Description

Sonos is a well-known sound experience brand that manufactures and sells audio products and services for home entertainment. For a more in-depth description, you can refer to Dogsarelife Sonos post from January.

As one might expect, the COVID pandemic accelerated demand for these types of products as people focused on home improvements rather than travel or other discretionary out-of-home entertainment. Sonos benefitted greatly from these trends and the stock was rewarded by roughly tripling from its pre-COVID prices. However, like many other stocks that reached all-time highs post-COVID, it’s since declined 45%.

While VIC member "Dogsarelife" lays out a compelling bull thesis and the street has 4 Buy and 3 Hold ratings with price targets in the $30’s and $40’s, we believe Sonos is returning to its pre-pandemic self. Over the past few months, we’ve spoken to several former Sonos executives and heard fairly consistent feedback. They noted that COVID created significant demand pull-forward, particularly in high margin home theater sales and installed solutions (“IS”). Pre-COVID, the IS channel business grew 5% to 10%, relying on new product launches and new generation TVs that customers attach soundbars to. Otherwise, Sonos relies on home renovations and to a lesser degree its partnership with Lennar for newbuilds.

As one contact we spoke to put it, COVID drove demand in the IS channel “through the roof”, driving pricing up with it. This surging demand, per our contacts, resulted from a surge in home renovations, as consumers had few options for discretionary spending outside the home. One high-level former employee bluntly said, “The reality is that Sonos didn’t become a better business during COVID; it simply benefitted from a one-time pull forward and better channel mix”.

Sonos also relies on one-time hardware sales while maintaining lifetime responsibility for software maintenance and upgrade expenses inside the speakers and multi-room solutions. The revenue model is front-end loaded while the cost structure has a long tail.

Our field contacts suggest Sonos could face significant challenges if hardware sales growth slows as the cost of maintaining the software in existing speakers and systems can’t be reduced. The only potential lever is sales and marketing expense, which would slow the topline further. We believe this slowdown is fast approaching as one field contact noted signs of demand starting to peak as early as Q1 2021.

On February 9, 2022, Sonos reported Q1 2022 results with revenue growth of 3% relative to increased guidance of 14% to 16% growth for the fiscal year, citing confidence in the backlog and easing supply chain constraints for the expected sequential improvement. Looking under the cover, 3% growth implies units sold declined sharply when factoring in the high-single-digit unit price increases during the quarter. To hit its FY 2022 guidance, Sonos must see a significant rebound in units sold through the remainder of the fiscal year, generally its slowest period (non-holidays).

We are aware of the bull story that Sonos is really a software company with a large runway to penetrate the premium home audio market, along with a margin expansion story as the company continues shifting towards the higher margin DTC channel. However, we do ask ourselves if this is plausible when we see insightful company insiders aggressively selling stock. For instance, the CEO, who routinely sold stock in $1 million to $2 million increments throughout 2021, decided to sell $21 million of stock in January 2022 with the stock 30% off its highs. In addition, the Chief Commercial Officer aggressively sold all of his sellable stock during the second half of 2021 with the stock falling and sold another $2.4 million of stock at $25/share in March 2022, a month after the company raised revenue guidance. Seems odd that they would do this if they were true believers.

In summary, we believe Sonos’ business results will revert to pre-COVID levels when the stock traded between $10 and $20 per share. Its stock currently trades at a 1.6x EV/sales multiple, a meaningful premium to its pre-COVID range of 0.7 to 1.0 times. We believe the company will miss its 2022 guidance and the stock will trade closer to 1.0 times, or $15 per share, 35% downside from current levels.

Catalyst

Earnings