SodaStream International LTD (SODA) finished the trading week on an up note with the stock finishing at $72.83 on Friday and through a rough trading tape that witnessed all three major averages falling on the day. The stock has benefitted from recent rumors that it is or may become the target of an acquisition by a major beverage producer like PepsiCo (PEP) or Coca-Cola (KO). With such rumors ever-present in the marketplace, it is important to understand how to better define the validity of such rumors which is why in our last article I outlined the following for investors: Here is the problem with the initial dissemination of the report/rumors; thus far, SODA has not been placed on Goldman Sachs restricted stock list nor any brokerage house's restricted stock list as it would otherwise have to be based under the circumstances and the requirements thereby governed by the SEC. Having said that, this does not conclude that PepsiCo is not considering initiating negotiations or that the reporter simply confused some of the research at hand. The above mentioned statement offered to investors should serve to underscore the difference in reporting by various media outlets and reporters/journalists; it's a matter of finding the right resource and that requires due diligence on the investors part.
The following articles offer very little to investors in the way of discernable facts, but rather perpetrate the rumors and speculate thereupon and as investors we all deserve better (see here and here). After reading these articles, investors were unfortunately still left to question whether an offer had ever been delivered to SodaStream or not.
The worst part about the onslaught of reporting that ensued thereafter the first set of rumors circulating a buyout of SodaStream was the lack of knowledge-based information available to investors. I must have personally read 50-75 different articles, all speculating and regurgitating the same set of information and offering little if any course of action for the average investor. And then as expected came the short players who hoped to capitalize on the rumors, knowing very little about the business of SodaStream and what has made it such a successful company over the last 7 years. Followed by the short speculators were the few who had a similar understanding of SodaStream's business. For each and every article citing the potential buyout rumors of SodaStream, commentary followed. The purpose of this article will be to provide logical reasoning for investors to consider regarding the latest rumors and provide a better understanding of what the major beverage producers are up against based on their business and the business of SodaStream.
Most comments on the articles recently published focused on the belief that neither PEP nor KO would buyout SodaStream. While I wouldn't argue the validity of these comments, it's the reasoning for such a belief that fails to accommodate logic when one hopes to better understand a company's business and/or structure. The common misconception or belief that most market participants have when discussing a possible tie-up between SodaStream and a major beverage producer is that these major producers don't need SODA and they can simply sell their own competing syrups to take market share away from SODA. Some even believe that KO or PEP could produce their own soda makers and drive SODA out of the market altogether, yet here we are 7 years since SODA's initial market expansion began and none of the big boys are playing ball in this market arena. I don't want readers to be confused by the information within this article, so with that said let's all accept that, in the marketplace anything is possible, but most things are unlikely. With that widely accepted understanding let's move forward. While I accept that KO or PEP could quite easily manufacture and produce their own syrups for sale in like packaging to that of SodaStream's and for the very same consumer, I sit here acknowledging some 7 years into a huge land grab by SODA that they have yet to do so. So what is the explanation for KO, PEP or any major beverage company to allow such an event to take place without interceding? There is likely no singular reason, but we can certainly discuss a few.
One concern the major beverage producers would have upon deciding to enter this particular product category is simply the outstanding contracts they have with existing bottlers. Quite simply put, the bottlers would have to ramp up their respective capital expenditures in order to accommodate new production lines. Subsequently or even consequently, now what happens to the capacity utilization of older manufacturing lines and older product categories; what is the long term effect to the business model which basically becomes irrelevant due to the move into the at-home carbonated beverage market? Again, the bottlers have scaled there business alongside that of the major beverage producers and their respective businesses move simultaneously as they are completely dependent upon each other.
There is a reason the label "disruptor of industry" has been attached to SodaStream. The label defines SodaStream as a game changer. The product ecosystem offers a new way for the consumer to purchase and consume sparkling water and soda. Furthermore, it places its predecessors such as the major beverage producers in a precarious position of antiquity. The antiquated business models of KO, PEP and Dr. Pepper Snapple Group (DPS) suggest that the consumer will depend on these titans of industry for all their sparkling beverage taste needs indefinitely. SodaStream suggests otherwise through its product ecosystem.
So if we get back to the major beverage producers and their respective bottling partners we understand that these businesses and business relationships have been around for over a century. With each passing decade the companies expand and scale up their business to meet growing consumer demand and in accordance with the existing business model. The carbonated soft drink business has been scaled unilaterally and in one direction for more than 100 years. If the major beverage producers want to get into the syrup selling business, direct to the consumer, they are going to have to succumb to a major shift in business and/or reduce the scale of the existing business dramatically. This is no simple shift in business strategy and would equate to the Titanic stopping on a dime and making a 180 degree turn.
Now we get to the most important and probably most cerebral portion of understanding why scaling the majors' business in an entirely new direction could be potentially disastrous for the titans of the carbonated soft drink (CSD) industry. In the at-home carbonated soft drink industry, that which is promoted by SodaStream, you have a choice; you either do it all or you do nothing. Here's what I mean by that statement: The majors can't just make syrups for the consumer; they have to develop the entire product ecosystem which has already been evidenced by other manufacturers whom attempted to break into the at-home carbonated soft drink business segment and failed due to an incomplete portfolio of products. At least a dozen different corporations have attempted to get into the SodaStream business over the last 5 years and each and every one has failed in quick order.
If KO, PEP or DPS sell syrups only, they encourage more consumers to buy at-home soda making machines from SODA. Consequentially, the consumer is now introduced to additional syrup product offerings from a host of other companies alongside SodaStream's proprietary syrup flavor offerings. Additionally they have the dynamic capability that they never had before to dose their CSD to personalize taste. The chances that the consumer will purchase additional flavors along with their favorite KO, PEP or DPS syrup is highly likely and further evidenced by ever-increasing syrup sales for SodaStream on a YOY basis. Moreover, now the major beverage producers have locked their customer into the at-home CSD market and quite possibly, rather likely, losing their away from home customer in a hand-off to SodaStream. With this key point of understanding in mind, it's not KO or PEP that would suffer the biggest blow in the early going, it's the bottlers. The bottlers would initially be hit with order declines that are unsustainable given the scale of its business. As the consumer opens his/her eyes to ever-expanding at-home CSD flavors offered through SodaStream, every purchase outside that of the KO, PEP or DPS purchase results in reduced orders for the bottlers. If you don't think the bottlers haven't discussed this at length I would greatly disagree. Seven long years folks and the major players are still on the sidelines. This is what we call deductive reasoning.
I've seen other arguments that some investors and market participants pose when stating that the major beverage producers can make and market their own soda makers and syrups. They cite their reasoning based on Starbucks (SBUX) now making its very own brewer and coffee flavored pods. As usual, they don't have the data to support what Capital Ladder Advisory Group already knows, which is that Starbucks is just as competitive with Green Mountain Coffee Roasters (GMCR) brewer systems as Cuisinart is competitive with SodaStream's soda maker systems. It really is a big flop for SBUX based on our channel checks. Without giving too much away, Cuisinart sells, on average, 1 soda maker system for every 19 sold by SodaStream. That unit selling average is even worse for SBUX in its competition with GMCR. Fortunately for SBUX, they did not manufacture the brewers wholly as they partnered with a German manufacturer whom bore a significant amount of the cost associated with the products. However, what has been clearly demonstrated through the SBUX/GMCR partnership is that once you allow your customer to experience your product through another's proprietary product category, they tend to latch onto the other products associated within that product category. How many SBUX coffee k-cups have been sold accompanied by a GMCR K-cup and how many since that time have now eliminated the use of a SBUX K-cup in favor of other K-cups. And you wonder why SBUX came out with its own machine do you? We call this more deductive reasoning.
While SODA investors relish in the eventual licensing agreements with the major beverage producers this would not be the most sound business decision which needs to be understood for long term investors in KO, PEP or DPS. However, the alternatives are even worse for the majors if they don't coalesce. We've witnessed illogical business decisions made by Fortune 500 companies in the past, but if I was an investor in any of the aforementioned companies and witnessed either of them begin to produce and mass market direct-to-consumer syrups, I would take my profits and look to reinvest elsewhere. It's very simple to see how fast this situation can get out of control with the already accelerating adoption rate of the SodaStream ecosystem. It's also one of the reasons members of SodaStream's management team have been quoted as saying that if any of the major beverage producers wants to make their own direct-to-consumer syrups we will be on the first plane to their headquarters to shake their hands. SodaStream will sell even more syrups, even more machines and even more CO2 in excess of 90% gross margins. So you see, it's really not logical for the major beverage producers to hand over their customer to SodaStream for safe keeping. SodaStream is not a facilitator of the existing soft drink industry, it is a disruptor. Again with the whole deductive reasoning thing.
So why can't the major beverage producers build soda makers and syrups? Well, nobody said they can't, but we suggest again that they shouldn't. The cost associated with such a new business segment would rival that of an absolute buyout of SodaStream. It simply doesn't make logical sense at this stage of the at-home CSD market, which is dominated to extreme proportions by SODA, to dedicate that kind of capital with the hopes of competing where others continue to fail. They would get all the benefits that come along with the SodaStream business sin the hassle of the start-up costs of going-it-alone should they make an outright bid for SODA. The major beverage companies don't have to tip their foot into the water here to see if the at-home CSD business works, SodaStream has done that for them.
Cuisinart, by Nacco Industries (NC), is one of the world's most respected household appliance brand makers throughout the world. The company specializes in the production and marketing of small appliances. Last year Cuisinart, with all its years of experience in the small appliance category introduced its own soda maker and CO2 products. Capital Ladder Advisory Group has tracked sales for Cuisinart's soda maker and CO2 since it originally launched at Bed Bath and Beyond (BBBY) last year. Thus far, all indications are that the Cuisinart product line is failing and it has forced Cuisinart into the production of a lower cost soda maker line and the development of syrups to complete its product ecosystem. In laymen's terms, Cuisinart's existing product line was not competing well with SodaStream's product line and thus the company returned to the drawing board one more time and devoted even more capital to try and advance its product ecosystem. Cuisinart is without a doubt one of the top global brands in the small appliance industry and the brand is likely to fail in its current attempts at gaining sales in the at-home CSD market, yet investors in KO, PEP or DPS suggest their companies could dive head-first into the same spider's web. With this logical framework laid out for investors to better scrutinize for themselves, it is clear that the major beverage producers need to commit to an entire, massive scale reduction, shift in product, production line and capacity utilization or do exactly what has been rumored upon and buyout SodaStream.
So exactly how poorly is Cuisinart's at-home CSD market business fairing? Below is a scanner-generated report from a major retailer selling Cuisinart's CO2 exchange cylinder. We have effectively truncated our screen shot to include the nationwide total chain store sales:
The evidence is painfully clear to those trying to compete with SodaStream and to the major beverage companies. SodaStream is not only here to stay, but it is here to change the landscape of how we consume beverages for years to come.
A fellow Seeking Alpha contributor noted brand loyalty as being a risk factor to the SodaStream business model. Of course he drew this assumption without relevant data, but rather simple speculation. Based on any usage, any at all prior to the introduction of SodaStream, we have to assume that current users of the SodaStream system were once drinkers of KO, PEP and/or DPS products. So this categorized assumption of risk just doesn't make any sense now does it? It's not a matter of every KO, PEP or DPS drinker switching as the evidence suggests they have and will continue to, it's to what degree and how rapidly the consumers switch before any of the major beverage companies makes a discernible market move.
Okay, so now some are thinking, "Well then doesn't this eliminate the potential of a major beverage company partnering with SodaStream for co-branding deals?" Well, it depends on the major beverage company you're talking about and timeframe for consideration. Frankly speaking, eventually they will all have to succumb to "dealing" with SodaStream. The consumer is clearly leaning toward the growing trend of at-home CSDs for a variety of reasons and with case volumes for CSDs falling by some 7.7% recently for the major beverage producers, they will need to do something to offset such declines long term. For those following these companies you have to better understand the global eco-friendly trends, the healthier alternative trends, the convenience trends, the economic trends, the taste specific trends and even the taxation trends. Some countries are denouncing plastic bottles and cans altogether, proposing absolute bans. Take a look at the video offering from a Belgian politician calling for a ban on plastic bottles and cans.
Lastly, here's the biggest problem the major beverage companies face in the at-home CSD market, the CO2. SodaStream has already built an insurmountable CO2 distribution network. Possibly the hardest part of SodaStream's business is advancing the C02 network as the CO2 exchange process is completely new to the concept of retailing. The retailer is essentially asked to provide a refilling service on behalf of SodaStream, but locally to the consumer. Additionally, the retailer must partake in the reverse logistics process which tasks the retailer to send back empty CO2 cylinders to SodaStream in exchange for full ones. The sales associate providing the refilling service for a consumer must log the transaction in an assigned book for tracking purposes as well. The process is time consuming and also requires the storage of CO2 behind customer service desks at participating retailers. Due to the relative complexities in this CO2 exchange service, many retailers have held off on partaking in such a service, but over the last couple of years the retailers have succumb to realize the repeat foot traffic and sales provided by the CO2 exchange service. It will require a lot of luck getting the retailers to do a second and separate company's CO2 exchange service. It's difficult enough to do one let alone two. The sales associates sometimes put the wrong brand cylinder in the wrong box and ship it back to the brand provider for which now the retailer has to pay for the misplaced cylinder. Some retailers have tried in the past to perform multiple gas exchange brand services and failed, so they eliminated all-but the SodaStream gas exchange service.
Ok, so let's revisit the sales discovery we offered you earlier through a look at the performance of Cuisinart's sales. Without a comparable to SodaStream's sales we may still have some skeptics right? Capital Ladder Advisory Group is the leading national sales accumulator for SodaStream products as we look to advance our product category coverage moving forward. So with that said, here is a look at SodaStream's comparable CO2 sales report from the same national retailers:
In closing, the reasons to support the notion that the major beverage producers can enter the at-home CSD market profitably and wholly is illogical based on the evidence provided. Again, logic and sound business decisions don't always go hand and hand as suggested earlier. Therefore, anything is possible, but the likelihood …? Capital Ladder Advisory Group remains bullish on SODA as a long term investment with a Buy rating because of the extremely misunderstood, high barriers to entry in this market segment. It's been 10 years or more for European operations at SodaStream in its existing form, some 4 years in the Asian-Pacific region, roughly 3 years in North America and over a year in South America. So for over 10 years, the major beverage producers have allowed SODA a land grab because they can simply step into the same marketplace? Is that really true? Well no, it is not. Just like the rumors surrounding a buyout of SodaStream, this article serves to prove that where there's smoke there's fire. We've supplied readers with the logical elements emitting smoke to better understand the beverage sector moving forward.