Another day, another upgrade. Sander Morris Harris
KEY POINTS
* We hosted a series of investor meetings with Sonus Networks management on
December 12. While management did not say anything new on near-term trends,
their comments on customer and market traction, combined with our industry
checks, continue to keep us confident on business momentum and suggest
potential upside to our estimates.
* While we are modeling Q4'06 down sequentially from the September quarter's
record levels due to revenue recognition timing issues, our checks indicate
that Q406 orders could achieve record levels (around $90 million), driving
strong visibility into early 2007.
* We believe there could be upside to our 2007 revenue growth estimate of 22%.
We base this on a VoIP market growth rate that is likely to continue in the
20% to 25% range, especially with momentum among Tier 1 carriers, and Sonus
growing at or above market pace. We also believe there is upside to our
operating margin estimate of 16.6% for 2007 as Sonus consistently achieves its
operating margin at a targeted 17% to 20% by mid-2007.
* We believe Sonus is building momentum globally with Tier 1 carriers: 1). We
expect orders to rebound in the U.S. in December driven by Cingular and early
adopters, including Global Crossing and Level 3. We also believe that Verizon
has started to contribute significantly to orders starting in Q3'06 and
continuing into Q4'06; 2). We believe Japan will likely remain a strong
contributor over the next few quarters, with KDDI potentially representing a
$100 million-plus opportunity in the next couple of years; 3). We believe
Europe is the largest incremental revenue opportunity for Sonus in 2007. DT is
undertaking a large network deployment with Sonus for all enterprise VoIP
customers, which should contribute to revenue in early 2007. In addition,
several other wins, including C&W, will likely drive significant revenue
growth in 2007.
* We believe that while Tier 1 carriers are focusing on VoIP infrastructure
deployments, the competitive landscape still appears to be weak, with
incumbent voice vendors focusing on mergers and combinations rather than VoIP
technology leadership and product development.
Raising price target to $7.50. At $6.61, Sonus shares appear somewhat fully
valued, at 27.5 times our 2007 EPS estimate of $0.24 (we use a 10% tax rate).
However, given the company's leadership in an important segment of comm.
equipment that is benefiting from reallocation of spending, solid near-term and
long-term growth prospects, and an approaching inflection point in the VoIP
market that could make our 2007 estimates conservative, we think Sonus deserves
a premium multiple to the comm. equipment group. We are therefore establishing
a new 12-month price target of $7.50, which represents a 31 times multiple on
our 2007 EPS estimate of $0.24. We believe investors will start focusing on
2008 estimates in the next couple of quarters. Given a strong growth rate for
earnings and revenue, the multiple on our 2008 estimates will be more
attractive. We are maintaining our Buy rating and would recommend purchase at
current levels. Our previous 12-month price target was $6.
Continue to expect next 12 months will represent an inflection point for the
VoIP market and Sonus. The landscape in the VoIP market continues to evolve,
driven by: 1). growing VoIP penetration into the trunking market - Sonus has
established itself as the leader in the trunking VoIP architecture market, with
market research indicating over 30% share. While this segment of the VoIP
market represents most VoIP equipment revenues, we believe there are significant
growth opportunities in the market over the next few years given robust growth
in long-distance traffic, especially on wireless networks, and low penetration
of VoIP infrastructure into this market (only 20% of long-distance traffic
passes over VoIP networks); 2). carrier and vendor mergers - while carrier
migration creates the need for better end-to-end equipment suppliers, we believe
"best of breed" vendors will continue to have a strong position in
next-generation technology markets. The positioning of best of breed vendors
like Sonus as a second supplier could improve via the merger of incumbent
vendors; and 3). carrier focus on Voice over Broadband (VoBB) and IP Multimedia
Subsystems (IMS), the converged wireline/wireless network architecture going
forward - Sonus is one of the early leaders in the VoBB market and has won deals
with leading VoBB providers, such as Vonage and AT&T CallVantage, as well as
international Tier 1 carriers planning to implement VoBB, including KDDI and
Japan Telecom. IMS represents an exciting and potentially very large revenue
opportunity for VoIP vendors, and we believe this market is still in the early
stages of evolution. While incumbent vendors such as Alcatel Lucent have
enjoyed some early design wins at Tier 1 carriers, we believe there is
significant opportunity for technology leaders like Sonus to control a
disproportionate segment of this market as real deployments of large-scale
systems begin. We believe incumbent voice equipment vendors, especially
international incumbents, lag the technology leaders like Sonus in offering
truly scalable and software-rich IMS solutions, creating the opportunity for
wins and potential partnerships for Sonus.
Key Risks
Weak financial controls including material weakness in internal controls;
revenues will be lumpy given the early stage of this market; customer
concentration |
