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Stocks Under $10 With SU10 Team 

Merger Has Us Exiting Position

By SU10 Team   | 2017-05-23 12:12:36.0
Actions Taken:
Symbol Action # Shares Traded Recent Price % of Portfolio* Shares Owned*
SONS Sell 1150 $8.23 0.0 0

* Indicates results after trade.

We will close the Stocks Under $10 position in Sonus Networks (SONS:Nasdaq) after you receive this Alert by selling all 1,150 shares at or near $8.23. As we do this, we'll note that with today's pop in SONS shares, the position has returned break-even results since being added to the portfolio in October 2014.

This morning, a merger of equals was announced between Sonus Networks and Genband, a company that provides software and hardware that 600 telecommunications providers use to deploy voice and multimedia services. At first blush, we welcomed the strategy to expand Sonus' footprint in the increasingly intellectual property- and cloud-based communications networks.

After digging into the details and financials at Genband, however, we're somewhat less enthusiastic given Genband's modest profitability. While Genband delivered revenue of $427 million in 2016 with gross margins above 50%, compared to $262.6 million and 69% at Sonus, Genband's outsized operating expenses in 2015 and 2016 led to bottom-line losses and to razor-thin profits in 2016 on revenue that grew just 2.4%. To us, this sounds like Sonus is merging with a relative "fixer-upper" that has the potential to deliver operating and financial benefits provided the combined company can deliver on forecasts of savings and synergies.

The transaction is expected to close during the second half of 2017, and the combined entity is expected to achieve annual cost savings of $40 million to $50 million. While we like the sound of that, we have to chuckle somewhat to ourselves because at the midpoint that equates to roughly 6.5% of combined 2016 revenue, and as we know, more often than not most companies tend not to deliver fully on forecast synergies and savings. That's just the way it works. There is also the fact the new company will have 50-50 ownership structure between Sonus and Genband, and while we try not to be too pessimistic, more often than not these mergers of equals tend to take more time than expected to sort themselves out.

Then there is the fact the new company will issue 50 million shares of common stock to Genband's equity owners as well as $22.5 million in unsecured notes. For some perspective, in 2016, stand-alone Sonus delivered EPS of $0.33 per share, but combined Sonus-Genband, including the issued equity, would have delivered EPS more like $0.18-$0.20 per share. In other words, a rather dilutive combination for two companies that have been more in cost-reduction mode than revenue-growth mode.

Donning our portfolio manager's hat, SONS shares have been a strong performer even before the pop on today's news. All told, year to date the shares are up more than 30% and that has helped return the Stocks Under $10 position to break-even status. Our view is there is far more uncertainty into the combined entity and a far greater need to deliver on cost reductions, particularly given modest revenue-growth expectations near term. As we review Sonus' guidance reiteration calling for flat to slow single-digit revenue growth year over year in 2017, we are reminded of that old Wall Street saying that a company can't cut its way to growth.

Given all of the above factors and concerns, we'd rather walk away near a break-even position than get caught in a cycle of hopes and wishes for cost savings and growth.

Regards,

Christopher Versace

Closing Out of 2 Positions
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We're booking profits of 60% on one and more than 100% in the other.

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