Piper Jaffray & Co.
KEY POINTS:
We are initiating coverage of Sonus Networks with a Market Perform rating and $5.50 price target. We believe Sonus is one of the best positioned companies in the VoIP market, but the current valuation leaves little room for price appreciation.
* Best Pure-Play on VoIP " Sonus is the only pure-play in the VoIP equipment market, which we believe justifies a premium valuation due to the growth characteristics in that space and the company's proven traction with tier 1 service providers.
* Impressive Customer Base " Sonus has an impressive list of customers that includes AOL, AT&T, Bellsouth, Cingular, NTT, Qwest, Time Warner, Verizon, Vonage and others. We believe this premier customer base is evidence the company's media gateways and soft-switches are technologically superior
and provide the carrier-scale reliability needed from tier 1 accounts.
* Backlog and Book/Bill Provide Excellent Visibility " Sonus has experienced solid demand over the past several quarters with a variety of large contracts providing good visibility into future quarters. The company has provided a glimpse of order levels over the past 3 quarters by announcing a book/bill ratio slightly below 2.0x in 2 of the past 3 quarters.
* Voice-over-Broadband Gaining Stride " We believe Sonus is one of the best positioned companies for VoBB deployments and has already landed AOL, AT&T, NTT, Vonage and others. VoBB is still relatively nascent with an estimated 1 million subs exiting 2004 and expectations for 22 million by 2009.
* Valuation " Our $5.50 price target represents 30x our 2006 operating income assumption plus cash. We believe a 30x multiple is appropriate given the growth characteristics in the VoIP space, but also represents one of the highest multiples in the carrier equipment space and our
estimates are not fully taxed.
INVESTMENT RECOMMENDATION:
We believe the VoIP market will experience significant growth over the next decade and view Sonus as one of the best positioned equipment suppliers in the space. The company has landed a variety of tier 1 accounts for trunking
and access applications in both wireline and wireless networks and will benefit once these initial deployments become full-blown VoIP build-outs.
While we remain upbeat with respect to Sonus' position in this market, we believe the stock fully reflects our optimistic view and we see little price appreciation from current valuations. That said, we would become more
aggressive with this name if the stock were to dip or if we saw evidence that existing customers were accelerating their VoIP network build-outs.
RISKS TO ACHIEVEMENT OF TARGET PRICE:
We believe the competitive landscape for VoIP equipment will increase with several larger telecommunication equipment suppliers targeting this space. We also believe Sonus will experience lumpy revenues due to the high degree of customer concentration and large contract sizes with tier 1 customers.
COMPANY DESCRIPTION:
Sonus Networks is a leading provider of packet-based voice infrastructure products for carriers. The company's media gateways and softswitches are a critical component of next generation voice networks that allow service
providers to migrate voice traffic onto IP networks.
Leading Supplier of VoIP Equipment " The emerging VoIP equipment market has a variety of competitors ranging from the large incumbent suppliers (Nortel and Lucent), up-and-coming next generation equipment vendors and a host of
smaller private companies. The VoIP market is one of a select few trends in the carrier equipment market that is expected to experience significant growth over the next decade as carriers begin to migrate phone calls over IP networks. Despite the stiff competition in the VoIP equipment market, we
believe Sonus is one of the best positioned companies in the space and anticipate that the company will capture a significant portion of this multi-billion dollar market.
Strong Customer Base " Sonus Networks has an impressive list of customers that includes some of the industry's leading tier 1 service providers. We believe this is evidence the company's media gateways and soft-switches are technologically superior and provide the carrier-scale reliability needed by tier 1 service providers. The company has announced significant wins with the likes of AOL, AT&T Wireless (now owned by Cingular), Bellsouth, Global
Crossing, Level 3, NTT, Qwest, Time Warner Telecom, Verizon, Vonage and numerous other accounts. We also believe Sonus is in a good position to win the Voice-over-Broadband contract at Verizon due to the company's existing relationship with AT&T. The following exhibit highlights recent customers
that have exceeded the 10% of quarterly revenues.
Rapidly Growing Industry " We believe the VoIP market represents one of the few secular growth stories in the carrier equipment space and should continue to experience meaningful year/year growth well into the future.
Voice infrastructure equipment has historically represented a relatively large piece of overall carrier capital expenditures and this industry is estimated to have exceeded $20 billion annually for the past several years.
This large addressable market has been disproportionately dominated by legacy equipment suppliers of TDM-based infrastructure gear, but the migration to IP is clearly underway and we believe VoIP equipment suppliers
will continue to capture a growing portion of this attractive market.
Sonus is exposed to various different product categories within the VoIP market, but is primarily focused on developing the industry's leading media gateways and soft-switches. The company has a variety of strategic
partnerships with other leading VoIP equipment and applications suppliers and allows carriers the flexibility to select media servers, application servers and session border controllers from a list of certified third-party
partners. This has allowed customers the ability to select best-of-breed technology that fits their specifications.
Looking at the two markets that Sonus is most exposed to (media gateways and Soft-switches), research firm IDC has estimated that both markets will experience rapid growth and reach multiple billions of dollars over the next
few years. The media gateway market is expected to grow from roughly $1.0 billion in 2005 to $5.4 billion in 2009 for a compounded annual growth rate of approximately 38%. This information is highlighted in the following exhibit.
Looking at the softswitch portion of the VoIP equipment market, IDC is estimating that soft-switch sales reached $886 million in 2004 and are expected to grow to $5.1 billion in 2007. This equates to a compounded annual growth rate of approximately 90%. The following exhibit highlights
IDC's forecast for the worldwide soft-switch market.
Growing Backlog and Impressive Book/Bill Provide Excellent Visibility "Sonus has experienced solid demand over the past several quarters with a variety of large contracts providing good visibility for future quarters. We believe Sonus has landed a variety of new deals throughout 2005, but hasn't
been able to announce these wins due to competitive concerns at the carrier level. The company has provided a glimpse into order levels over the past few quarters by announcing a book/bill ratio slightly below 2.0x for Q4 2004 and Q1 2005. This equates to orders of roughly $150 million during that 2 quarter time frame. We believe the traction on the order side will begin to work its way through the income statement and anticipate the company will post solid results in the back half of 2005 and throughout 2006. We would like to caution investors that Sonus' revenues will likely be lumpy over the next 4-6 years, so we would not be surprised to see a down sequential quarter followed by a quarter of significant upside (similar to the results in the first half of 2005).
Growth Initiatives Include Wireless and Partnerships " Sonus has done a fantastic job winning business from leading service providers, but a majority of the success has been limited to wireline carriers in North America. We believe Sonus has turned the company's focus on expanding into
international markets and targeting the wireless VoIP opportunity. We are very optimistic with respect to 3 announced partnerships, which include China Putian, Motorola and Samsung. The China Putian partnership was announced in November 2004 and should help Sonus penetrate some leading
carriers in China. The Motorola and Samsung deals are primarily focused at the wireless opportunity with Samsung targeting Korea and other select Asian geographies and Motorola targeting Europe, Middle East and Africa. |
