Pando

Sonos' IPO: A first day pop, but can it fight off Apple, Amazon et al and win for the long term?

By Kevin Kelleher , written on August 3, 2018

From The IPOs Desk

When Sonos was founded in Santa Barbara, Calif., in 2002, the world of the audiophile was very different.

Napster, that early digital death knell of packaged music, had just shut down. The iPod was about a year old and Apple had sold only around 600,000 of the pocket music players. Spotify, Pandora, even iTunes didn't even exist. 

And if you wanted to dig into a deep library of music to play on a high-quality system, you had your work cut out for you. Big-box speakers connected to consoles with a tangle of cables, towers of CDs arranged in meticulous order to find the right album quickly. And if you wanted sound in more than one room, you might need a PhD. 

Sonos' founders, who had recently sold off their dot-com startup Software.com, were looking for a new problem to solve. The first idea, creating local-area networks for airplanes, never took flight. They decided instead to make home sound systems not only wireless, but easy for anyone to set up and use - “to being able to play anything you want any place you want,” as Sonos founder and former CEO John MacFarlane put it in a Pando interview. And that is the origin story of Sonos. 

Sonos has not been an overnight success. It took 16 years of hard work to get here, including solving formidable technical issues and inventing new technologies, but Sonos finally went public this week, debuting on Nadsaq yesterday. The reward for that hard work was a first-day pop of 32%. Sonos priced at $15 a share late Wednesday and finished Thursday up 33% at $19.91. It's up another 6% at $21.01 a share today.

But first-day pops for tech IPOs have been notoriously fleeting in recent years. And that 33% first-day gain is just a little bit deceptive. Sonos initially tried to price its IPO between $17 a share and $19 a share, but settled for the lower $15 a share price. So the stock at Thursday's close was only modestly higher than what it initially hoped for.

And there's one problem that Sonos still quite hasn't solved – and may still struggle with for some time: it built its business in the consumer-hardware business, some of the meanest soil for a company to try and harvest profits from. 

In recent years, some hardware companies, like Jawbone and Pebble, have simply shut down. Others, like Lytro, have had to pivot. Still others, like Magic Leap, keep kicking their release date down the road. Some, like GoPro, benefit from a fad that fades out over time. And a precious few, like Fitbit, will eke out a decent business as a public company.

Sonos seems like it belongs in that last group. But even Fitbit saw net losses in 2016 and 2017, and its stock is trading at about a quarter of the $20 offering price of its 2015 IPO. Fitbit too saw an impressive first-day pop.

There are two other hardware companies, Apple and Roku, which have enjoyed success, but their business models differ from Sonos'.

Although Apple reached its $1 trillion valuation only a day after Sonos' IPO, its success is as hard to replicate as it is well documented. And increasingly, Apple is broadening beyond device sales alone. Apple's services, including its App Store and Music revenue, now makes up nearly a sixth of its total revenue and grew by 22% last quarter, or about seven times the growth rate of iPhones.

Roku's stock, meanwhile, has more than tripled its $14 a share offering price. But Roku, if anything, is a cautionary tale for Sonos. Roku realized years ago that it couldn't survive on sales of its streaming-TV boxes alone, so it began offering its software platform to other companies, especially TV manufacturing like Hitachi and Sharp, which have stronger brands and more capital to spend on manufacturing. 

One thing that has always stood in Sonos' favor is the strength of its management. Its four founders have worked together since the dot-com days, adhering to its any-music-you-want-anywhere vision without taking shortcuts. That cultivated a base of loyal customers, who would first buy one speaker, then others throughout their homes.

MacFarlane stepped down as CEO in early 2017 to make way for current CEO Patrick Spence. He maintains a role as mentor – his LinkedIn profile describes his role as “intern, unFounder” - but his plans to step down last year were reportedly delayed because of a new threat that Sonos faced starting in 2015, a threat the company didn't see coming as it pursued its vision: Amazon's Alexa.

Sonos was profitable in its 2013 and 2014 fiscal years. Revenue in 2014 grew by 75%, Then revenue growth slowed to 9% in 2015, 7% in 2016, and 10% last year. Sonos also posted net losses in its last three fiscal years. Which is odd, considering that the revenue slowdown coincided with a rise in music-streaming usage.

The culprit seems to be Amazon's voice-powered Echo speakers. Amazon began selling Echos in 2015 and sold 2.4 million in the first year alone, a figure that rose to 22 million last year. Google and Apple have since introduced their voice-powered speakers, and each one sold is another speaker inside a home that isn't a Sonos.

Sonos announced layoffs in March 2016 as the company moved belatedly to address voice-powered speakers. "I fell into that trap where I’ve been watching voice recognition for years,” MacFarlane told the New York Times when he resigned as CEO. “I tried Echo in the beginning and wrote it off. I had too many distractions at that time. I wasn’t playing at the level I should have been playing at in all frankness.”

The Alexa threat underscored another vulnerability at Sonos, one that it still has today. Voice activation is powered by software. It can transform a cheap piece of hardware to make it more desirable to many consumers than a speaker with great sound. Sonos remains, in good part, a hardware company in a market where dominance is currently being defined by software features.

Under Spence's leadership, Sonos has integrated Alexa into its speakers. Last month, it did the same for Apple's Siri by allowing AirPlay 2 on some – but not all – of Sonos speakers. Compatibility with Google Assistant is planned for later this year. That's helped Sonos' financials: Revenue is up 18% in the most recent six months, during which Sonos swung back to profitability. 

Still, the longer-term threat remains: Sonos may have forged partnerships with its biggest rivals, but those rivals have much more capital on hand. And Apple, at least, is trying to match Sonos on sound quality with its HomePod.

There's one other consumer-hardware company I haven't mentioned, even though it resembles Sonos in many ways. Back in 2002, when Sonos was founded, TiVo was a hot company. Its DVRs were cutting edge, and beloved by customers. But cable operators like Comcast began offering cheaper – in price as well as quality – alternatives to their installed customer base. TiVo has lost about 90% of its peak value in the early 2000s.

Again, Sonos' strength lies in the managers guiding it. 16 years ago, they intuited the world of streaming music we live in today. So they may be able to outmaneuver companies like Apple, Amazon and Google as they encroach on the turf Sonos staked out for itself early on. It may well be that Sonos will rise beyond its first-day pop and stay there for the long term. But don't discount the possibility it could become like another artifact of 2002 – the TiVo.