Sonos IPO: will its strategy fall on deaf ears?

Having made a name for itself by providing home sound systems with high-end audio quality, Sonos has announced it is going public. But can the company find its place in the growing and highly competitive smart speaker and virtual assistant market?

Market data
Source: Bloomberg

Sonos has been expected to list in New York for some time, and the company has now confirmed it is looking to join the NASDAQ sometime later this year, with August touted as a likely month for it to be completed.

The company has long been a pioneer in its industry, focused on providing top-notch audio through its range of speakers that encourage customers to build a home sound system rather than just buying one product. It was the first company in the world to release a wireless multi-room home sound system in 2005 and now its new generation of products has hit the shelves as Sonos tries to find its feet in the next generation of products: smart speakers equipped with voice assistants. The problem is, Sonos does not have a voice assistant of its own, leaving it highly dependent on the big tech firms that have developed the technology. But these firms, like Amazon, Apple and Alphabet’s Google, all have smart speakers of their own.

Sonos IPO: how much is it raising and at what price?

Earlier targets had laid the expectation that Sonos would go public with a market valuation lingering somewhere near the $3 billion mark, but having priced its initial public offering (IPO) at between $17 and $19 per share to raise a maximum of $264 million, Sonos is set to boast a value closer to $2.2 billion based at the midpoint of the proposed price. However, the firm has said the IPO price could change before it actually lists, leaving its initial valuation up for debate.

Sonos is to sell 5.6 million shares in the business under the IPO to net about $100 million at the midpoint of the proposed price range, with existing shareholders to offload about another 8.3 million shares for $150 million.

Shareholder Before IPO After IPO After IPO w/over-allotment
KKR Stream Holdings 25.7% 22.4% 21.9%
Index Ventures* 13% 12.2% 12.1%
Founder John Macfarlane 12.9% 7.6% 7.2%
Valdur Koha 7.4% 6% 5.8%
Redpoint Ventures 5.2% 4.9% 4.8%
CEO Patrick Spencer 1.5% 1.4% 1.4%
All board members 16.3% 15.4% 15.2%

(*Representing chairman Michaelangelo Volpi’s stake)

All of the existing major shareholders of Sonos, including its board of directors, intend to sell off a fraction of their holdings under the offering to maintain substantial stakes in Sonos after the IPO. Although the founder of Sonos, John Macfarlane, is selling off a chunk of his shareholding potential investors will welcome his name on the register. Macfarlane stepped down as chief executive in early 2017 to make way for current CEO and long-time executive Patrick Spence to takeover, in what the founder described as a ‘magical moment’ for the business.

Investors wary of Sonos as hardware companies fall out of favour

Sonos will start life as a public company in a stronger position than many other hardware or software companies that have come to market in recent years. The company has delivered 12 consecutive years of revenue growth and the firm was profitable in the latest six month period, but it still has a long way to go with cumulative net losses of $175 million over the three and a half years to the end of March 2018.

($, millions) 28 Sep 27 Sep 3 Oct 1 Oct 30 Sep 1 Apr 31 Mar
2013 2014 2015 2016 2017 H1 17 H1 18
Products sold (units) 1.5 2.9 3.4 3.5 3.9 2.4 3.1
Revenue 441.9 774.5 843.5 901.3 992.5 555.4 655.7
Gross profit 209 349.3 382.1 403.4 456.1 245.9 277.5
COSTS              
Research and development (R&D) 44.6 70.6 100.7 107.7 124.4 57.6 68.8
Sales and marketing 124.8 204.8 272.4 258 270.2 137.2 153.3
Admin 34 46.9 64.8 68.5 77.1 35

43

Operating profit 5.6 26.9 (55.7) (30.9) (15.6) 16.1 12.6
Adj EBITDA margin 5.4% 7.3% (0.5%) 3.3% 5.6% 8.8% 7.7%
Pre-tax profit 6.2 23.3 (65.5) (35.6) (16.5) 13.2 13.8
Net income  8.5 21.9 (68.8) (38.2) (14.2) 15.3 13.1

Sonos has also made it clear that the latest profit should not be taken as a sign of things to come, the company spending on developing new products to squeeze its margins going forward. Like so many tech companies, the immediate challenge for Sonos will be maintaining the growth in revenue and demonstrating that sales have nowhere near reached their peak.

($, millions) 2015 2016 2017 H117 H118
Net operating cash flow 38.7 43.3 64 60.7 4.6
Net investment cash flow (65.5) (52.5) (33.6) (12.4) (21.9)
Net financing cash flow 35.6 8 24 19.1 2.3
Net cash flow 5.7 (1.4) 55.7 67 (12.8)

Sonos looks likely to join the market with a value equal to about three times its annual revenue, whereas tech companies focused on software like Facebook and Twitter are currently valued at 12 to 13 times their most recent annual revenue figure. This is because the margins and profits attached to hardware are considerably lower than that of software companies, and due to the poor performance of other hardware firms that have disappointed since going public.

GoPro, known for wearable HD cameras, listed in the middle of 2014 with an IPO price of $24 per share and wearable fitness tracker maker Fitbit followed a year later at a price of $20 per share. Today, GoPro shares trade below $6.5 while Fitbit is south of $6.

Sonos: what does it do and how does it do it?

In a nutshell, Sonos makes money by selling its range of hardware through 10,000 third-party physical retail stores, on e-commerce platforms like Amazon and on its own website. All of its products are controlled by its own Sonos app, which also gives access to content and services from a slew of tech partners like Spotify and Amazon for people to get the most out of their sound system.

Read more about Spotify learning the tough lessons of going public

The unique part of the business model is that they sell multiple products to create a home sound system. On average, a customer that purchases a single Sonos product will end up having a total of two or three Sonos products four years later, while those that initially purchase a bundle of three Sonos products end up having five products in their homes four years later. Customers returning to expand their sound system is integral: 38% of all sales in the last financial year were made to customers that already owned a Sonos product.

At the end of March Sonos estimates it had over 19 million products in 6.9 million households worldwide, with nearly half of them opening the Sonos app on a daily basis. Back in 2013 there was only 1.2 million households using Sonos products.

Revenue ($, millions) H1 2017 H1 2018 % of total
Wireless speakers 296.5 359.3 55%
Home theater speakers 183 217.2 33%
Components 69.8 71.2 11%
Other 6 7.9 1%

 

Sonos products are currently sold in over 50 countries around the world, but the US remains its number one market and accounts for 45% of all revenue. There are still some major markets that Sonos is yet to enter, with ambitions of opening up in the likes of Japan – the world’s second largest music market – in the future.

Revenue ($, millions) H1 2017 H1 2018 % of total
Americas 273.9 324.7 50%
Including: the US   245.8 296.1 45%
Europe, Middle East and Africa 253.5 253.5 253.5
Including: the UK 68 70.5 11%
Germany 60.3 77.2 12%
Asia Pacific  27.9 31.7 5%


Its biggest wholesale customer in the US is Best Buy, which accounted for 17% of all revenue in the latest six-month period, while its European distributor ALSO Group that distributes Sonos products to Germany, Sweden, Denmark and Norway accounted for 12%.

Although it designs its products it does not manufacture them itself. This is instead outsourced to a company in China named Inventec which ships products to Sonos distribution facilities, mostly to its one in California in the US and its one in the Netherlands that serves its European operations. Notably, either Sonos or Inventec can cancel this deal with 180 days’ notice, posing a possible threat especially as the Chinese firm is also responsible for sourcing the vast majority of components needed to build Sonos speakers: Inventec is not only the manufacturer but effectively the supply chain.

Sonos vows to keep platform open to reveal reliance on partners

‘Our system is not—and never will be—an entry gate into a walled garden. We’re deeply committed to keeping Sonos open to every voice assistant, streaming service and company that wants to build on our platform,’ – Sonos.

Before we started connecting all our devices in our home, companies like Sonos and Bose were focused on providing superior audio at a time when ever-smaller devices and flat-screen televisions were being developed at the sacrifice of sound quality. Now the race is on for the next wave of speakers, the smart ones equipped with voice assistants.

Sonos claims the openness of its platform is ‘unique in our industry’. But being unique is not always a positive. The Sonos One smart speaker that was released last year was the company’s first voice-enabled speaker that was equipped with Amazon’s Alexa voice assistant. The latest Sonos product to hit the market, the Beam soundbar that forms part of a larger sound system, also utilises Alexa and there are plans in the pipeline to integrate voice control by Apple’s Siri via Airplay 2 and Google Assistant in 2018.

Read more about how Chinese tech company Xiaomi has performed since listing

Equipping its speakers and systems with a voice assistant is essential and the fact Sonos has to rely on the likes of Amazon for such a vital part of its product is a cause of concern. The big tech firms that are most aggressively pushing their smart speakers are not trying to make profit from flogging hardware, which may leave some scratching their heads at the opportunity Sonos, a hardware business, actually offers.

Read more about whether Amazon is valued correctly and where the company is headed next

Amazon has its own range of speakers which it is pushing vigorously into the market. Not because it makes a ton of profit from selling them, but because the task at hand is to get as many people using them as possible so they use it to order more Amazon products and services (like its music and video streaming services) and to install a hub in as many homes as possible that is able to provide a rich flow of invaluable consumer data. Amazon’s Echo range of speakers were among the best sellers in the e-commerce giant’s recent Prime Day sale, and up to half of all Amazon customers are expected to have an Echo in their home following the event.

At the bottom line, a smart speaker from Sonos without a voice assistant or access to the services and content that customers want is not smart. It therefore is in the pockets of those providing such valuable internet services like Apple, Google and Amazon. Yet all three of them have their own rival smart speakers. While they can comfortably afford to lose Sonos, Sonos cannot afford to lose them.

Read more about Amazon vs Google in the battle of the tech giants

That might sound pessimistic. Apple is the only one solely targeting the upper end of the smart speaker market to rival the Sonos One’s price tag of about $199. The others, with the view of shifting volume rather than making money, are making cheaper models that vary between $30 and $100. Plus, Sonos provides another channel for these firms to reach more customers. But regardless of the likelihood that one of these big players could pull out, investors need to be aware that the threat is very real. The company admitted in its prospectus that Amazon could ‘disable the Alexa integration in our Sonos One and Sonos Beam products with limited notice’.

Sonos: focus on music should help as streaming services grow

Sonos has partnerships with over 100 streaming services and the likes of Radio by TuneIn is built directly into its products. Music has always been at the heart of the company, but it is branching out by adding the likes of podcasts and audiobooks through Audible (also owned by Amazon).

While music streaming services have seen rapid growth and accumulated substantial pools of subscribers – Spotify’s most recent figures showed it had 180 million on the books – Sonos believes this is just a fraction of the market potential. Using data from Kagan, the company claims there is nearly 860 million households currently hooked up to broadband internet and they expect 55% of households in the US to have at least one voice-enabled device by 2022.

Usage is also rising. Sonos customers listen to about 70 hours’ worth of content each month and according to the company, they listen to 80% more music after purchasing their first Sonos product – a testament to the company’s sound quality and software. Overall, Sonos customers consumed 33% more audio content in the last financial year than the year before.

For some rough perspective, data from Nielsen suggests that the average increase in the amount of time spent by Americans listening to music in 2017 was about 37% compared to two years earlier, consuming about 32 hours per month – considerably lower than the average for Sonos customers.

Sonos: focus on audio quality should help capture potential of music streaming

The firm believes the rise of voice assistants is being driven by their uses for music, claiming that industry data shows 75% of consumers use voice-enabled smart speakers to stream music. However, how people use these speakers will change over time, with Sonos expecting half of all web searches to be conducted by voice by just 2022.

Read more about how EVR Holdings is turning virtual insanity into virtual reality

Sonos gives out mixed message to the market

‘We are at our core a software company. We just happen to monetise through hardware,’ – Spence, May 2018.

Sonos believes the software side of the business is underappreciated by the market. While it needs companies like Spotify to provide the services and content that customers want it, does trumpet its own software development. This includes all the subtle features like the ease of controlling multiple speakers through the app and the ability to access third-party apps through said app to prevent the need for users to constantly switch between services.

The company had 630 patents and over 570 patent applications pending at the end of March and spending on research and development (R&D) has increased at a faster pace than revenue since 2013. Sonos spent equal to 12.5% of its annual revenue in the last financial year on R&D, up from 10% in 2013. 

Learn more about our guide to smart speakers and virtual assistants

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