News came yesterday that Coca-Cola (NYSE:KO) and Green Mountain Coffee (NASDAQ:GMCR) are partnering up to expand Green Mountain's Keurig brand. From soup to soda, Green Mountain is expanding its product base. With its new partnership, Keurig is set up to challenge SodaStream (NASDAQ:SODA) in the home soda industry.
Coca-Cola's 10% stake in Green Mountain stock comes with a soda production partnership and a licensing agreement. With the Coca-Cola brands (Coke, Sprite, Fanta, Minute Maid, Vitamin Water, Fuze Tea, and more), Green Mountain is likely to gain serious ground on SodaStream's market share.
In this article, I would like to discuss a worst case scenario for SodaStream to determine a fair value for its stock. Its shares have been falling recently, and accompanied by another major drop after the Coca-Cola/Green Mountain partnership, have reached their 52-week low - is it worth the drop?
Scenario: SodaStream retains it current users (not accounting for future gains to cancel the potential losses), and continues to sell them their flavors and refills at the current rate.
In a previous article I outlined SodaStream's barrier in the home soda marketplace: their gas exchange program. With over 13,000 locations in just the USA, it could take competitors years to duplicate. In a worst case scenario, SodaStream would still earn revenue from selling their flavored syrups and carbonation refills (for their machines).
In 2013, SodaStream had $562M in revenue, with just over $50M in adjusted net income. While SodaStream will not reach its $1B 2016 revenue goal in a 'worst case scenario', it will still generate margin healthy revenue.
For Q3, SodaStream broke down revenue by Segment. Even though flavors and carbon refills are higher margin businesses, we will still use the 54.1% Q3 gross margins as a 'worst case scenario'.
Hence, 54.1% margins on $79.1M would leave SodaStream with $42.8M in operating profit in just a quarter. The second half of the year is historically weaker for SodaStream, so it would be conservative to expect $320M in annual revenue, and $175M in operating profit.
Current operating costs are at a higher level than normal, as SodaStream is spending tens of Millions on advertising. It is impossible to know the exact amount in which a slimmed SodaStream would spend on operating expenses. I will estimate $15M in sales and marketing, and $10M on general and administrative purposes a quarter. This would come to $100M a year in operating costs, leaving the company with $75M in pre-tax income.
Using a 10.5% effective tax rate, Soda would generate approximately $68M in net income a year. Valued at just 12x earnings, the new SodaStream would be worth $816M.
SodaStream dropped below $31 during after hours when the news was announced. However, it rebounded to $34.50 by 10pm after closing the day at $35.70 (down 3.6% from session close). If shares were to open at $34.50, SodaStream's market cap would be below $730M, or more than 11% below my 'worst case scenario' evaluation.
Adding into the equation SodaStream's shareholder equity of more than $325M, I believe that shares are extremely undervalued even if shares were to take a turn for the worst.
SodaStream may still put up a fight in the home soda market, and continue to produce and market new products. I believe the current shares are extremely undervalued, and come with a backup value that I believe to be 10% above current evaluations.
Green Mountain Coffee went through a similar pattern, and has emerged even stronger. With more than a $1B investment from Coca-Cola, their partnership shows how big the home soda market may be. SodaStream is in a strong position to give a fight, and remain a significant player in the market.
Coca-Cola's Billion dollar investment made me realize the potential for the home soda market. SodaStream may be able to ink deals with other iconic soda brands, in particular Pepsi (NYSE:PEP). If Coca-Cola begins to gain the upper edge, Pepsi may be able to swoop in and buy out SodaStream to compete with Coke.
While acquisition talks are long ways away for a company that's about to drip away marketshare, SodaStream already owns several barriers that would make it easier for other companies to enter the market, and is trading at a very lucrative price......