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Company Background

Muscle Pharm Corporation (OTCQB:MSLP) is a relatively young company. It was formed in late 2006 under the name "Tone in Twenty" for the purpose of engaging in the business of providing personal fitness training. In February 2010, Tone in Twenty acquired all of the issued and outstanding equity and voting interest of "Muscle Pharm, LLC" (which was formed in early 2008). As a result of this transaction, Muscle Pharm, LLC became a wholly owned subsidiary of Tone in Twenty, and Tone in Twenty changed its name to "Muscle Pharm Corporation."

What Does This Company Do?

As the name suggests, Muscle Pharm manufactures and markets sports nutrition products for athletes, bodybuilders and health minded individuals.

The company's product portfolio (currently 34 products) includes Assault, a pre-workout supplement; Battle Fuel, a supplement that supports testosterone production; Bullet Proof, promotes deep sleep and supports growth hormone/testosterone output; Combat Powder, a high protein supplement; Shred Matrix, a weight-loss supplement; and Re-Con, a post-workout recovery supplement. The company also recently introduced FitMiss, a new and innovative branded line of fitness supplements designed specifically for women with active lifestyles.

Muscle Pharm products are available in over 10,500 U.S. retail outlets, including Dick's Sporting Goods (NYSE:DKS), General Nutrition Centers (NYSE:GNC), Vitamin Shoppe (NYSE:VSI) and Vitamin World. The supplements are also sold to over 100 online channels, including bodybuilding.com, amazon.com, gnc.com and vitacost.com. Muscle Pharm also has a strong international presence - where its supplements are sold in over 110 countries. Currently international sales account for approximately a third of the company's total sales.

Brand Popularity

Considering that bodybuilding is a hobby of mine (you can call it an obsession), I know a thing or two about the supplement industry. For example, I know that Muscle Pharm is among the most popular supplement brands in the industry. Even the "Top 50 Seller" list on bodybuilding.com (most popular supplement website), features eight different Muscle Pharm products. In fact, I have been periodically checking this list for the last three years and Muscle Pharm has been on it every single year, this tells me that the brand has "staying power."

Muscle Pharm has won many supplement awards over the last few years. More recently, at the 2012 Bodybuilding.com Supplement Awards, Muscle Pharm received three Awards of Excellence; "Brand of the Year" award, "Packaging of the Year" award, and "Pre-Workout Supplement of the Year" award for its "Assault" pre-workout supplement. In addition to the three awards I just listed, the company also won the GNC "Rising Star" award.

Muscle Pharm is the official supplement provider and sponsor of the Ultimate Fighting Championship (UFC). For those of you who watch the UFC, you might have noticed the Muscle Pharm logo on the fighting mat and on the uniforms of the company-sponsored UFC fighters. Considering that millions of people watch the UFC, this is very good marketing for the company.

The company sponsors many athletes in a wide variety of sports. However, I would say that the football player, Michael Vick, is the most famous athlete currently sponsored by Muscle Pharm.

The company also launched an advanced website in seeking to tap into the social networking world to further its brand and consumer awareness. The company currently has over 617,000 fans combined between its Facebook (NASDAQ:FB) and Twitter accounts.

Huge Growth Potential

According to the Nutrition Business Journal, the market for nutritional supplements in the United States was estimated to be approximately $30 billion in 2011 (the most recent year for which data is available). The market has reached its present size due to a number of factors, including increased interest in health and wellness, increased awareness of the health benefits of dietary supplements, a growing population of older Americans, successful new product introductions, and a trend towards preventative measures and healthy living.

If Muscle Pharm is able to capture just 1% of the domestic nutritional supplements market - that would equal $300 million in sales. With an 8% profit margin (industry average), the company would earn $24 million. Based on the current market capitalization of approximately $56 million, the shares would only be trading at about 2.3x earnings. A more reasonable earnings multiple of 10x would give us a fair value of $240 million. Obviously if Muscle Pharm continues posting double digit growth rates, Mr. Market will assign a much higher multiple to its earnings. Depending on the growth and the overall financial condition of the company, even a price multiple of 20x would not be unreasonable (giving us a fair value of $480 million).

Since a large portion of growth will come from overseas, I believe it is also important to analyze the global market. According to BBC Research, the global market for sports nutritional supplements is forecasted to reach approximately $92 billion this year. I should also mention that the global market has been growing at over 20% per annum. As Muscle Pharm continues with its international expansion, I think we will continue to see impressive growth from this company for years to come.

Risks

Perhaps the biggest risk is that Muscle Pharm has no "economic moat" (at least not yet). The nutritional supplement industry is extremely competitive and the company's competitors are larger, more established and possess greater resources. Muscle Pharm must continue introducing new and innovative products in order for its brand to stay relevant. This is definitely not a stock retirees should own in their portfolios.

Another risk is the company's reliance on a limited number of customers for a substantial portion of its sales. For the year ended December 31, 2012, two customers accounted for approximately 45% of total sales (Bodybuilding.com ~ 33% and GNC ~ 12%). While this is definitely a huge risk, the likelihood of it losing either of these customers is low (as long as there is demand for Muscle Pharm products).

It is absolutely crucial that the company becomes profitable this year. If it fails to do so, it will be forced to both take on additional debt (increasing risk) and issue more equity (causing more dilution).

One final risk that I need to mention is the inexperienced management (mostly inexperienced CEO). However, I go further into depth on this topic when I talk about management.

Management

Brad J. Pyatt is the company's President and CEO. He founded Muscle Pharm LLC in April 2008, two months after filing for bankruptcy. The reason for his bankruptcy was a company called "Hard Nutrition." Back in 2003, Mr. Pyatt made a substantial investment in the company; however, it turned out to be a total failure, which left him with a near worthless stock and a lot of debt. Mr. Pyatt's lack of business experience is not the only thing that concerns me. The executive compensation is also a problem. For instance, Mr. Pyatt received over $2.8 million in compensation in 2010 (including bonuses and stock awards). Key executive compensation totaled $6.2 million for the same year. This kind of compensation is absurd for such a small company. Although, I must admit that the company's compensation has become more reasonable in recent years. For example, key executive compensation totaled $5.2 million in 2011 and only $2.5 million in 2012. However, it is still troubling to see that the company pays for "private golf memberships" for certain key executives (including Mr. Pyatt). One final thing that I must mention is that insiders control more than half of the voting power (Mr. Pyatt alone controls a third). Given this, outside investors have little say in what happens at the company.

Fundamentals

Growth:

It is not very often that one has the opportunity to invest in a company with an annualized revenue growth rate of over 300 percent! Take a look at these revenue numbers:

2010 Revenue: $4.0 million

2011 Revenue: $17.2 million

2012 Revenue: $67.1 million

2013 Revenue: > $100.0 million (estimate)

I believe that the company should have no problem exceeding $100 million in revenue this year. In fact, if the company can only achieve a third of its 2012 growth (~ 290%), revenue will exceed $125 million this year. Obviously, we cannot expect the company to grow at this rate for very long. However, it should still be able to post double-digit growth (~ 20% per annum) for the foreseeable future.

Profitability:

Muscle Pharm has spent the last few years trying to capture as much market-share as possible, which means profitability has not been something that management has focused on. Of course, this is actually a smart strategy and it is something companies like Amazon (NASDAQ:AMZN) are famous for (capture market-share first, worry about profitability later).

2010 Free cash flow: ($3.9) million

2011 Free cash flow: ($6.6) million

2012 Free cash flow: ($1.6) million

2013 Free cash flow: > $0.0 million (estimate)

While the company will continue growing and grabbing more market-share, management has stated that one of their major goals for 2013 is to focus on the bottom line. Actually, they said that the company will become profitable this year, which is good news for investors.

Financial Health:

Muscle Pharm is in good financial health at the present moment. The company has $6.3 million in cash and minimal debt (primarily capitalized operating leases of $2.7 million). In fact, the company's cash and accounts receivable comfortably exceed total liabilities. Part of the reason why the balance sheet looks so good is because management has been busy raising funds. In the last two months alone (February and March), the company has raised $16.7 million in net proceeds. These new funds were used to reduce debt and improve working capital.

Note: It is important to mention that the company significantly understates its lease obligations, so my estimate of $2.7 million is more conservative.

Valuation

Considering how fast the company has been growing and how popular its products are, I strongly believe that this makes it an acquisition target. Below I examine what similar companies have been acquired for to help us determine an approximate fair value for the stock.

(click to enlarge)

According to my research, the average buyout price for supplement companies has been around 2.7x annual revenue. During the most recent year, Muscle Pharm had just over $67 million in revenue, which would give it a fair value of approximately $181 million (or $23.15 per share, based on 7.82 million diluted shares). Considering that the stock price is currently trading for around $8.30 per share, this gives us an upside potential of nearly 180%. However, the company probably will not get acquired anytime soon. This means that if the acquisition does happen eventually (very probable), the company's revenue will be higher (north of $100 million), which means that the buyout offer will also be higher.

Even when using conservative estimates, the upside potential is huge. Although, investors do not need to wait for someone to acquire the company in order to make a profit. There is one short-term catalyst that will push the shares higher, which I talk about next.

Upcoming Catalyst

Muscle Pharm should be uplisted to a major stock exchange sometime this year (possibly during the summer). In all of my years of investing, rarely have I seen a stock underperform when it gets uplisted. This is because uplisting typically results in a significant inflow of new investor demand to a previously underfollowed stock. For example, most institutional investors simply do not invest in an OTC stock. Due to this lack of institutional following, many research analysts are reluctant to initiate coverage on OTC stocks, which in itself contributes to a lack of investment by institutional funds. For those willing to play this corner of the market, this is one case where the individual investor has a huge advantage over the institutions.

Conclusion

Peter Lynch once said: "Go for a business that any idiot can run - because sooner or later, any idiot is probably going to run it." Luckily for us, Muscle Pharm is that kind of business (even inexperienced management cannot stop it from flourishing). Once the stock begins trading on a major stock exchange later this year, I believe the shares will pop due to institutional buying. There is another benefit to the uplisting; it increases the likelihood of the company getting acquired. For those who can handle the short-term price volatility, I believe this is a great investment with huge upside.

Source: Muscle Pharm Will 'Bulk Up' Your Returns