Sonus Networks Flush With Cash, Risks

WESTFORD, Mass. ( TheStreet) -- Sonus Networks ( SONS) shares have traded sharply higher amid praise for its strong cash position, but a crowded telecommunications-technology space make the company's success anything but certain.

Sonus Networks has been billed as a speculative name for investors to play the rapid transition telephony companies are making to an all-Internet protocol, or IP, technology.

But unlike many other stocks trading under $5, Sonus Networks is flush with cash and is carrying no debt. When it reported fourth-quarter results on Feb. 25, Sonus said it ended the period with a cash position of $420 million. That translates to approximately $1.53 a share, which provides investors with limited downside risk.

However, Sonus isn't guaranteed a pathway higher, due to increasing competition and worries that consolidation in the telco sector could negative impact Sonus Networks and its turnaround story.

Cramer: Sonus and Its Cash

While it may not be a well-known vendor name, Sonus boasts a customer list that includes AT&T ( T), Verizon ( VZ), AOL ( AOL), Qwest ( Q), Vonage ( VG) and France Telecom ( FTE), among many others.

The diverse list of customers has helped Sonus reverse its luck when it comes to revenue growth. For the fourth quarter, Sonus said sales totaled $68.7 million, which was down 23% from the year-ago quarter but up 22% sequentially.

That sequential rebound in sales comes after Sonus navigated through a particularly difficult stretch that began in 2007, when the share price floated above the $8 mark. Full-year revenue has fallen from $320.3 million in 2007 to $227.5 million in 2009. Following suit, Sonus' share price has fallen more than 60% to about $2.77.

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As the share price dropped, Sonus experienced a painful facelift, with three layoff announcements from December 2008 to March 2009 that cut its workforce by 150. In addition, long-time Chairman and CEO Hassan Ahmed was replaced in 2008 by Richard Nottenburg.

"In 2009, we successfully reengineered Sonus," Nottenburg said during Sonus' last quarterly conference call. "Our industry is at a strategic inflection point. As service providers and enterprises move toward offering and increasing number of IP-to-IP multimedia services, we see a significant growth opportunity."

Nottenburg and other Sonus Networks executives declined to comment for this article, citing the quiet period before first-quarter earnings results are released.

The expectation now is that Sonus will return to top-line growth in 2010 and beyond, thanks to legacy replacements and new products that Sonus plans to launch midyear. Sonus said last month that it expects flat to low-single digit percentage revenue growth in 2010 on an annual basis vs. fiscal 2009.

"There is strong potential in terms of legacy replacements, but it all depends on macroeconomic factors," Wall Street Strategies analyst Carlos Guillen said in a recent research note. "If legacy replacement steps up, revenues may come stronger than management guidance of flat to up low-single digits percentage." Guillen has a buy rating on Sonus.

The bigger challenge, though, comes from competition. Despite being flush with cash, Sonus should be wary of rival equipment vendors such has Alcatel-Lucent ( ALU) and Cisco ( CSCO), which have longer, well-established relationships with customers.

"These legacy relationships give many of the company's competitors a degree of leverage with service providers that Sonus often finds difficult to overcome," Cantor Fitzgerald analyst Edward Jackson, who has a buy rating on Sonus, wrote in a recent research note.

"An inability to continue to penetrate carriers would have a significant negative impact on the company's ability to grow revenues and possibly result in declining shareholder value," Jackson added.

More investing options for investors are appearing, too. Earlier this week, Calix Networks ( CALX), a rival broadband systems and software company for communications service providers, traded sharply higher in its debut on the New York Stock Exchange Wednesday. The IPO was backed by Goldman Sachs.

Cantor Fitzgerald's Jackson also highlights the risk of more consolidation in the telephony industry.

"There has been a massive level of consolidation in the communications services market and there is always the risk that an important customer of Sonus will be acquired by another operator that then chooses to discontinue or curtail purchases of the company's products," Jackson notes. "Furthermore, the consolidation of carriers potentially gives them tremendous bargaining power relative to pricing, which could negatively impact the financial results of Sonus."

Guillen notes that in the company's fourth quarter, Sonus had two customers that contributed more than 10% of total revenue. The top five customers represented approximately 58% of total revenue during the quarter.

Jefferies analyst George Notter argues that the risk/reward profile in Sonus is balanced, as he's nervous about the company's push into the enterprise market with its new session border controller (SBC) development program. He's also concerned about limited short- and intermediate-term revenue growth prospects.

"Given the cost structure required to remain competitive in this business, it's difficult to envision the company generating interesting profitability for investors without a significant top-line improvement," Notter wrote in a research note last month. He has a hold rating on Sonus Networks.

Avian Securities analyst Catharine Trebnick argues that Sonus Networks' projection of flat to single-digit revenue growth in this year indicates that the company's Hybrid TDM/IP products have reached a plateau. That means for revenue to grow, the company's new IP-to-IP communications product line and new market segments need to be the big contributors

Despite these concerns, many analysts do expect Sonus to prosper, although the upside may be limited. Price targets for the stock go as high as $3.25, which is only 17% assuming analysts are correct.

"Near term, the company will need to articulate a clear vision for the operator on how it will enable the operators to monetize data traffic," Trebnick writes in a research note. "Once the vision is articulated, we believe Sonus has an opportunity to generate new revenue outside its current customer base and market segments."

Jackson writes that he continues to "sense that Sonus is positioned to turn the corner and that the pieces are in place for a return to sales growth and sustained profitability."

The bottom line for investors is that there may be safer ways to play the migration to the IP communications than Sonus Networks, But despite the risks, Sonus could reward investors and provide a floor for losses with a sizeable cash balance.

-- Written by Robert Holmes in Boston.

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