MusclePharm (OTCQB:MSLP) is a fast growing sports nutrition company with expected sales of over $100 million for FY 2013 and a market cap of approximately $70 million. Based on my analysis below, I believe there is significant upside potential for the shares over the next 3 months as the company releases FY2014 guidance and updates on the progress on various initiatives that have taken in place in FY2013.
- The current share price does not reflect the fundamental improvements in the underlying business, which has transformed the company during FY 2013.
- There is a significant valuation overhang on the shares from the on-going SEC investigation and the pending NASDAQ uplisting, both of which I expect will be resolved within the next 3 months.
- Currently trading at around $8, the shares appear to be significantly undervalued. Based on conservative assumptions on growth and profitability I derive a fair value of around $14 per share.
- Recent insider purchases by MusclePharm management and the announcement of a share repurchase program further support this observation.
- The company's strategic development has been financed by a group of investors led by Phil Frost (CEO and Chairman of Opko Health (OPK)) who invested $2.5 million through a common share offering at $10.50 per share in August of this year. MusclePharm raised $12 million in February 2013 at $8 per share.
Below is an overview of the key strategic developments that will come to bear fruit in the coming quarters:
MSLP data by YCharts
Overview: 2013 Strategic Initiatives
|Description||Near-term catalyst||Financial Impact|
|Arnold Product Line|
The agreement is set for an initial 3-year term. Arnold's compensation consists of a mix of royalty payments and stock comp. As part of the transaction, he effectively acquired a 7.7% stake and became the largest common shareholder.
Management reported $3.6 million in sales for the first 2 months since launch implying $22 million in sales on an annualized basis using simple extrapolation.
4Q2013 sales and margin update during the 2014 strategy update in mid-January will be critical to determine whether this project can be deemed a success.
An agreement with Costco was signed on August 7, 2013 to carry Combat Protein Powder nationwide in all 430 stores. The product appears to be selling well as the company announced on November 19, 2013 the addition of its Amino-1 product to the Costco line up.
|YES||No financials have been reported to date. The addition of a second product is a huge positive, implying that Costco is satisfied with MSLP as a supplier. Detail on sales and margin impact will be a catalyst for the shares.|
On November 13, 2013, MusclePharm signed a definitive purchase agreement to acquire all of the assets of BioZone and its subsidiaries for approximately $12 million in all stock. Management believes that the acquisition will provide cost savings around distribution and manufacturing.
|NO||Integration of the acquisition will likely take 3-6 months post closing. Upwards revision on gross margins going forward represents a significant upside catalyst. As stated in the 8K, the transaction is expected to close prior to year end December 31, 2013.|
|FitMiss Walgreens||Starting in January 2014, the FitMiss Delight product will be available nationwide in all 7,000 Walgreens stores. Additional products of the FitMiss line will be added in June 2014.||NO||Significant revenue opportunity but sales will not be reported until 1Q2014. Limited impact on share price over the next 3 months.|
|Fuse Investment||A Strategic Investment in Fuse Science, Inc. (OTCQB:DROP) was announced on November 8, 2013.||NO||No valuation impact in the near term. Any new pipeline product coming out of this collaboration will have to prove itself in the market place first.|
|Uplisting||The intention to seek a listing on the NASDAQ or NYSE was initially announced during the 1Q2013 earnings call. Management updated during the 4Q2013 call that they are in "active discussions with NASDAQ with respect to potential uplisting and hope to bring this to a conclusion shortly"||YES||Uplisting to NASDAQ would significantly enhance liquidity in the shares and allow a broad range of institutional investors to invest in the company's shares. There are currently only a small number of funds that invest in OTC traded stocks.|
In summary: The strategic activity over the past year will support further topline growth going into 2014 and beyond, largely driven by Costco, Arnold Series and FitMiss. I expect margins to improve and the company to become profitable as manufacturing and distribution is being moved in-house. 3Q2013 results show $9.6 million of inventory were acquired through the quarter which compares to just $1.2 million during the previous quarter. The benefit on margins will be seen in the coming quarter.
The 4Q2013 to FY 2014 financial forecast below serves as the basis for my valuation and is based on the following assumptions:
2Q2013: Management made a decision to end certain advisory contracts in the second quarter rather than continuing to amortize the cost. This whole amount booked as an expense for these advisory contracts in the second quarter of 2013 totaled approximately $3 million.
3Q2013: For the quarter ending September 30, 2013, the company had an operating loss of $4.8 million. $4.2 million of the $4.8 million was non-cash charges as disclosed during the Q&A part of the earnings call.
- 4Q2013 discounts decline back to previous levels of around 10% in line with previous quarters. The spike in 3Q2013 was driven by the Assault inventory clearance as the new version of the product was launched.
- Net sales are assumed to grow by $9 million in 4Q2013 assuming the Arnold Series generates monthly revenue of $2 million. The product generated sales of $3.68 million during the first two months since launch. Based on that a monthly run-rate of $2 million is conservative in my mind. Furthermore, as a placeholder for now, I am assuming Costco will add another $1m in sales per month. Assuming $6 million and $3 million in incremental sales for Arnold and Costco respectively should be an achievable scenario for 4Q2013.
- 4Q2013 and FY2014 gross margins are assumed to recover to 32% and 36% respectively, which is in line with previous quarters. Given the recent investments in distribution, warehousing and manufacturing this should also be a conservative estimate
- Operating expenses are assumed to be slightly higher in 4Q2013 taking into account the one-off legal expenses of $1.1 million in 3Q2013. On that basis they are increasing by $1.0 million from $11.1 million to $12.1 million. FY2015 EBITDA margins are in line with the margins of previously acquired competitors BSN and Optimum Nutrition.
To derive a valuation estimate for MSLP's shares based on the forecast above I looked at the current valuation of publicly listed companies in the same or similar industry and looked at the implied valuation multiples of acquisitions consummated in the health supplement and nutrition space.
The analysis of public trading comps shows a range of multiples between 6.5x to 15.6x on a FY+1 basis with a mean and median of 10.2x and 9.7x respectively.
Precedent transaction comparables
The analysis of precedent transactions shows a range of multiples between 7.4x to 12.5x. Target companies with a lower transaction multiple like the acquisition of Glaxo's US OTC brands tend to also have lower growth, in this instance in the mid-teens as the products being acquired are typically mature non-core assets that are being divested.
As of 3Q2013, MSLP's fully diluted share count was 10.4 million shares with a net cash balance of $5.7 million.
Applying a EV/EBITDA multiple of 10.0x to MSLP's projected 2014 EBITDA of $16 million derives an enterprise value of $160 million and an equity value of $154.3 million, which translates to $14.83 per share. The valuation target of $14.83 implies 100% upside compared to yesterday's closing share price of $7.32.
Upside to current projections and valuation target:
- Sales from the Costco distribution deal exceed $3 million in 4Q2013 with significant growth ramp on a month to month basis.
- 4Q2013 sales for the Arnold series products shows significant ramp and imply annual run-rate sales of > $20million.
Downside to current projections and valuation target:
- On-going legal issues further delay the uplisting to NASDAQ. The SEC investigation will have to be resolved prior to that taking place. While the MusclePharm audit committee announced on November 15, 2013 that no accounting restatement was required, the SEC might have a different view.
- Delayed closing of the BioZone acquisition: Shareholder rights law firm Johnson & Weaver, LLP on November 19, 2013 announced an investigation of the BioZone asset sale. I assume the investigation did not lead to anything material as BioZone announced on November 27, 2013 a reverse merger with Washington-based biotech Cocrystal Discovery Inc., a company specializing in antiviral medicines.
- Disappointing sales and margin contribution from the Arnold Series in 4Q2013 due to heavy discounting, sales incentives and other launch expenses.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in OTCQB:MSLP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.