Can Sodastream Redefine the Home Beverage Experience?

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When I first heard about Sodastream's (NASDAQ: SODA) business model of developing home-based carbonated beverage solutions, ABC’s reality TV show Shark Tank immediately came to mind. The idea of making your own version of Coca-Cola at home seemed like the perfect fit for the husband-wife tandem or group of college students who frequent the show, seeking investment from Mark Cuban or a host of other self-made millionaires. However, in actuality, Sodastream is an established corporation with $389 million in sales revenue during the last four quarters, and its shares have been listed on the NASDAQ exchange since November 8, 2010.

Although Sodastream’s roots date back to the early 20th century, the company didn’t achieve formal commercial success until UK conglomerate Cadbury Schweppes purchased it in 1985. Sodastream’s sales topped £15 million for the first time in 1989. According to the Bank of England’s online inflation calculator, Sodastream’s sales in 1989 are equivalent to £30.6 million today, based on an annualized inflation rate of 3.2%. When £30.6 million is converted into US dollars, we arrive at a sales figure of approximately $49 million based on today’s exchange rate. This indicates that Sodastream’s annual sales revenue has grown approximately 8 times from 1989 until present day, somewhat of an unimpressive figure considering more than 20 years have elapsed.

Let’s not write off Sodastream just yet, however. The company only recently made its segue here to the United States and has received a strong welcome, selling more than two million units of its home beverage maker in relatively short order. Furthermore, the bulk of Sodastream's results have originated from its home base in Western Europe, and are just beginning to reflect the enormous growth opportunity that exists in the Americas and Asia-Pacific as Sodastream begins its rollout on a global basis.

During the second quarter ended June 30, 2012, Sodastream reached its first ever $100 million quarter in sales revenue when the top-line number came in at $103.0 million, an increase of 49.1% from revenue of $69.1 million achieved during the second quarter of 2011. Fast-forward to the third quarter ended September 30, 2012, and Sodastream’s revenue reached an impressive $112.5 million.

Let's evaluate the respective bull and bear arguments for Sodastream, consider the company's valuation based on current market price, and talk about whether Sodastream's home soda unit could have a lasting impact on the beverage industry as a whole.

Bull case for Sodastream

  • The company will be airing its first Super Bowl commercial in February, directly competing with the likes of Coca-Cola (NYSE: KO) and PepsiCo (NYSE: PEP) for consumer attention. It is highly unlikely that Coca-Cola and Pepsi would consider directly competing with Sodastream by offering their own home-based beverage makers, as this would significantly undermine the value in their traditional retail business. Shares of KO and PEP have underperformed the S&P 500 index this year.
  • Carbonated beverage sales have been in decline for the last 7 years, according to industry publication Beverage Digest. Sodastream has the opportunity to capitalize on this trend, as the two main factors attributed to the decline are health concerns over consumption and cost. According to Sodastream, the Company’s regular sodamix flavors contain “less sugar, calories, carbohydrates and sodium than national drink brands, and they contain no high-fructose corn syrup.” Furthermore, Sodastream claims their system is more economical vs. purchasing soda off the shelf.
  • CEO Daniel Birnbaum, age 50, is an experienced manager and holds an MBA from Harvard Business School. In addition to Sodastream, Birnbaum currently serves as General Manager of Nike Israel, a testament to his business and leadership expertise. In 1995 he established Pillsbury Israel and served as Chief Executive.
  • The sell-side analyst community has a positive bias towards Sodastream. Following the company’s Q3 FY12 earnings release on November 7, Oppenheimer believes shares are undervalued based on management’s strong operating execution and continued growth potential.  Shares are rated an outperform with a $55 price target. J.P. Morgan feels the stock market is not considering the significance of the U.S. business, which it values between $300 – $400 million in market capitalization alone. JPM believes shares could reach the high $40’s to low $50’s once the marketplace realizes sum-of-the-parts valuation.
  • The company’s recent banned television commercial in the U.K. turned into a huge positive as the video went viral on YouTube worldwide. The advertisement shows soda cans exploding and is believed to have received a ban in a protectionist move by U.K. broadcasters in preference to the traditional beverage industry. Sodastream hasn’t incurred any cost for its YouTube success, yet there have been several million views of the commercial.

Bear case for Sodastream

  • Comparisons are being made to Green Mountain Coffee Roasters (NASDAQ: GMCR) on a fundamental basis in regards to the potential for escalating competition. Furthermore, bears cite the overall price action and level of volatility in Sodastream's stock can resemble that of Green Mountain.
  • US sales cannot continue growing rapidly per annum, unless SodaStream manages to expand distribution through a larger retail presence. In other words, market participants believe Sodastream sales could be approaching their peak level as the product is already available at Best Buy, Costco, and Wal-Mart stores nationwide.
  • Short interest: According to November 15 data, the Company has nearly 50% of its outstanding shares being sold short, meaning an extraordinarily high number of market participants are placing bets that the share price will decline over coming weeks and months. A short sale takes place when one investor borrows shares of stock from another investor who is long the shares. The short seller hopes to make money by experiencing a decline in share price, thereby having to pay the owner of record less when the shares are returned.

Valuation

The most recent twelve month earnings are equal to $2.00 per diluted share, giving the company a 20x trailing multiple. This appears pricey compared to Green Mountain, which has a different consumer business but similar growth rate. On a forward earnings basis, Sodastream's multiple appears far from expensive based on analyst consensus estimates for FY 13. Combined with the high short interest, it seems that the primary motivation for the low market valuation is a certain degree of skepticism regarding Sodastream's future operating results. A clear divergence exists between the sell-side analyst community and the marketplace based on the Company's current share price.

<table> <tbody> <tr> <td> </td> <td><strong>Sodastream International<br /></strong></td> <td><strong>Green Mountain Coffee Roasters</strong></td> <td><strong>The Coca-Cola Co</strong></td> <td><strong>PepsiCo Inc</strong></td> </tr> <tr> <td><strong>Market Capitalization</strong><span> ($)</span></td> <td>797.6 M</td> <td>5.6 B</td> <td>169.1 B</td> <td>108.7 B</td> </tr> <tr> <td><strong>EPS</strong><span> (TTM)</span></td> <td>2.00</td> <td>2.28</td> <td>1.92</td> <td>3.75</td> </tr> <tr> <td><strong>Price/Earnings</strong><span> (TTM)</span></td> <td>20.03x</td> <td>16.57x</td> <td>19.51x</td> <td>18.65x</td> </tr> <tr> <td><strong>PEG Ratio</strong><span> (TTM)</span></td> <td>0.67x</td> <td>0.89x</td> <td>2.39x</td> <td>3.02x</td> </tr> <tr> <td><strong>Short Interest</strong><span> (% of float as of 11/15/12)</span></td> <td>49.57%</td> <td>39.21%</td> <td>Less than 1%</td> <td>Less than 1%</td> </tr> <tr> <td> </td> <td> </td> <td> </td> <td> </td> <td> </td> </tr> <tr> <td><strong>Gross Profit Margin</strong><span> (TTM)</span></td> <td>55.14%</td> <td>32.89%</td> <td>60.45%</td> <td>52.25%</td> </tr> <tr> <td><strong>Operating Profit Margin</strong><span> (TTM)</span></td> <td>11.01%</td> <td>14.74%</td> <td>22.38%</td> <td>13.92%</td> </tr> <tr> <td><strong>Net Profit Margin</strong><span> (TTM)</span></td> <td>10.67%</td> <td>9.42%</td> <td>18.63%</td> <td>9.06%</td> </tr> <tr> <td> </td> <td> </td> <td> </td> <td> </td> <td> </td> </tr> <tr> <td><strong>Next Year Avg. Analyst EPS Estimate</strong></td> <td>2.61</td> <td>3.07</td> <td>2.19</td> <td>4.41</td> </tr> <tr> <td><strong>Forward Price/Earnings</strong></td> <td>15.21x</td> <td>12.29x</td> <td>17.21x</td> <td>15.88x</td> </tr> </tbody> </table>


Sodastream market presence

In recent years Sodastream has expanded its geographic presence beyond its Western Europe foothold, entering markets in Japan and Brazil while expanding here in the United States and Australia. Consider the below table which best illustrates Sodastream’s recent growth rate and market presence.

<table> <tbody> <tr> <td><strong>Geographical Revenue Breakdown</strong></td> <td colspan="4"><strong>Sequential Quarter Revenue Growth</strong></td> </tr> <tr> <td> </td> <td> </td> <td> </td> <td> </td> <td> </td> </tr> <tr> <td>Revenues (in millions)</td> <td><strong>Segment Revenue</strong></td> <td><strong>30-Sep-12</strong></td> <td><strong>30-Jun-12</strong></td> <td><strong>31-Mar-12</strong></td> </tr> <tr> <td><strong>Western Europe</strong></td> <td>50.20%</td> <td>$ 52.6 M</td> <td>$ 54 M</td> <td>$ 45.7 M</td> </tr> <tr> <td><strong>The Americas</strong></td> <td>31.31%</td> <td>38.7 M</td> <td>30.7 M</td> <td>25.6 M</td> </tr> <tr> <td><strong>Central & Eastern Europe, Middle East, Africa</strong></td> <td>8.37%</td> <td>10.3 M</td> <td>8.4 M</td> <td>6.7 M</td> </tr> <tr> <td><strong>Asia-Pacific</strong></td> <td><span>10.12%</span></td> <td><span>10.9 M</span></td> <td><span>9.9 M</span></td> <td><span>9.9 M</span></td> </tr> <tr> <td><strong>Total</strong></td> <td>100%</td> <td>$ 112.5 M</td> <td>$ 103 M</td> <td>$ 87.9 M</td> </tr> </tbody> </table>


Can Sodastream have a lasting effect on Coke and Pepsi?

Although I am far from an expert on consumer behavior, it appears only time will tell if consumers decide the better nutrition, lower cost, and related 'fun factor' makes Sodastream worthwhile or if ultimately the device proves to be an inconvenience to traditional off-the-shelf soda. In the near-term, however, it appears that Sodastream can accelerate the existing decline in carbonated beverages based on positive results from comparison taste tests and the fact that it contains less sugar, fewer calories, and no high fructose corn syrup vs. national brands. Even Coke-Cola and Pepsi’s next generation beverages Coke Zero and Pepsi Next contain high fructose corn syrup. I feel Sodastream represents one of the more legitimate threats to the traditional beverage business in decades.

My take


I do not feel the comparison to Green Mountain Coffee Roasters is accurate or representative. Sodastream is an international business with a presence in 42 countries, and U.S. sales represent a fractional 31% of the pie. Furthermore, the Company has reported the sale of only 2 million units thus far in the United States, indicating the market here is far from saturated. Competitors such as Cuisinart could enter the market, but are unlikely to do so in a big way and their product offerings will not be as diverse. In regards to Green Mountain, management has stated it still expects 15 to 20 percent revenue growth in the next few years, and no single partner brand represented more than 6% of sales during 2012. The current valuation for GMCR is reasonable based on the data table.

In regards to Sodastream's potential for continued US sales growth, carbonated beverages are a consumable, and demand for consumables can grow on an individual store basis. This argument is supported by a recent television interview in which Daniel Birnbaum stated Sodastream sales could double over the next year within the existing store base. Furthermore, recent market research indicates Sodastream has been selling out at Wal-Mart stores.

Although I personally agree more with the facts presented in the bull argument, there are differences between company fundamentals and the supply/demand dynamic for a company's stock. The high level of short interest gives me pause, which I discuss in my Fool conclusion below.

Foolish bottom line


I believe there is ample evidence the fundamental story is intact for Sodastream and expect the company to deliver a strong fourth quarter number and FY 2013 guidance. Regardless of whether the bull case or bear case plays out in the future, the extremely high level of short interest is a recipe for increased volatility going forward. Furthermore, short sellers could be motivated by the civil unrest currently taking place in Israel, and any escalation of the conflict could disrupt factory production at Sodastream. Personally, even though I expect management to execute and shares to be higher in 12 months, I would advocate taking a pass on Sodastream as the market is providing plenty of other opportunities to invest in growth with greater certainty.

A few items of consideration for Fool readers who choose to do more homework on Sodastream. First, you will want to look for Form 6-K among the SEC filings and not Forms 10-K/10-Q, as the Israeli-based Sodastream is considered a foreign issuer. Second, the company changed its reporting currency to the U.S. dollar (USD) beginning with the first quarter ending March 31, 2012. Sodastream reported in Euro (EUR) prior to Q1 FY12.

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johnmacris has no positions in the stocks mentioned above. The Motley Fool owns shares of SodaStream. Motley Fool newsletter services recommend SodaStream. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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