Sonos IPO: There's Still Upside Left
Summary
- At the very last minute, Sonos slashed the starting price of its IPO to $15 per share.
- It had originally intended to price its IPO in a range of $17-19, indicating that institutional demand for the offering was lackluster.
- Shares soared more than 30% to close near $20 on the first day of trading, however, indicating that Sonos left some money on the table.
- Shares still remain reasonably valued and still retain decent upside.
In all fairness, Sonos (NASDAQ:SONO) picked a pretty bad time to go public. The NASDAQ has had a couple of rocky sessions in the past few days, as investors questioned valuations in the tech sector after a slew of disappointing results from the likes of Facebook (FB) and Twitter (TWTR). Sonos chose to go ahead with its IPO, and that meant cutting the opening price.
I'm still bullish on Sonos, as I noted in a prior article. I think the company wields a powerful product brand, while at the same time posting strong financials that are on much stabler ground than most technology IPOs. That being said, there are some cautions to note when investing in a pure hardware play. Let's dive into more details.
First day action
When Sonos last updated us on its intended IPO valuation, it had set an original range of $17-19 per share. Now, for some context - for the most part, all tech IPOs have priced above the initial range, and some have even gone to the lengths of boosting the range multiple times before going public. The fact that Sonos ended up having to cut its IPO pricing to $15 - about 18% lower than the midpoint of its original range - speaks volumes about a lack of institutional demand for the offering.
But if Sonos was intentionally pricing its IPO low to produce a "pop" on its first day and generate marketing buzz, it succeeded - and perhaps also left nearly $50 million of cash on the table. Shares jumped 33% on the first day of trading to close at nearly $20, blowing the original top end of the pricing range out of the water. Unlike other recent IPOs like Pinduoduo (PDD) and Opera (OPRA), Sonos is also one of the few recent IPOs to have a rising one-day chart - whereas previous IPOs tended to open at a high point, and sink throughout the course of the day. Shares of Sonos even continued to extend their run in after-hours trading to above $20. Here's the first-day trading chart below:
SONO Price data by YCharts
Key topics and debates
There are good bullish and bearish arguments on both sides of the coin for Sonos - and with a controversial name like this one, it's useful to take a balanced viewpoint.
- For bulls: Sonos' ~$1 billion in revenues is still growing at a high teens rate, and relative to other hardware companies, its ~42% gross margin is also fairly rich. New products, such as Sonos Beam and Sonos One, seem to be doing a good job at accelerating the company's revenue growth. That's not to mention the fact that Sonos is also one of the few technology IPOs to post an essentially breakeven bottom line.
- For bears: Hardware is an ill-fated sector, especially in a year where high-profile hardware startups like the smart lock company Otto have failed. Sonos has been in the market for many years, and some would consider it to be fairly saturated. New product categories like Sonos Beam (home theater) might provide a short-term kick to revenues, but in the long term, Sonos' growth prospects are limited. Add that to the fact that the market for smart speakers is littered with competition. Sonos could very well be a dying fad.
At the moment, the story looks clean for Sonos. Its financials for the first half of 2018 are showing respectable growth and stable margins, but should the company's first earnings release or guidance fall short of expectations, the stock could be in for a rude reversal.
Other IPO details
Here's a look as well at where other important details of the IPO landed:
- Sonos sold 13,888,888 shares in the offering, exactly as planned. The pricing, however, seemed not to go according to plan, with the final IPO price of $15 falling 17% short of the original target midpoint of $17-19 per share.
- Gross proceeds in the offering were $208.3 million (about $42 million short of original expectations). Note also that as originally planned, 8,333,333 of the shares offered in the IPO are not new issuances and are instead being sold by existing shareholders.
- Patrick Spence, Sonos' CEO, is not selling any shares in the IPO.
- After netting out expenses, Sonos expects net proceeds to the company at $75.3 million. Its listed use of proceeds for these funds is rather broad and vague, citing "working capital and other general corporate purposes."
- As per usual, there remains a 15% greenshoe option that could sell an additional 2.08 million shares and raise an additional $31.2 million, of which $12.5 million (gross) would accrue to Sonos and the remainder would go to existing shareholders.
- Post-IPO, there are 98.384 million share outstanding, indicating that Sonos went public at a market cap of $1.48 billion and is now trading at $1.96 billion
- The offering was led by Morgan Stanley (MS) and Goldman Sachs (GS).
It's worth noting as well that some pundits expected Sonos' valuation to reach as high as $2.5-3.0 billion in its IPO, when in reality it went public at half of that.
It's always dangerous to anchor IPO valuations to previous private expectations, however. The strongest case in point is Domo (DOMO), the business intelligence software company that was once rumored to be worth $2 billion. After the company went public and showed its heavy losses to the world, its valuation got slashed to under $500 million. That being said, however, Sonos' problems don't mirror Domo's - its near breakeven margins don't expose it to the same risks.
Valuation update and verdict
As noted above, Sonos' market cap now stands at $1.96 billion. The company is also holding $117.8 million of cash on its balance sheet, not including expected IPO proceeds of $75.3 million, and $39.7 million of debt. If we net out the total pro forma cash balance and add in the debt, Sonos is left with an enterprise value of $1.81 billion.
How does this stack up against Sonos' financials? As a refresher, take a look at the company's historical results below:
Figure 1. Sonos financials
Source: Sonos finalized prospectus
In the absence of more firm guidance from the company, let's assume that the company will achieve 15% revenue growth this year to $1.14 billion (consistent with the 18% y/y revenue growth in the first half of the year - we assume that the growth rate will drop off in the latter half to compensate for the lack of new product launches that stacked the deck this summer).
This puts Sonos' current valuation multiple at 1.59x EV/FY18 revenues. If we also assume a 6% adjusted EBITDA margin on those revenues (consistent with last year's margin of 5.6%), we also arrive at an EBITDA estimate of $68.4 million (+22% y/y) and an implied valuation of 26.5x EV/FY19 EBITDA.
Note that Sonos has plenty of opportunity on the EBITDA and EBITDA margin front. Heavy sales and marketing expenses have sliced down profitability in the first half of this year relative to last year (adjusted EBITDA margins dipped 110bps), but once the company fully ramps and exits its launch phase, EBITDA margins should return to "normal."
As I've previously written, I think a good price target to shoot for is $25, implying 20% upside from current levels and representing a valuation of 2.0x EV/FY18 revenues. Sonos will need a few good quarters and a rock-solid guidance in order to convince investors that it deserves this valuation (most hardware companies like Fitbit (FIT) trade at less than 1x revenues), but it's undeniable that Sonos is as much of a bottom line/profit story as it is a growth story.
While Sonos isn't the most exciting IPO to invest in at the moment (I have my eye on Pinduoduo, especially after bears have taken hold after reports of a fake goods investigation), there's certainly merit in investing in this top-tier brand name at its less-than-initially expected valuation. Keep an eye out for an entry point.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SONO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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