SodaStream (SODA) is Worth $85 / Share

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SodaStream International (SODA)
Stock Price: $41.50
Diluted shares: 21.5MM
Market cap: $894MM
Cash: $29MM
Working capital surplus, ex-cash: $157MM
LT Debt: $0
Other Liabilities, not including Deferred Taxes: $2.6MM
EV: $711MM

As alluded to in my last post, I have been aggressively buying shares of SODA post the GMCR / KO news. Here are my buyside notes:

Despite IPO’ing only a few years ago (Nov 2010), SODA is not a new company. In fact, it produced its first drink for home carbonation in 1955. The original SodaStream machines became popular in the UK during the 70s and 80s and in 1985 the Company became a subsidiary of Cadbury Schweppes. The business was purchased for $26MM by its Israeli distributor in 1998 and became known as Soda-Club. Then in 2007, after years of poor management and ineffective marketing it was purchased again by Fortissimo Capital for $6MM and Daniel Birnbaum was installed as CEO. As you might be able to tell, there’s been lots of ownership changes and operational volatility. But once Birnbaum took the reins, things started to get interesting. When he was first hired, Birnbaum described the Company as “rusty, dusty, [and] not very exciting”. The product was outdated. The Company had fired its marketing department. Quite simply, SodaStream was failing. Birnbaum implemented a turn-around plan focused on revamping the product and marketing the company around its core value proposition: environmental friendliness, a healthy alternative to high-fructose corn syrup, convenience, and cost effectiveness. The turnaround was immediate – SodaStream went from losing a million bucks in 2007 to making $700k in 2008 and $9MM in 2009. Three years after being taken over by Fortissimo, the Company went public, raising $91MM in late 2010.

The history is important because the bears look at the Company and say “this business is a fad and it will die. Just take a look at how many times this business has traded hands historically.” I look at this business and say, “The right leader can change everything. Look no further than Apple, which nearly went out of business until Steve Jobs came back.” In the Birnbaum era SodaStream has accomplished some pretty remarkable things. Just take a look at the trends in their historical EBITDA:

SODA Historical EBITDA

These financial results are driven by three main factors: (1) product innovations, (2) partnerships – both in product and retail distribution, and (3) great marketing. I’ll cover each of these things later, but first let’s understand the SodaStream business:

SODA operates a razor / razorblade model. The razor is obviously the soda maker – SODA, like GMCR’s / Keurig’s at home machines, makes little gross margin on the soda maker – on a recent call they mentioned gross margins in the 30% range. Where they make their money is on the razorblades (75% gross margins). And SODA has 3 blades: the CO2 refills, the flavor syrups (which have a shelf life) and the bottles. This business is really all about growing an installed base of consumers and keeping them active / buying more product. What I find interesting is looking at the operating margins of their Swiss business versus their US business – what it tells me is that once you build your installed base and the mix moves from primarily selling soda makers (the razor) to primarily selling consumables (the blade), EBIT margins can move dramatically higher (this also probably has to do with marketing expenses going down as awareness grows – no need to do in-store presentations, for example):

Operating Margins

SodaStream sells its product through (1) company owned stores in Europe, (2) retail partners in the US, and (3) online. SODA is sold in 45 countries, 22 directly by SodaStream and in 23 countries via distributors (they are exclusive contracts but distributors need to meet performance hurdles). In some countries they have Apple-esque retail spaces:

SodaStream Store

Let me just get right to the point: the US is the single most important market for SodaStream – it’s the world’s largest economy, the world’s second fatest country and the single biggest market for carbonated beverages. The growth of the business – and the future value of SodaStream – is dependent on the US.

What will the US look like in the future? It’s an impossible question to answer, but if you believe – like I do – that the past is prologue then it is probable that in 5 – 10 years, the US will look like what Europe looks like today for SODA… just look at these penetration rates:

SodaStream Household Penetration

If SODA can get US penetration rates similar to what it’s achieved in Germany (where it has 3% household penetration), then the US will be contributing roughly $500MM per year in revenues to the Company.

So how will SODA cross the chasm and become a mainstream product in the US? The answer, according to Birnbaum, is through partnerships. This is a strategy that makes complete sense to me. In advertising, there is an old rule of thumb: it takes six impressions to get a targeted consumer to react. Why? Because frequency leads to awareness, awareness to familiarity, and familiarity to trust. And trust has an uncanny way of getting us to open up our wallets. SodaStream has spent the last few years really focusing on partnerships to increase awareness and to get consumers to trust their brand. They have executed their distribution strategy perfectly (up next: grocers and drug stores):

SodaStream Distribution Strategy

Their retail partnerships mean SodaStream has distribution in 15,000 stores across the US (that’s up from 5,000 at the beginning of 2012). Here are some of their global retail partners:

Retail Partners

Strategic Partnerships

SODA’s strategic partners help advertise SODA’s brand across multiple retail and marketing channels. All of these partners believe in SODA. Why don’t the bears? Heck, all bears need to do is make a quick visit to Google Trends – it tells you all you need to know about consumer awareness (which – as stated above – leads to trust and sales):

SodaStream Google Trends

Yet despite all their recent success, the company isn’t resting. They have a goal to do $1BN in revenue in 2016, which means over 20% per annum growth in each of the next 3 years. To accomplish this, they are extending their tendrils into many different areas:

  1. They are starting to explore partnerships in the alcohol industry (a consumer-facing Compari product is currently available in Italy and they are selling professional-level soda makers to bars in Europe).
  2. Their recent “powered by SodaStream” partnership with Samsung places SODA in high end refrigerators which are currently being sold in the US, Canada, Korea and Australia and will be sold in Europe starting in 1H14. They are simultaneously expanding by geography and by model (starting at the higher end $2,500 refrigerator units and then moving to lower price points over time). More “powered by SodaStream” partnerships are likely.
  3. SODA is looking to license its proprietary carbonating technology to third parties.
  4. They are going after every partner they can get, even Bethenny Frankel of Skinnygirl.

SODA has the right products, the right partnerships and the right platform to make their $1BN goal a reality. But will they?…

It isn’t all rabbits and roses at SodaStream. There are some real concerns that many have about their business, the most prominent being:

Despite these concerns, consumers seem to love SODA’s product. Revenues continue to climb higher off the back of effective marketing, beautifully designed products, and partners that consumers know and love.

SODA Quarterly Revenue

The giant unknown in this story is whether Coke’s / Keurig’s entrance into the category in 2015 will displace SodaStream (Coke has already failed once in this space). If they can come up with a carbonated beverage maker that doesn’t require CO2 canisters and still tastes good, then I think SODA may have a problem. But high-level, I don’t believe this is a winner-take-all type of business – this is a consumer business where multiple players can (and likely will) win. SODA’s been building their moat for years all alone without any real competition. And they still have a year or more to continue executing a playbook they’ve had in place since Birnbaum became CEO in 2007. At this price, with their track record and an active installed base of 7MM customers, my money is on SodaStream.

 

The math

I have a model, but let me simplify and focus on what truly matters here: The most important metric to watch is revenue growth in the US, driven by the number of soda maker units sold (e.g., installed customer base after factoring in attrition = “active” customer count) and the number of CO2 refills sold (activity of installed base). “Active” customers are defined as someone who uses SodaStream once every two weeks (or makes several canister exchanges per year). The data tells a compelling story of uptake:

I have redacted this data. If you want it, email me: analyst @ this domain dot com.

Approx. 50% of their sales and marketing expenditures are advertising. Once they are embedded in a household, this can be cut dramatically with benefits to the operating margin line. I suspect these guys should be able to reach low 20s EBITDA margins over time. And consider that this isn’t a capital intensive business. Once their new plant is finished – a manufacturing facility that will provide ample growth runway (see 5th bullet below) – their recurring / maintenance CapEx is only about $20MM per year. It isn’t hard for me to envision a scenario where a couple of years from now these guys do $900MM top-line with 17% EBITDA margins, $133MM in pre-tax cash flow and $110MM in after-tax cash flow. I believe a razor / razorblade business like this one deserves a 15 multiple, conservatively.

On my math, SodaStream is worth $85 / share.

 

Some additional things to note:

 

Sources:

Recent webcast: http://cc.talkpoint.com/morg007/111913a_jw/?entity=4_BE4PQL7
Investor Day Presentation 1: http://sodastream.investorroom.com/file.php/356/Investor+Day+Presentation+Part+1.pdf
Investor Day Presentation 2: http://sodastream.investorroom.com/file.php/357/Investor+Day+Presentation+Part+2.pdf
Recent Company Presentation: http://sodastream.investorroom.com/file.php/376/SodaStream+Investor+Presentation.pdf
Latest earnings: http://www.sodastream.com/webfm_send/189


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