Sonos is one of the world's leading brands in the global audio market. Like many other companies, Sonos faced challenges in fiscal years 2022, 2023, and 2024 due to factors that will be discussed later in this analysis. Nonetheless, Sonos has an intriguing business model, and management is confident that the company will continue to grow. But does this make Sonos a good investment? This is what I will explore in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Sonos. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in Sonos' competitors either. Thus, I have no personal stake in Sonoss. If you want to purchase shares or fractional shares of Sonos, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
The Business
Sonos, founded in 2002, is an American company specializing in premium audio products, best known for its multi-room wireless audio systems. A pioneer in the sound experience industry, Sonos introduced the world’s first multi-room wireless sound system in 2005. Over the years, the company has expanded its product lineup to include wireless, portable, and home theater speakers, as well as headphones, components, and accessories. In June 2024, Sonos entered the personal listening category with the launch of Sonos Ace, marking its debut in the headphones market. As of fiscal year 2024, the average household owned 3.1 Sonos products, up from 3.05 in the previous year, with existing customers accounting for 44% of new product registrations. This highlights the strong loyalty and engagement of its customer base. Sonos generates revenue through multiple streams, primarily from the sale of its audio products, including wireless and home theater speakers and system components. Additional revenue comes from partnerships with companies like IKEA and Sonance, third-party accessories, licensing, advertising, and subscription services such as Sonos Radio HD and Sonos Pro. Geographically, the Americas region is the largest revenue driver, contributing 66% of total sales, with the United States alone accounting for 61%. The EMEA region follows with 28%, and the APAC region contributes 6%. Sonos benefits from a moat, anchored by its brand leadership, proprietary software, and open platform. Its software enables seamless integration with popular streaming services and allows for frequent updates, enhancing both functionality and user experience. The company’s design philosophy emphasizes high-quality sound, sleek aesthetics, and user-friendly simplicity, which resonate strongly with its audience. By the end of fiscal 2024, Sonos had nearly 50,4 million registered products across 16,3 million households globally, with 39% of households owning more than one product.
Management
Patrick Spence is the CEO of Sonos, a role he has held since 2017 after joining the company as Chief Commercial Officer in 2012. Prior to his tenure at Sonos, Patrick Spence held various leadership positions at RIM/BlackBerry. He holds an Honors Degree in Business Administration from the Richard Ivey School of Business at the University of Western Ontario in Canada. Since becoming CEO, Patrick Spence has led Sonos through tremendous growth, transitioning the company from focusing solely on hardware products to also monetizing services like Sonos Radio HD. Patrick Spence has emphasized that great leadership involves not being involved in every detail but ensuring that the right people are in the right roles. During the pandemic, he led by example by taking a 20% pay cut, a measure he later extended. Patrick Spence has also been outspoken about his concerns regarding the dominance of companies like Google and Apple, which he believes stifles competition and suppresses innovation. His efforts and achievements have earned him recognition as one of Canada’s Top 40 Under 40, a program that honors exceptional achievers, visionaries, and innovators in Canadian business. Patrick Spence is well-regarded by Sonos employees, as evidenced by his 84 rating on Comparably, which places him in the top 5% of CEOs at companies of a similar size. He has also received positive feedback on Glassdoor, further reflecting his leadership qualities and respect within the organization. Based on his leadership, experience, and innovative approach, I am confident that Patrick Spence is the right person to guide Sonos in the right direction and ensure its continued growth and success.
The Numbers
The first metric to examine is the return on invested capital (ROIC). Ideally, we seek a 10-year history with all figures consistently exceeding 10% annually. However, since Sonos went public in September 2018 and its fiscal year ends in September, we only have data from 2019 onwards. Unfortunately, Sonos has delivered a negative ROIC in four out of the past six years, which is far from ideal. There are several reasons for the negative ROIC in the past two years. Sonos has faced significant macroeconomic challenges, prompting the company to make substantial investments in marketing and research and development to maintain its market share. Additionally, the company encountered issues with product launches, particularly with its new app, which negatively impacted revenue. Moreover, a decline in revenue combined with an increase in operating expenses has further pressured margins. Management has implemented measures to improve ROIC moving forward, aiming to return Sonos to positive ROIC levels. While these efforts are promising, the current numbers remain underwhelming. If I were to consider investing in Sonos, I would need to see clear signs of improvement in ROIC over the coming periods.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. We only have data from 2019 onward, as Sonos made its IPO in September 2018. Sonos managed to grow its equity steadily until 2021, but it has since declined year over year as the company began facing various challenges, as previously mentioned in the analysis. Management has implemented measures aimed at improving the company, which will be discussed later in this analysis. These efforts are expected to help stabilize and improve equity moving forward.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Sonos has managed to deliver positive free cash flow in five out of six years since its IPO, which is encouraging. Notably, the company delivered its second-highest free cash flow ever in fiscal year 2024, despite it being a challenging year. The increase in free cash flow during fiscal year 2024 can be attributed to working capital improvements, driven by Sonos' efforts to better manage inventory. Management has indicated a continued focus on improving free cash flow through effective cash management strategies, which should support further increases in free cash flow moving forward. Additionally, the levered free cash flow margin increased in fiscal year 2024, reaching its third-highest level since the IPO. This is another positive sign, particularly given the challenges Sonos faced during the year. Furthermore, the free cash flow yield is at its highest level ever, suggesting that Sonos may be trading at an attractive valuation. However, this is a point that will be revisited later in the analysis.
Debt
Another important aspect to consider is debt. It is essential to evaluate whether a business has a manageable level of debt that can be repaid within a three-year period, typically determined by dividing total long-term debt by earnings. After analyzing Sonos' financial statements, I found that the company has no debt. In fact, Sonos has been debt-free since 2020. I personally favor companies without debt, as it allows for greater financial flexibility and reduces risk. Considering that Sonos has maintained a debt-free position for several years, it is unlikely that debt will become a concern in the future. This financial stability is a positive aspect of the company's overall profile.
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Risks
Macroeconomic factors pose a significant risk to Sonos because its products and services are considered consumer discretionary items, meaning their demand is closely tied to economic conditions. Sonos' products, including wireless speakers and home theater systems, are non-essential purchases. During periods of economic uncertainty or global recession, consumers tend to prioritize essential spending and cut back on luxury or premium goods. This dynamic was evident in fiscal years 2023 and 2024, when economic uncertainty, inflation, and high interest rates reduced consumer spending, leading to a decline in demand for Sonos products. Inflation erodes consumers' purchasing power, making them more price-sensitive, while high interest rates increase borrowing costs, further limiting disposable income. These factors have created significant challenges for Sonos, as many consumers delayed or reduced purchases of its products. The audio product category has been under prolonged pressure, and the retail environment remains difficult. For example, Sonos has had to rely heavily on promotional periods like Black Friday and Cyber Monday to drive sales, as consumers increasingly seek discounts and promotions. While this strategy helps support short-term sales, it places pressure on profit margins and is not a sustainable long-term solution. Overall, macroeconomic factors such as inflation, high interest rates, economic uncertainty, and declining consumer confidence directly impact Sonos' ability to sell its products, posing an ongoing challenge for the company.
Competition poses a significant risk for Sonos due to the highly competitive and rapidly evolving nature of the home audio and consumer electronics industries. Sonos faces challenges from a wide array of established and emerging players, including major companies such as Bose, Samsung, Sony, Bang & Olufsen, Sennheiser, Apple, Google, Amazon, and Masimo. These competitors have substantial financial, technical, and marketing resources, allowing them to frequently launch new products, invest heavily in research and development, and implement aggressive pricing strategies. Many competitors subsidize their products to monetize through complementary services, creating additional pressure on Sonos to maintain its pricing structure and protect its profit margins. Furthermore, competitors often leverage broader access to sales and distribution channels, giving them greater influence in the marketplace. Some competitors also engage in significant discounting or permanent price reductions, making it difficult for Sonos to compete on price alone. Additionally, tech giants like Apple, Google, and Amazon bundle their audio products within larger ecosystems, offering seamless integrations with their smart home and personal device platforms. This poses a unique challenge for Sonos, as it must compete not only on product features but also on ecosystem compatibility, an area where these companies have a distinct advantage due to their expansive platforms and customer bases.
The launch of the redesigned Sonos app in May 2024 poses a significant risk for Sonos due to operational challenges and negative customer feedback. The rollout introduced performance issues and missing features, leading to widespread customer dissatisfaction, including complaints about setup difficulties and unreliability. Negative feedback shared on social media and review platforms has further damaged Sonos' reputation, potentially hindering its ability to retain existing customers and attract new ones. These app-related issues have already had a tangible impact on sales, as reduced customer confidence has reportedly lowered demand for existing products. The situation was further exacerbated by the delay of two new product launches originally scheduled for the fourth fiscal quarter of 2024, affecting revenue during a critical sales period. To address these challenges, Sonos has incurred short-term costs of up to $30 million, which includes hiring additional customer support staff and making improvements to the app experience. The app is central to Sonos’ product ecosystem, as it enables setup, control, and integration across devices. Any disruptions in its functionality risk alienating users and discouraging future purchases, thereby undermining Sonos' growth strategy and long-term prospects. These challenges underscore the critical importance of delivering reliable, high-quality software. Persistent issues with the app could result in further reputational harm, increased costs, lost sales, and a weakened competitive position in the home audio market.
Reasons to invest
Sonos' flywheel business model is a compelling reason to consider investing in the company, as it highlights the brand’s ability to generate organic growth and foster customer loyalty. The "Sonos Flywheel" operates on the principle that satisfied customers, or households, make repeat purchases and advocate for the brand, creating a self-reinforcing cycle of growth. This model emphasizes the strength of Sonos’ ecosystem and the loyalty it inspires among its customer base. In fiscal 2024, despite challenging macroeconomic conditions, Sonos grew its base of active households to 16,3 million, adding approximately 1 million new households. This underscores the company’s ability to attract new customers even during difficult periods. Existing households also played a significant role, contributing 44% of new product registrations - a consistent trend that reflects the ecosystem's stickiness. Furthermore, the average number of products in multi-product households increased to 4,42 in fiscal 2024, demonstrating customers’ propensity to expand their collections over time. Once customers enter the Sonos ecosystem, they are likely to invest in additional products to enhance their audio experience, driving repeat purchases. This behavior not only ensures a stable revenue stream from the existing customer base but also strengthens the company’s long-term growth potential. The Sonos Flywheel exemplifies the company’s ability to leverage customer satisfaction and loyalty into sustained business growth.
Sonos’ focus on launching new products is a compelling reason to consider investing in the company, as it highlights its ability to adapt to market trends, expand into new categories, and maintain a competitive edge. Over the years, Sonos has built a reputation for delivering exceptional product quality, and recent launches - such as the Ace headphones, Arc Ultra soundbar, and Sub 4 subwoofer - underscore its commitment to innovation. The Ace headphones mark Sonos’ strategic entry into the premium over-the-ear headphones market, moving beyond its traditional home audio offerings into the personal listening category. This diversification broadens Sonos’ addressable market and showcases the company’s ability to leverage its expertise in sound engineering and its strong customer loyalty. Sonos is also advancing its core product categories. The Arc Ultra soundbar and Sub 4 subwoofer exemplify the company’s focus on cutting-edge technology and design. The Arc Ultra introduces Sound Motion technology, enabling transducers to be three times smaller while delivering twice the bass of its predecessor, all within a slimmer design. This sets the stage for further advancements in compact, high-performance audio. Similarly, the Sub 4 builds on an iconic product by improving audio performance, upgrading its architecture, and incorporating sustainable materials - an appealing feature for environmentally-conscious consumers. Sonos’ strategy of consistently launching at least two new products annually reflects its sustained investment in innovation. By enhancing existing categories, as seen with the Arc Ultra and Sub 4, while expanding into new ones like the Ace headphones, Sonos not only strengthens its market leadership but also unlocks additional revenue streams, reinforcing its long-term growth potential.
Sonos' transformational initiatives present a compelling reason to invest, as they are designed to streamline operations, enhance efficiency, and drive sustainable, profitable growth. Lessons learned from recent challenges, such as the app rollout, have prompted Sonos to refocus on its "Sonos Flywheel" model - acquiring new customers, enriching the experience for existing ones, and driving repeat purchases. This refined focus ensures that strategic priorities are closely aligned with operational execution, positioning the company for future growth. A critical aspect of these initiatives is cost optimization. In fiscal 2024, Sonos began simplifying its organizational structures, expanding offshore capabilities, and leveraging AI tools to reduce costs and improve customer service. These efforts are now being extended into areas such as research and development, as well as sales and marketing, ensuring that investments deliver the highest returns and directly contribute to profitability. By refining internal processes and adopting a data-driven approach, Sonos aims to better understand and target customer needs while identifying growth opportunities. These initiatives are not merely about cost-cutting but represent a forward-looking strategy to optimize operations for long-term success. Sonos remains committed to maintaining the premium quality its customers expect while building a leaner, more efficient organization. This combination of efficiency and strategic investment positions Sonos well to navigate market challenges and achieve sustainable growth and success in the years to come.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. For this calculation, I used an EPS of $0,49 from 2022, the last year Sonos reported positive EPS. I selected a projected future EPS growth rate of 10%, consistent with Sonos' average growth over the past five years. Additionally, I have selected a projected future P/E ratio of 20, which is twice the growth rate. This decision is based on Sonos' historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $6,28. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Sonos at a price of $3,14 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 250, and capital expenditures were 50. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 35 in our calculations. The tax provision was 11. We have 121,8 outstanding shares. Hence, the calculation will be as follows: (250 – 35 + 11) / 121,8 x 10 = $18,55 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Sonos' Free Cash Flow Per Share at $1,11 and a growth rate of 10%, if you want to recoup your investment in 8 years, the Payback Time price is $13,96.
Conclusion
I believe Sonos is an interesting company with capable management. The company benefits from a moat driven by its brand leadership, proprietary software, and open platform. However, its negative ROIC over the past two years is concerning, even though it managed to deliver its second-highest free cash flow in fiscal 2024. Macroeconomic factors pose a significant risk for Sonos, as its discretionary products are highly sensitive to economic conditions. In fiscal years 2023 and 2024, inflation, high interest rates, and reduced consumer confidence led to decreased demand, forcing the company to rely heavily on promotions. While these promotions supported short-term sales, they pressured margins and raised concerns about long-term sustainability. Competition also presents a significant challenge, with well-funded rivals like Apple, Google, Amazon, and Bose frequently introducing new products, employing aggressive pricing strategies, and leveraging their broader ecosystems. This dynamic pressures Sonos’ pricing, profit margins, and ability to compete on features and compatibility. The launch of the redesigned Sonos app added further hurdles. Initial performance issues and missing features led to customer dissatisfaction, reducing confidence in its ecosystem. These challenges impacted sales, delayed product launches, and increased costs, potentially undermining future growth if not effectively addressed. On the positive side, Sonos’ flywheel business model is a compelling reason to consider the company. By leveraging customer satisfaction and loyalty, Sonos drives repeat purchases and organic growth. In fiscal 2024, despite challenging conditions, the company added 1 million new households, with existing customers contributing 44% of new product registrations. This highlights the stickiness of its ecosystem and its long-term growth potential. Sonos also continues to demonstrate its commitment to innovation with the launch of products like the Ace headphones, Arc Ultra soundbar, and Sub 4 subwoofer. These offerings diversify its portfolio, enhance its core lineup, and strengthen its market leadership, unlocking additional revenue streams. Furthermore, Sonos’ transformational initiatives aim to streamline operations, improve efficiency, and drive sustainable growth. By optimizing costs, leveraging AI, and focusing on high-ROI investments, Sonos is positioning itself for long-term profitability while maintaining its premium product quality. Despite these strengths, the negative ROIC remains a concern. Until there are clear signs of improvement in this metric, I will not be investing in Sonos.
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