Shares of Sonus Networks (SONS) have delivered solid gains for investors over the past 12 months, rising almost 46% as the company moves to capitalize on continued growth in the session border control market. However, we believe that further gains are to come in 2014 as Sonus continues its expansion into these new markets and reduces its reliance on legacy markets such as VoIP gateways. Although shares of Sonus do trade at a premium to its competitors, we believe that such a premium is fully justified. The bulk of Sonus' competitors are entrenched blue-chip telecommunications and technology companies, often growing revenues and EPS in the single digits while Sonus is posting robust double-digit revenue growth and forecasted triple-digit EPS growth. Furthermore, with an enterprise value of under $800 million, Sonus may very well catch the eye of one of its larger competitors. However, even on a standalone basis, we believe that shares of Sonus are compelling, particularly ahead of its March 13th analyst & investor day, at which we believe that Sonus will provide fresh insights into the solid market opportunities that lie ahead of it, particularly in software defined networking. We see upside of at least 21% on an EV/Sales basis, and potentially far more if investors were to credit Sonus with the triple-digit EPS growth it is set to post in both 2014 and 2015, or the company submits to a takeover. Unless otherwise noted, financial statistics and managerial commentary will be sourced from one of the following: Sonus' Q4 2013 earnings release, its Q4 2013 earnings presentation, its Q4 2013 supplemental financials, or its Q4 2013 earnings call.
Founded in 1997, Sonus markets a variety of networking and mobile products designed to help the company's customers link together their multi-protocol systems, including application servers, session management servers, VoIP switches, analytics platforms, and other communication systems.
With just over $276 million in 2012 sales, Sonus is far smaller relative to most of its competitors, which include some of the bluest of the blue-chip firms in telecommunications, such as Cisco Systems (CSCO), Alcatel-Lucent (ALU), and Ericsson (ERIC). Oracle (ORCL) is also a chief competitor, via its Acme Packet unit. However, Sonus' size belies the sizeable opportunity ahead of it. By 2017, Sonus' addressable market is set to reach $3 billion, driven by global growth in LTE; the company is forecasting that by 2019, there will be 2.9 billion total LTE subscribers globally, driving huge growth in the demand for diameter signaling controllers, which help service providers scale and manage their ever-growing mobile traffic, including the burgeoning voice over LTE (or VoLTE) market. The shrewd takeover of Performance Technologies (which closed in February 2014) for just $34 million alone expanded Sonus' total addressable market by 50% to $3 billion by 2017. We note that on a combined basis, Sonus' addressable market is set to triple relative to 2013, where it stood at $1 billion. In fact, as Sonus management has stated, a key driver of the acquisition was the increased ability it offers for the combined company to capture market share, helped in part by partnerships with both Microsoft (MSFT), Juniper Networks (JNPR), and F5 Networks (FFIV). And it is the threat of Sonus taking market share, which we believe will be on full display in 2014, which may drive the company's competitors to solve the issue with an acquisition.
2013 Results: Session Border Controls Control the Progress
Sonus' 2013 results were driven by solid growth in its sales of session border controls, or SBCs, which helped offset declines in legacy sales. For those unfamiliar with SBCs, they are, at their core, devices used within VoIP networks to control signaling and any media streams that might be involved in such calls. SBCs also provide security defenses against threats such as denial of service attacks and toll fraud, and offer encryption protocols. In addition, SBCs also offer quality of service monitoring systems and can also help customers comply with telecommunications regulatory requirements. We highlight Sonus' 2013 results in the table below.
Sonus Networks Q4 & 2013 Results (in Thousands of $)
Product Gross Margin
Service Gross Margin
Total Gross Margin
Operating Expenses as a % of Revenue
As the table above shows, Sonus posted fairly anemic revenue growth during the quarter, driven by the ongoing decline of its legacy product lines. However, key session border control revenue grew by 59% to $41.6 million in Q4 2013, accelerating from the 44% growth seen in Q3 2012, and now accounts for almost 55% of Sonus' total revenue, up sharply from the 35.8% contribution in Q4 2012 (SBC revenue grew by more than 48% in 2013 as a whole). The structural shift to SBC sales has also helped push Sonus into profitability in 2013, leading to meaningfully higher gross margins in both the fourth quarter and 2013 as a whole. Combined with disciplined expense controls, Sonus has seen its higher gross margins flow through to its operating income and EPS figures. We note that for Q4 2013, Sonus matched EPS estimates, but beat consensus revenue estimates by over $8 million. On the company's earnings call, Sonus management attributed its strength in SBC during the quarter to several market trends, namely strong enterprise adoption, which was helped in part by the company's Lync partnership with Microsoft, as well as increasing market share in service provider peering and SIP trunking. The Lync partnership has yielded solid benefits for Sonus, with CEO Raymond Dolan noting that the company is benefiting from strong trends in EMEA, and share gains versus Oracle and its Acme Packet subsidiary.
It is these strong trends that have allowed Sonus to issue robust guidance for Q1 2014 and 2014 as a whole. For the first quarter, Sonus is guiding for total revenues of $70 million, inclusive of $3 million in Performance Technologies revenue, and a loss of one cent per share, representing year-over-year revenue growth of 10.61% and a 1-cent reduction in EPS losses. Consolidated gross margins are forecast at 63% (63.5% for standalone Sonus), and while this does represent a decline relative to Q4 2013 results, Sonus' margins fluctuate from quarter to quarter. We await Q2 guidance to see if there is a larger margin issue. We note that Sonus' revenue guidance was well ahead of consensus at $64.1 million (EPS guidance was in-line), and full-year guidance of $300 million in revenues ($285 million for standalone Sonus) was ahead of consensus estimates for $285.6 million. Full-year EPS is projected at $0.05, inclusive of a 1-cent dilutive impact from Performance Technologies, which is forecast to be accretive to EPS in 2015. Of note is the company's SBC revenue guidance. For all of 2014, Sonus is forecasting $165 million in SBC revenues, representing 27% growth relative to 2013, or 29.31% when the $3 million in SBC revenues contributed by Performance Technologies are accounted for. Sonus notes that today, 80-85% of new customers are purchasing SBCs, and with 670 new customers acquired in 2013, Sonus is well positioned to continue expanding its SBC business. Assuming the company's guidance holds, SBC sales will account for 58% of total revenue in 2014, well above their 47% contribution in 2014. On the company's earnings call, management also spoke about the burgeoning VoLTE market opportunity.
Although VoLTE has not contributed to Sonus' performance in 2013, management has pledged to clarify the market opportunity in 2014, and we expect a portion of the company's upcoming investor day will be spent quantifying the market for analysts and investors. CEO Raymond Dolan noted that the company's guidance does not call for meaningful VoLTE revenue in 2014 because the market is in its early stages, and that VoLTE revenues are much more likely to start being recognized in 2014 and 2015. Market research firm Infonetics has estimated that there are 8 million VoLTE subscribers around the world at the end of 2013, with around 75% of those in the Asia-Pacific region. However, there are signs that the market is set for meaningful growth, as many of the leading wireless carriers in the United States are preparing to release VoLTE service. AT&T (T) has begun testing VoLTE service here in the United States; its first VoLTE phone was unveiled at CES in January (manufactured by Asus) and reports have suggested that the company has also partnered with Samsung to test VoLTE on the Samsung Galaxy. Verizon (VZ) has pledged to launch VoLTE service this year. For its part, Sprint (S) has inked a partnership with BroadSoft (BSFT) to roll out VoLTE service, but has not given a firm timeline on when it will launch, likely electing to focus its attention on completing its Network Vision overhaul. T-Mobile (TMUS), however, has been cagey with its commitment to VoLTE, and there have been no official pronouncements of a timetable for the launch of VoLTE service. However, with three out of the four national carriers planning VoLTE service, the market is set for substantial growth in the years to come, and Sonus is well positioned to benefit when it does, and further expand its SBC market share. While concrete market share figures for 2013 are not yet fully available, Sonus captured 19% of the SBC market, up 730 basis points from 2012, and based on its solid SBC revenue growth in 2013, we expect that it has, at a minimum, managed to maintain its SBC share in 2013, thanks in part to a slate of partnerships with Juniper Networks and F5 Networks.
In May 2013, Sonus and Juniper inked a partnership in which Sonus' 5000 series of SBCs would be integrated with Juniper's MX routers and SRC Policy Engine framework to enable service providers to deal with the ongoing surge in video and "unified communications" traffic on the basis of software defined networking, which Juniper has embraced in its push to compete more effectively against archrival Cisco. And in July, Sonus partnered with F5 to integrate its 5000 series of SBCs with F5's signaling delivery controllers to better enable service providers to scale their networks, as well as ensure more seamless roaming between mobile networks, including transitioning between LTE and 3G networks when necessary. Sonus management has affirmed its desire to ink more (and deeper) partnerships to expand its SBC business, and we expect that it will announce more partnerships over the course of 2014, perhaps as early as its investors and analyst day.
Financial Profile: Creating Room for Capital Deployment
Sonus' 2013 results reflect a clear improvement relative to its 2012 and historical results in several aspects, most notably the company's free cash flow. The table below breaks down Sonus' operating and free cash flows over the past decade.
Sonus Networks Operating & Free Cash Flow; 2004-2013 (In Thousands of $)
Net Income (Loss)
Operating Cash Flow ex-Changes in Working Capital
Changes in Working Capital
Operating Cash Flow
Free Cash Flow
*Net income in 2006 was boosted by one-time tax benefits
Sonus generated over $33 million in operating cash flow during 2013, nearly approaching its 2009 record of $33.757 million, and the company's $27.158 million in free cash flow was the highest in a decade, further strengthening Sonus' balance sheet and giving the company further room to deploy capital. Sonus ended 2013 with $245.669 million in cash & investments, offset by just $7.423 million in debt, for a net cash balance of $238.246 million, or $0.89 per share (based on 266.2 million outstanding shares). With Sonus' shares closing at $3.76 on February 21, 2014, almost 24% of Sonus' market capitalization is in cash, and the company has noted that it is willing to deploy said capital. Sonus spent almost $60 million on share buybacks in 2013 (its $100 million buyback was announced in July 2013), and has $40 million in remaining authorization on its current buyback program (equivalent to around 10.638 million shares at current prices, or 4% of the company's outstanding shares). In its earnings presentation, Sonus highlighted that even with the acquisition of Performance Technologies, the company is continuing to consider various growth acquisitions, and has reiterated its commitment to returning excess capital to shareholders. With revenue and EPS growth forecast for 2014, Sonus is likely to see year-over-year growth in both operating and free cash flow, helping offset the $34 million purchase of Performance Technologies. We expect Sonus to discuss its capital strategy at its investor and analyst day next month.
Peer Comparison & Valuation
Per its latest 10-K, Sonus' key competitors are, as we mentioned above, some of the largest names in telecommunications, including Cisco, Alcatel-Lucent, and Ericsson. In addition, Sonus competes with Oracle's Acme Packet division, AudioCodes (AUDC) and NEC, traded in Tokyo under the ticker 6701 and here in the United States under the ticker OTC:NIPNF.
ERIC A (Stockholm)
Net Cash (Debt)
Net Cash (Debt) per Share
Adjusted Share Price
Last FY Sales
Current FY Sales
Current FY Sales Growth
Next FY Sales
Next FY Sales Growth
2-Year Forward Sales Growth
Last FY EPS
Current FY EPS
Current FY EPS Growth
Next FY EPS
Next FY EPS Growth
2-Year Forward EPS Growth
Current FY EV/Sales
Next FY EV/Sales
Current FY P/E
Next FY P/E
While it is clear that Sonus trades at a premium to its competitors, it is also clear that Sonus is growing at a much more rapid pace. Over the next two fiscal years, Sonus is set to grow revenues by over 17%, whereas its competitors will see revenue growth of less than 3% over the next two fiscal years. The differential in EPS is even starker. Over the next two fiscal years, Sonus is set to grow EPS by 400% to $0.10, versus an average of less than 34% 2-year growth for its competitors, with growth driven by the continued expansion of Sonus' SBC business.
The question now is this: what is a fair value for shares of Sonus? Given that its revenue growth is almost 500% higher than the average of its peers (17.32% versus 2.9%) and its EPS growth is over 1,000% higher (400% versus 33.58%) assigning a premium of that size would yield price targets that can easily approach $20. We believe that a more realistic approach is to value Sonus on an EV/Sales basis, assigning the company a 100% premium to account for its peer group-leading revenue and EPS growth over the next two years.
Sonus Networks Price Target
Current FY EV/Sales
Next FY EV/Sales
Assigning Sonus EV/Sales multiples of 3.21x and 3x respectively its fiscal 2014 and fiscal 2015 EPS yields a pro forma price target of $4.55, representing upside of 21.01% relative to its February 21, 2014 closing price of $3.76. However, while such upside is meaningful, it pales in comparison to what Sonus may receive in a takeover.
Takeover Potential: Is There a Suitable Suitor?
As the peer comparison table shows, Sonus, along with AudioCodes, is the only company within its peer group that carries an enterprise value of $1 billion, making it one of the few "digestible" publicly traded companies that grant exposure to the growing SBC market. And given that Sonus is growing its SBC sales at a double-digit pace, and has almost certainly taken further market share in 2013, there is a rationale for a deal to be done to gain exposure to the SBC market. Oracle certainly thought so a little more than a year ago, when it spent $2.1 billion to acquire Acme Packet to gain access to the SBC market in early February 2013. While Oracle's offer of $29.25 per share represented a premium of only 22% relative to Acme Packet's prior day close, Oracle's offer valued Acme Packet at over 6x EV/Sales; by comparison, Sonus trades at an EV/Sales multiple of just 2.75x (based on its 2013 sales), and 2.51x based on its 2014 sales; we note that on an EV/Sales basis, Sonus is trading at a material discount to Oracle itself.
With Acme Packet holding around 40% of the carrier SBC market at the time of its acquisition by Oracle, and the #2 position in the enterprise SBC market, Sonus' inroads into the market are almost certain to affect Acme Packet. And with Oracle showing no signs of abandoning its strategy of growing via acquisition, there is possibility that the company may elect to shore up its position by acquiring either Sonus or AudioCodes. Alternatively, any one of Sonus' larger competitors may elect to expand their SBC market position via an acquisition. And based on the multiples that Oracle paid to acquire Acme Packet, the upside to Sonus investors in such a deal would be material.
That being said, we stress that our thesis for Sonus is based on the company's standalone prospects. We also note that Sonus has a poison pill in place, which was extended in June 2013 and is now set to expire on June 26, 2015. The poison pill was put in place in June 2008 amidst extraordinary trading volumes in shares of Sonus, as well as contentious negotiations with Legatum Capital, the company's largest shareholder, which at the time owned 25% of the company. Sonus and Legatum settled their dispute in early 2009, in which Legatum gained control of 2 Sonus board seats (out of 11 total) and succeeded in splitting the role of Chairman and CEO. Legatum remains Sonus' largest investor, holding close to 60 million shares, equivalent to a stake of 22.52% based on Sonus' current share count (the hedge fund Empire Capital Management is Sonus' 2nd largest investor, holding close to 10% of the company). While Legatum has not been applying pressure on Sonus since the two companies reached their agreement in 2009, Sonus' board is not staggered, meaning that should an activist investor decide to apply pressure to the company, Sonus would be vulnerable to a proxy fight. Per the terms of the company's poison pill, the plan is triggerable when an investor acquires more than 15% of the company's outstanding shares, and while the plan may prevent any single investor from amassing a controlling stake, the threshold does leave room for an activist to apply meaningful pressure to the company.
Sonus Networks' ongoing transformation is poised to lead to further upside for shareholders. The company is moving to sustained profitability, and in 2013 its highest free cash flow in a decade, and moved operating cash flow to a nearly 10-year high. We believe that at present levels, shares of Sonus present a compelling opportunity ahead of the company's March 13 analyst and investor day, in which Sonus is likely to further quantify its market share, position, and the totality of the opportunities in front of it. We believe that investors should add to or initiate position in Sonus ahead of this meeting, and ahead of what we believe will be a solid 2014 for the company as it continues to outpace its SBC competitors, thereby delivering value not only for its partners and customers, but for its shareholders as well.