The Black Box

[wahz]

part 4 Changing Business Model At Sonus Reflects Deployments Based More On
Subscription Models---Future Revenues Should Smooth As Adoption Drives
Subscription Annuities. Historically, Sonus has generated revenues primarily
from port deployments in hardware infrastructure build outs. Over time, this
model is likely to gradually shift to more of a subscription model where
service uptake drives annuity revenues in access even as the hardware ports
enabling line termination continue to drive hardware revenues. Earlier this
year, Sonus announced VoIP/IMS contract wins with Earthlink and AOL. In our
view, this indicates Sonus is gaining traction, not just in VoIP, but in the
IMS world as well. Sonus' deployment at AOL provides actual convergence, in
this case between voice and instant messaging. AOL is expected to use Sonus
ASX (Access Server) to provide its customers with a suite of voice and instant
messaging products, which integrate voice and multimedia applications. This is
a more software intensive product, which enables Sonus to charge on a per
subscriber basis, resulting in an annuity stream to the company. As Sonus
engages in more IMS contracts, which require more software intensive products
like the ASX and its new IMX platform, the larger the portion of Sonus' revenue
stream will be recognized by annuity streams as opposed to one time gateway
sales. While it is difficult to determine when IMS deal flow and software
intensive product sales will become meaningful enough to blunt Sonus' lumpy
revenue line, we view this transition in Sonus' product portfolio as a positive
not to be understated by investors.

We View Recent Weakness As An Opportunity, And We Reiterate Our Buy Rating At
These Levels. Due to a disappointing September quarter earnings release, and
the announcement of several IMS contract wins by Lucent, Sonus shares have been
weak of late. Sonus' relatively small customer base renders it vulnerable to
wild swings in its quarter to quarter top-line performance. As a result, we
urge investors to focus on the company's long term prospects. We also think it
valid to focus on the company's year over year growth rates, as opposed to
looking at the quarters on a sequential basis. In our view, Sonus is clearly
the technological leader in VoIP, and has a compelling IMS offering that should
yield the equipment vendor considerable business in the future. IMS is an open
architecture that enables service providers to leverage best of breed
solutions, allowing them to build fully interoperable multi-vendor networks.
So while larger, incumbent vendors with large service and support organizations
have an inherent near term advantage in winning IMS deals, we think Sonus is
well positioned to capitalize on this market opportunity in the longer term
when carriers are ready to leverage best of breed solutions.

Despite being a pure play vendor in one of the fastest growing areas of
wireline carrier capex spending, Sonus trades merely in-line on a P/E basis
with its telecom equipment peer group, many of which sport product portfolios
laden with legacy equipment. We think the company should trade at a
significant premium to the group and we think the stock is significantly
undervalued at these levels. As a result, we are reiterating our Buy rating on
Sonus and our $7.10 target price.