Also appears to be some type of analyst day with SBSH on Monday, no link to it that I can find so will need to wait and see.
results of the meeting.
Our MeetingWith Mgnt Reaffirmed Our Belief That Sonus’ Biz Is Strong, Its IMS
Offering Is Strong And At These Levels, Investors Should Be Buyers Of Its Stock.
We recently hosted a meeting with clients and Sonus’CEO, CTO and COO, at the
company’s headquarters. The meeting was well attended and management’s tone was
noticeably upbeat. Management left us with the impression that business is strong,
management’s confidence in solid improving results, and they reminded us that the recent
financial statements do not tell the whole story, with good momentum beneath the surface.
While Sonus’most recently announced quarters have been less than impressive,
management, given its ability to see the company’s business both on and off the financial
statements, is seeing a very different and more positive picture. While management
refrained from addressing the current quarter, we think the positive tone of the meeting
spoke of the company having made significant progress. In the meetings we were able to
address several issues at the forefront of investor thinking in regards to the stock.
? Sonus’ Position As The Primary Class-4 Replacement VoIP Equipment Provider To
Cingular Is Secure And Continuing To Grow, According To Mgnt. There has been a
groundswell of concern over Sonus’ status at Cingular following the Lucent IMS contract
win at the wireless carrier. Investors have been speculating that Cingular, due to
interoperablity concerns, may decide to cap its investment in Sonus gear and give all of
its IMS/VoIP business to Lucent. Sonus’management adamtantly stated that its business
with Cingular is strong, and there have been no discussions with, or indications from the
carrier that it is looking to cease purchasing equipment from Sonus. According to Sonus’
management, the idea that interoperability between Sonus’ and Lucent’s gear is an issue,
is “garbage”. Sonus’ equipment is in a completely different portion of the Cingular
network than Lucent’s. Sonus is providing class-4, long distanct trunking for the carrier
while Lucent’s equipment will be placed on the access side of the network. Additionally,
the very premise of IMS is that it’s an open architectural approach to networking,
enabling carriers to leverage best of breed solutions on a standardized platform. This is,
one of IMS’most appealing characteristic for carriers.
? We’re Still In The Very Early Stages Of IMS Deployment, And LU’s ContractWin
Will Likely Do More Good Than Harm To Sonus’ Business. In the data networking
world, we recently witnessed a large incumbent vendor, Cisco Systems, announced its
intended foray into an emerging market (layer 4-7 switching), poised for significant
growth acceleration. Leading this market is F5 Networks, a much smaller, more nimble
equipment vendor with superior technology. While the announcement of Cisco’s
entrance into the layer 4-7 market initially hurt F5’s valuation, F5 actually saw its
business accelerate as Cisco’s announcement thrusted the layer 4-7 space into the
limelight and into the forefront of customer thinking. We believe investors should draw a
number of parrallels between that scenario and what has just taken place between Lucent
and Sonus. We view Lucent as being similar to Cisco, as the large incumbent entering an
emerging market, while we view Sonus as being similar to F5, in that it is leading the
market, due largely to its superior technology. VoIP/IMS, relatively speaking, is a small,
high growth market poised for a dramatic expansion, in our view. We believe Lucent’s
announced IMS contract wins have created the catalyst needed to accelerate this market
and bring IMS to the forefront of customer thinking. Sonus confirmed this viewpoint by
citing a noticeable heightening of the intensity of its discussions with IMS customers and
we think potetnially an accelerating commitment to the deployment of this technology.
This comparison between F5 and Sonus has one key difference however. While F5,
benefitting from the heightened attention now paid to layer 4-7 switching, went on to
outperform street expectations for the quarters subsequent to the Cisco announcement,
the same cannot be said of Sonus, with any degree of certainty, due to its revenue
recognition policy and the nature and timing of deployments in the telecom equipment
world. We think the results at Sonus will reaccelerate and these shares should rebound.
We believe IMS drives to standards based on SIP and Diameter protocals and less to the
older ATM based protocols used in the Legacy Class 5 implementations. From the get
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go, these have been the heart of the Sonus design. We think Lucent has managed to get
on this architecture, but we think a number of the other incumbants are further behind on
this transition.
FromATechnology Standpoint, Sonus’Original VoIP OfferingWas Best Positioned For
The Evolution To IMS, Enabling Sonus To Gain A Jump Start On Most Others. To be
clear, IMS (IP Multimedia Subsystems), in terms of being incremental to the VoIP
movement, is nothing more than a set of standardized functions and interfaces. It is simply a
widely agreed upon network architecture approach, which was first advocated and promoted
by the service providers. The equipment providers have rapidly adopted IMS as the
standard, rendering the network architectural wars over. IMS mandates that SIP (Session
Initiation Protocol) be used as the signaling protocol to set up and tear down sessions within
the network. Sonus’ original VoIP offering leveraged SIP from the very beginning, a claim
none of its competitors can make. We note however that Lucent’s acquisition of Telica also
positioned its VoIP portfolio favorably, as it pertains to adapting it to the IMS architecture, as
it also leveraged SIP as its signaling protocol. Lucent’s acquisition of Telica however only
provided Lucent with a few components of the IMS portfolio whereas Sonus can provide a
complete solution today.
GSX4000 Signifies Sonus’Entry Into A Sizeable MarketWith Real Barriers To Entry.
Sonus has already made significant progress with its GSX4000 with orders already on the
table. The sales cycle of the GSX4000 is considerably shorter than that of equipment sold in
the TDM world, or even that of the GSX9000. This is particularly true for existing Sonus
customers with GSX9000s already deployed, looking to fill in the ‘gaps’ of their VoIP
networks. We think the GSX4000 expands Sonus’ addressable market by 50%. With this
product, domestically, Sonus is entering a market in which competition is essentially limited
to one other vendor, AudioCodes. Based on Sonus’ reputation in the high density media
gateway market, and AudioCodes’ own endorsement of the product’s capabilities at our
technology conference in September, stated that the GSX4000 should prove to be a very
competitive product, we think Sonus’ product here will be successful. Additionally, in our
meetings with management, Sonus echoed AudioCodes’ sentiment that the low density
media gateway is a very different product, technologically, than the high density media
gateway. Sonus added that it took the company about a year’s worth of R&D to develop this
product, despite the fact that Sonus’VoIP skills are considerable, and it already had a head
start in that it was working off the GSX9000’s base. We think it would take considerably
longer for an equipment vendor with lesser IP skills, to bring such a product to market. As a
result, we think the barriers to entry in the low density media gateway market are
considerable, while the benefits to it are likely not enough of a lure for a large equipment
vender with an annual revenue base in the billions. Smaller companies such as Sonus
however, could stand to benefit in this arena.
While Management May Have Spoken Too Soon, Disappointment In Sonus’Access
U.S. DealWins Can Be Largely Attributed To Several External Factors And Future
MomentumWill Likely Be Better. At the beginning of 2005, Sonus management stated it
believed the company would begin to generate more revenue from VoIP access business, on
a run rate basis, at some point in 2005. In the United States, this did not meaningfully
materialize, but we believe this is more a function of a slower developing market than
anything else. We continue to note that Sonus has deployed more access VoIP
implementations than any other vendor, but these deployments are primarily in the Asia
Pac/Japan geographies. The U.S. performance reflects a number of factors outside Sonus'
control that played into the disappointing 2005 access market.
• Consolidation Shrunk The Competitive Landscape, Dulling The Competitive
Impetus For Service Providers To Offer Residential VoIP Quickly.With the
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repealing of the UNE-P rules, VoIP and potential VoIP service providers such as
AT&T and MCI found themselves without a workable business model, ultimately
leading to them being acquired by larger carriers. In particular, AT&T’s VoIP
offering, CallVantage, was stalled for the majority of 2005, until its acquisition by
SBC was completed. Prior to the merger announcement, we expected AT&T to be a
10% customer of Sonus in 2005. We also expected rollouts like AT&T’s to provide
the necessary competitive impetus to force the larger local exchange carriers and
cable companies to aggressively market and deploy VoIP, funneling more business
in Sonus’ direction. The market now appears to be developing at a more measured
pace, boding well for 2006 and beyond, however rendering 2005 a lost year for
Sonus in class 5.
• Slow Adoption Of Broadband, Domestically—Need To Deploy The Footprint
Before The Applications Are Needed. The rollout of FTTX fiber deployments and
the conversion of the North American service provider infrastructures to an all IP
network topology is underway. But the first phase is primarily focused on rolling
out the connectivity/the broadband pipes. Due to the cost and complexity of class 5
VoIP deployment, it is now clear that VoIP will be delivered to the customer over a
broadband connection. This pegs the speed of VoIP deployment to the pace of
broadband deployment, which has been slower than hoped for by many in the
industry. Once broadband penetration achieves critical mass, we think VoIP
deployments will follow suit and Sonus will be one of the main benefactors. We
point to Sonus’ success in Asia Pacific as an indicator of what should take place in
North America. Broadband penetration rates are significantly higher in Asia Pacific
than they are domestically, and Sonus has won more than its fair share of business
there as a result.
• Sonus Has Demonstrated Its Ability To DeployWorking Access VoIP/IMS
Deployments In Japan Where Its The Market Leader. While the U.S. market
has had imbalances and infrastructure deployment issues, Sonus has had
considerable success in Japan at Fusion, Yahoo Broadband, KDI and NTT
deploying access footprint and IMS like application delivery. Sonus has more
successful access deployments than any other vendor. We think the success in the
international markets and the shift to a technology footprint that’s highly compatible
with the SIP/Diameter based portfolio of products offered by Sonus bodes well for
the comapny in being a key supplier into the U.S. Service providers over time. We
strongly doubt that the U.S. service providers will choose a single vendor approuch.
We note that in the closed architecture world of traditional Class 5 gear there are no
single sourced service providers. Its easier to be multi vendor in an open systems
environment so its highly likely there will be multiple equipment vendors at every
service provider over time. Sonus appears well positioned to be among the top 3 in
this arena and is currently the leader in terms of existing deployments.
Changing Business Model At Sonus Reflects Deployments Based More On Subscription
Models—Future Revenues Should Smooth AsAdoption Drives Subscription Annuities.
Historically, Sonus has generated revenues primarily from port deployments in hardware
infrastructure build outs. Over time, this model is likely to gradually shift to more of a
subscription model where service uptake drives annuity revenues in access even as the
hardware ports enabling line termination continue to drive hardware revenues. Earlier this
year, Sonus announced VoIP/IMS contract wins with Earthlink and AOL. In our view, this
indicates Sonus is gaining traction, not just in VoIP, but in the IMS world as well. Sonus’
deployment at AOL provides actual convergence, in this case between voice and instant
messaging. AOL is expected to use Sonus ASX (Access Server) to provide its customers
with a suite of voice and instant messaging products, which integrate voice and multimedia
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applications. This is a more software intensive product, which enables Sonus to charge on a
per subscriber basis, resulting in an annuity stream to the company. As Sonus engages in
more IMS contracts, which require more software intensive products like the ASX and its
new IMX platform, the larger the portion of Sonus’ revenue stream will be recognized by
annuity streams as opposed to one time gateway sales. While it is difficult to determine
when IMS deal flow and software intensive product sales will become meaningful enough to
blunt Sonus’ lumpy revenue line, we view this transition in Sonus’ product portfolio as a
positive not to be understated by investors.
We View RecentWeakness As An Opportunity, AndWe Reiterate Our Buy Rating At
These Levels. Due to a disappointing September quarter earnings release, and the
announcement of several IMS contract wins by Lucent, Sonus shares have been weak of late.
Sonus’ relatively small customer base renders it vulnerable to wild swings in its quarter to
quarter top-line performance. As a result, we urge investors to focus on the company’s long
term prospects. We also think it valid to focus on the company’s year over year growth
rates, as opposed to looking at the quarters on a sequential basis. In our view, Sonus is
clearly the technological leader in VoIP, and has a compelling IMS offering that should yield
the equipment vendor considerable business in the future. IMS is an open architecture that
enables service providers to leverage best of breed solutions, allowing them to build fully
interoperable multi-vendor networks. So while larger, incumbent vendors with large service
and support organizations have an inherent near term advantage in winning IMS deals, we
think Sonus is well positioned to capitalize on this market opportunity in the longer term
when carriers are ready to leverage best of breed solutions.
Despite being a pure play vendor in one of the fastest growing areas of wireline carrier capex
spending, Sonus trades merely in-line on a P/E basis with its telecom equipment peer group,
many of which sport product portfolios laden with legacy equipment. We think the company
should trade at a significant premium to the group and we think the stock is significantly
undervalued at these levels. As a result, we are reiterating our Buy rating on Sonus and our
$7.10 target price. |
