New Paradigm Investing
SONS and China

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By TinkerShaw
January 10, 2002

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On December 18 you suggested that SONS would benefit greatly from increasing its customer base (I guess all companies do don't they). But this was especially the case with SONS because of the risky nature of its largest customers (Global Crossing, XOXO, and QWEST).
Does the January 8 deal with China Netcom bolster your opinion of SONS. Is now a good time to take a starter position in SONS or a bad time (CISCO and Chambers announcement that it is increasing market share shows how the gorilla's grow in a downturn because of their ability to spend money) because money is going to CISCO and not SONS. Or is money going to SONS because SONS is a sea change?

Do you have any insight here?

First, there is a misunderstanding here regarding Cisco, SONS does not really compete with Cisco. SONS sells only carrier grade equipment. Cisco sells enterprise grade equipment and is nowhere near to SONS in its ability to sell to carriers, which is one reason why SONS is so often talked about as an acquisition target for Cisco. In addition, offering vendor financing won't help Cisco much as Nortel and Lucent already do this. Whether or not SONS will be acquired by Cisco, I don't know. But Cisco is not taking market share from SONS, since Cisco is not really competing in SONS's market. Neither is SONS taking market share from Juniper as has been rumored on the Yahoo! boards. SONS does not compete with Juniper, in fact they are partners. I expect to see SONS partner with Cisco as well (if it has not already done so privately).

In regard to the Chinese deal, it was not unexpected. If your going to build out a new network, VoIP is far cheaper than building a network from scratch using the traditional hard circuit method. In this regard there really is a second mover advantage. The U.S., for example, is completely hardwired with older equipment and have a more difficult time moving directly to more efficient next generation networks. Countries like China, on the other hand, with relatively little legacy structure, have the advantage of not having to deal with legacy equipment and moving straight into next generation equipment that is both cheaper and provides greater utility. As such VoIP was not a shocker in this regard for the same reason that GX and the other new next generation carriers were SONS' first customers. No legacy equipment to discard. Africa, as another example, will probably be mostly a wireless continent, as they will by-pass most of the fixed wire infrastructure that countries with more legacy infrastructures own and may actually have a better and cheaper telecommunication system some day than we in the West have.

Since SONS is the world leader in carrier grade VoIP equipment, it is expected that SONS will win a good share of business in China, particularly since China is mostly looking for a pure VoIP solution, and not a hybrid solution that companies like Nortel are mostly pushing.

So I don't consider the Chinese news anything unexpected. What I expect for SONS is that the VoIP market will grow into the many billions of dollars over the next 3 to 4 years, and that 2 or 3 players will win the vast majority of this business, SONS being one of these players, and most likely the leader. This progression will become a worldwide business, as next generation networks continue to spring up in places like China and Japan (SONS already has done a lot of work in Japan with Fusion, and their partnership with Juniper), and as legacy networks begin incorporating VoIP in their networks such as BellSouth, Qwest, Time Warner, AT&T, et al.

Since this market is enormous, has high barriers to entry, is software intensive, SONS offers an open platform unlike most of its competitors, and since SONS is the leader in both technology and market share, I expect SONS to grow strongly for years to come in this marketplace with Nortel comprising its primary competition.

Whether or not it is a good time to buy SONS, I don't know. As I've stated in the past, all my SONS shares were purchased at around $3. It was just too good to let sit. Technically I knew I should have sold at $8, but just couldn't afford the capital gains taxes for 2001, so I sat on the shares due to my long-term confidence. So if you ask me I think SONS is a good long-term buy here. However, that doesn't mean SONS won't crash back to $3 first before heading to $20 or $30.

So in general I would have to say, do some more research on SONS. VoIP is different from routers, and it should be a very enormous market, offering superior returns to those 2 to 3 players who come to dominate the marketplace. At this time I think it will be SONS #1, Nortel #2 (using their hybrid products to gain market entry, but also (hopefully for Nortel) not suffering from the innovator's dilemma and pushing the hybrid over the pure VoIP), and #3 is wide open. One might expect Lucent to play a prominent role here, but as of now Lucent is really a no show in this marketplace.

P.S. Again, this is trying to get in, in front of the curve. This market has the potential to be a gorilla market, but it is too early for conservative gorilla investors. It is also early as Class 5 softswitches are just now in trials and have not been extensively deployed. So buying SONS now, is getting in, in front of the curve. I'm doing so given what I see the very large discount between SONS's current valuation and what I think its likely potential is. Others have different risk preferences and different perceptions of SONS' potential. So my answer above is applicable to my situation.


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