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Optical/IP Networks

Sonus Sets for a Critical Q1

Softswitch vendor Sonus Networks Inc. (Nasdaq: SONS) is heading for a critical few months that could define its life as an independent company.

The firm wants to put its 2004 troubles behind it and could start the year with a bang or two (see Sonus: Whew!).

Why? Carriers are due to increase their capex budgets in 2005, and sales of VOIP gear are on the rise, with Sonus figuring prominently. (See Insider Sees 'Calm' Capex Growth, Carrier VOIP Equipment Rises 51%, Carrier VOIP Equipment Rises 69%, and Sonus Boasts Top Rankings.)

In addition, there are market expectations that Sonus could pick up a significant new customer in voice-over-broadband upstart Vonage Holdings Corp., and also pin down some 21st Century Network business from BT Group plc (NYSE: BT; London: BTA) via its new partnership with Marconi Corp. plc (Nasdaq: MRCIY; London: MONI). (See Marconi & Sonus Team for Next-Gen and HR Unties Sonus/Marconi Tie-Up.)

But there's nothing yet in the bag. Though observers believe Marconi is almost sure to figure quite prominently in the British carrier's plans, BT has yet to announce any hardware contracts for its planned $19 billion network. And neither Sonus nor Vonage would comment on any planned deal.

And other factors are weighing on the minds of the analysts at Pacific Growth Equities Inc., who have concerns about Sonus's near-term potential and believe its stock has attracted an "excessive" valuation.

In a recently issued research note, the analysts wrote that any deal with Vonage would be "small relative to expectations," and that limited uptake of the CallVantage VOIP service offered by major Sonus customer AT&T Corp. (NYSE: T) will likely lead to limited opportunities for additional orders in the near future.

The Pacific Growth team also has concerns about price and gross margin pressures, the potential for order delays, and increasing operational costs at the vendor.

In fact, they believe that AT&T and Vonage between them will install only an additional 800,000 lines in 2005, and will drive very hard bargains with their suppliers. As a result, this expansion could translate into sales for Sonus of between $16 million and $20 million, lower than investors may be hoping for.

"We believe the majority of Sonus’ shareholders are under the impression this revenue opportunity is larger than we have estimated here," write the analysts.

They're also worried about how reliant Sonus is on a small number of customers. The analysts say that, jointly, Global Crossing Holdings Ltd. (Nasdaq: GLBC) and Qwest Communications International Inc. (NYSE: Q) accounted for about 65 percent of the vendor's $46.8 million revenues in the quarter to September 30 (see Sonus Reports Rising Q3 Revenues).

That shows an increasing reliance on a smaller number of key customers, as, in the previous quarter, Sonus derived about half of its sales from three customers -- AT&T, Global Crossing, and Qwest. "We believe this high level of customer concentration significantly adds to the overall level of risk involved in holding these [Sonus] shares," write the analysts.

That sort of analysis has put a downwards pressure on Sonus's share price of late. It began December at $6.59, but sank to close at $5.19 on December 20. It closed a little healthier on December 23, however, at $5.58, giving it a market capitalization of $1.4 billion.

— Ray Le Maistre, International News Editor, Light Reading

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