successful launch of smart speakers has eroded investor interest in Sonos, which is why the company took out such an expensive loan.
  • Market concentration in the United States and Europe. Sonos generates 94 percent of its revenue from just the United States and Europe. The much larger Asia-Pacific region accounts for just 4 percent of sales as of March 2018. Given tough competition from the tech giants in the west, Sonos should increase its focus on the Asia-Pacific market and leverage its brand image to boost revenue growth.
Lackluster revenue growth despite new product launches. Source: SharesPost Research, Sonos S-1 filings.

Rohit Kulkarni is a managing director and head of research of SharesPost Inc.

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