How Big Is the Market Opportunity for Sonos?

Multi-room wireless audio provider -- Sonos -- has filed its preliminary registration statement with the SEC as the company gears up for an initial public offering.

In the following segment, the Industry Focus team explores Sonos' household reach and its larger market opportunity for investors eyeing this fast-growing sector of the consumer electronics world.

A full transcript follows the video.

This video was recorded on July 10, 2018.

Vincent Shen: Getting into some of the nitty-gritty for this business -- the company's registration statement was released to the public last Friday. I'd like to remind Fools that you can check out that S-1 filing by going to the SEC website and using its EDGAR search tool. Asit and I will cover a lot of essentials behind this business, but nothing can beat performing your own research and due diligence into the company.

The proposed ticker is SONO. The deal value that's listed in the prospectus is $100 million, but consider that a placeholder. It will very likely change as the company advances through its IPO process.

Sonos was founded in 2002. Their mission is to fill every home with music. They launched their first wireless multi-room speakers in 2005. Their product portfolio has only grown since then to various speakers, sound bars. As of last year, they've also taken the plunge into the voice-enabled smart speaker market with the help of Amazon's Alexa. We'll talk about that a little bit more.

Today, Sonos has been backed by private equity and venture capital firms, with about $450 million raised since 2005. Prior estimates of the company's valuation have been as high as about $2-3 billion, to give you a sense of the size of this company that we're looking at. My last tidbit so listeners have an additional sense of scale for this company -- Sonos reported $992 million of revenue in fiscal 2017, and actually cleared the $1 billion mark for the one-year period ending in March.

Asit, I'll pass the baton to you. Where would you like to dive in in terms of the business?

Asit Sharma: I'd like to give our fellow investors and listeners some background on the market opportunity for Sonos, talking about what their current base looks like. That's always important in an IPO, to figure out what kind of market this company has and how can it grow. These are stats provided in this registration statement. This is as of March 31st, 2018. That's their latest reporting period, and it covers six months of their current fiscal year.

Sonos customers, as of that end date, have registered over 19 million products in about 6.9 million households globally. They estimate that their customers listen to about 70 hours of content per month, and that they listen to 80% more music after purchasing a Sonos product. Also, out of these 6.9 million households, 61% of these had registered more than one Sonos product.

There's this phenomenon -- which, Vince, your family can attest to -- of buying your first Sonos product and then you add on. I always look for recurring revenue sources for companies where I can find them. I think it's a great way to grow revenue because you build a core that then becomes incremental each year. I like that statistic.

They say their customers can initially purchase one Sonos product, end up purchasing an additional 1.4 products. You can't really buy a half of a product, but that's how the statistics average out. Those customers who have purchased more than one started with an average of 2.9 Sonos products, and they purchased an average of an additional two products over a period of years.

I think this is a really good statistic to think about, considering that the market for multi-room wireless speakers is nascent, and it's only scheduled grow globally. We'll talk in a little bit about the global picture for this company. Those statistics really hit me up.

One more that I want listeners to be aware of his how they track the use of their speakers over time. 93% of Sonos products that have been registered since 2005 have received a software update in the 12 months ended that March 31st period that I talked about. Sonos automatically updates its software and hardware, as is de rigueur for most good products that are technologically oriented these days.

They've been tracking since they launched the company, and they have about a 93% update rate. To me, that's incredible, and it speaks to the utility of this product. Some of the IPOs that Vince and I have talked about over the last year have metrics which fall off. Customers buy a product or subscribe to a subscription service, and then they tend to drop off. Sonos is the other way. It's a hardware product, it stays in your home, it has more utility as you go on.

Shen: I think that's a really big part of the allure for these products. Even their older speakers released years and years ago are still getting those updates so that the functionality is there for users. I think that helps to build up a loyalty among their customers. That proves in terms of the numbers, in terms of these follow-up purchases that they will make that you mentioned, whether they're purchasing a single speaker at first or multiple speakers. I think, the way the Sonos speakers connect -- in terms of my personal experience with them, at least -- the experience with their product improves as you build up how many of them you have. I think that's a big part of filling your home with music.

Next, let's look a little bit at some of the financials and numbers. In terms of revenue growth and margins, revenue was up 7% fiscal 2016, but the rate accelerated in 2017 to 10%. It continues to pick up steam. It hit 18% year over year for the first half of fiscal 2018, reaching about $656 million. The company has attributed a lot of its recent growth to the release of its Sonos One smart speaker, which was released last October.

While that is promising, gross margins have declined in the latest fiscal year, going from historical levels, 45%, down to about 42%. I'd usually consider that a red flag, since that implies that these new smart speaker offerings have lower margins; but management notes that their gross margins are weakest for new products at launch, and improvements generally come over time as they achieve scale.

Given the fact that unit volumes jumped almost 30% from 2.4 million to 3.1 million products sold for the first half of fiscal 2018, I think Sonos management is in a position here where they're probably willing to take a little bit of the margin hit to boost growth in preparation for the IPO. As part of that effort, Sonos cut its workforce recently in May, which brings some of its costs down -- again, improving a little bit of the optics for this business as investors are diving into it before it hits the public market.

Some of the revenue profile and customer characteristics I wanted to get into, you covered those, Asit. I think that's really the beauty of when you can dive into these S-1 filings. The company will discuss things about its customer base, how users engage with the product, new and returning customer trends, that you can't get that elsewhere.