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Introduction

There have been a handful of articles written on MusclePharm (OTCQB:MSLP) on Seeking Alpha in the last few months where writers talked about the energy supplement industry, the company's phenomenal growth, recent recapitalization and future potential. There were also elaborated discussions on the quality of the company's products and customer feedback, some comments on management's background and initiatives, and suggestions on how the company can add value to its shareholders. However, there has been little discussion on what brought the company to where it is now, ownership structure and how that can possibly foretell its future. Although it's all history and MusclePharm is a completely different company now, especially after the recent recapitalization led by billionaire investor Dr. Phillip Frost of Opko Health (OPK), the company has a shady past that I would like to reflect on from a retail shareholder's point of view.

Looking back

As a shareholder of this company, I have experienced the growing pain of MusclePharm , which I enjoyed for most part, but I was disappointed by having the feeling along the way that old shareholders have never been a part of the plan. Like some of the writers of these recent articles, many retail shareholders, including myself, saw potential in this great little company with the only difference being the timing - they noticed it very recently while we identified and invested in it about a year ago. I was initially amazed by the exponential growth of this company and decided to invest in its common stock after some positive news releases by the company. All this started with the company's announcement of retirement of all of its toxic debt with internal cash flow, mezzanine financing and common stock on March 28, 2012, followed by preliminary 2012 first quarter financial results reported on April 23, 2012, where the company estimated operating profit of $1 million for the first time in its history, and a share repurchase plan laid out on the next day, April 24, 2012. The company raised its 2012 sales forecast to $75 million from $40 million and set its goal to be cash flow positive going forward.

When official results came out, shareholders were shocked to see a net operating loss of $727,293 for the first quarter of 2012. Further into 2012, the company lost more money, financed its growth and lavish expenditures, including hefty compensation package for its executives, by more toxic debt, diluting existing shareholders' base again and again. While the company was starving for cash, it paid close to half a million dollar in cash bonuses to three of its top executives for 2011 performance, which could have been deferred. MusclePharm's executive bonus program for 2011 was one of its kind -- it was approved in the fourth quarter of the year based not on any profitability metric, but on the company's sales growth compared to prior year and basically awarded the three executives one-third of the company (stock bonus). One of the beneficiaries of the bonus plan worked only for a few months (in 2011) for the company, while receiving a bonus for the full fiscal year -- it's a shame.

MusclePharm's treatment of its shareholders was, however, quite the opposite -- they paid the price all the time. Some of MusclePharm's business transactions were not transparent either. The company sold its clothing line to a Limited Liability Company (LLC) for $250K plus a 10% share in net profit of the LLC on a yearly basis. The profitability of the LLC that now owns MusclePharm clothing line is, obviously, beyond MusclePharm's control. How did MusclePharm get away with all these questionable decisions? Why couldn't stockholders stop all this? The answer is simple: they don't have any voice. Their votes don't count as two of the company's top executives control the majority of the voting rights through their holding of Series B Preferred Shares of the company. In other words, those two executives abused their power to benefit themselves, marginalizing common stockholders. All these missteps and short-sightedness of the management brought MusclePharm to such a point where the company needed cash badly, and a group of wealthy investors rescued it for $12 million for roughly 50% of the company, while the company reported a net revenue of over $50 million for the first nine months of latest fiscal year. The company also had to pay 8.4% of the company to two consultants who facilitated the recapitalization transaction. Again, at the cost of existing shareholders.

Moving on

Enough has been said on MusclePharm's past, now it's time to move on. Let's focus on how the company can do business differently in a more efficient way so that it can add a lot of value to its shareholders. Let's assume MusclePharm will be a profitable venture going forward and grow at a healthy rate for quite some time from now on. In that case, its value will be determined by its profitability and growth rate. What should be a reasonable profit target given a revenue of say, $100 to $200 million per year? To figure that out, we can use industry cases. We have two great real-life examples: Optimum Nutrition and BSN, both of which were bought out by Irish Nutritional Solutions and Cheese giant, Glanbia PLC (OTC:GLAPF). MusclePharm product lines are fairly similar to BSN's and Optimum's. Let's compare MusclePharm with Optimum and BSN based on some operation and acquisition metrics:

(sources: Optimum and BSN acquisitions by Glanbia)

Company Name

Sales

(in $ MM)

EBITDA

(in $ MM)

EBITDA margin

Acquisition price

(in $ MM)

Acquisition metric

Sales multiple

EBITDA multiple

Optimum Nutrition

185

(2007)

32

(2007)

17%

315

(2008)

1.70

9.84

BSN

135.4

(2011)

16.4

(2011)

12%

144

(2011)

1.06

8.78

MusclePharm

68*

*Revenue from first three quarters of 2012 was extrapolated to generate full year revenue

With respect to revenue generation and market penetration, MusclePharm is on track, but it is yet to record its first quarterly profit. MusclePharm's gross margin for the first nine months of 2012 was around 20%, which needs to be improved significantly (by at least 50%) in order to achieve a double-digit EBITDA margin. As pointed out by several Seeking Alpha contributors, MusclePharm can improve its gross margin by negotiating new contracts with its manufacturers as it now has the size to do so. It may be mentioned here that, unlike Optimum Nutrition and BSN, who have their own manufacturing facilities, MusclePharm uses third-party manufacturers. There are also excesses in the G & A category.

Conclusion

Can MusclePharm turn to profitability and grow its business in a sustainable manner? It is very much possible, but requires strategic vision, business acumen, strict discipline and precise execution of its business plan. MusclePharm's key executives sure know how to sell their products, but do they have the mettle to stand the test? I hope MusclePharm management has learned from its past mistakes and will take this opportunity to start doing business differently. It is MusclePharm's moment. Hope history won't repeat itself.

Source: MusclePharm: A Retail Long's Reflection On The Past And Pondering Of The Future