SodaStream Investment: The Whitney Tilson Thesis


Tilson's Survey Results.

CO2 Moat for SodaStream.

Competing products are less practical.

On March 6th, shares of SodaStream (NASDAQ:SODA) rose sharply due to the publicly recognized new position taken by Kase Capital and its infamous fund manager Whitney Tilson. On March 10th, shares of SODA soared once again as NPD weekly SodaStream sales data showed strength in sales for the creator of the popular soda beverage makers and sparkling beverage drinks. In this article, I will discuss Whitney Tilson's point of view regarding SODA and its prospects as well as the competition the company faces. Lastly, I will conclude this article with a brief overview of Keybanc's latest notes on the cold beverage platform category.

SodaStream's Q4 2013 performance was a disappointment and its forward looking guidance left much to be desired. With the bar reset and new competition on the horizon, Whitney Tilson has established a position in SODA based on the theory that the company's products and the product category is not a "fad" as once believed. I don't give much credence to the fad theory as this theory has been widely proven wrong in recent years, however, even "wrong" can linger in the psyche of the average investor.

The continued growth in sales in the United States, where I now estimate household penetration to be 1.4-1.65%, has served to disprove the fad theory even with the majority of the company's business taking place outside of the United States. The U.S. consumer is varied along many lines including cultural, social, economic and regional demographics. Moreover, this is why the U.S. market is a tough market to attract with regards to a new product category which goes against the conventional norms in place for over 100 years. The promoting and marketing of said product category needs to be varied along the aforementioned demographics and in a timely fashion to overcome/overwhelm conventional norms such as store bought sodas. This is an enormous undertaking for any company, but especially for a soda maker company, no? With that in mind, SodaStream has witnessed growth in every market, including the U.S. market, for the last 5 years and in the face of the global financial crisis of 2008. Say what you will about soda makers, but like Whitney Tilson says, "SodaStream is no fad"!

While Whitney Tilson's report to investors does offer some insights into the fundamentals of the SodaStream business and what constitutes the strength of its business, much of the investment thesis is founded upon a series of consumer surveys issued by Kase Capital. Here is a list of questions offered in the survey to consumers:

  1. Do You Currently Own A SodaStream? (388 respondents, 39.95% answered yes)
  2. How Familiar Are You With SodaStream? (238 respondents, 52.5% "a bit")
  3. How Likely Are You To Buy A SodaStream? 231 respondents, 41% "probably will not", 30% "maybe or will for sure")
  4. If you have owned a SodaStream in the past, why do you no longer own/use it? (30 respondents)
  5. How Often Is Your SodaStream Used? (167 respondents, 72% once a week or better)
  6. How has your usage changed over the past year (or since you got it, if less than a year ago)? (161 respondents, 67% same or more)
  7. If You Use Your Sodastream Less Than In The Past, Why? (53 respondents, varied reasons with additional survey questions)
  8. If A Friend Asked You, How Likely Would You Be To Recommend That They Get A Sodastream? (169 respondents, 81% somewhat likely to very likely)
  9. What Do You Use Your SodaStream For? (163 respondents, 81% make seltzer water)
  10. Why Do You Use SodaStream? (155 respondents, "environment, saves money, convenience")

What Kase Capital and Whitney Tilson show through their extensive surveys is where SodaStream's economic moat has long since been determined, the highly coveted CO2 business segment. Most home carbonation platforms are generally used for the purpose of making seltzer water. This is not to say the SodaStream flavored soda business is not a good business, growing units by roughly 24% YOY in 2013, but most users find the application of a home carbonation platform most beneficial for cost and the environment when compared to store bought seltzer water or sodas. The average sparkling water bottle on a per liter basis is about $.75 per liter. SodaStream's highly effective and patent protected CO2 delivery system cuts this cost for seltzer water down to roughly $.25 per liter. The added convenience of not having to lug cases of seltzer water home is another benefit. Lastly, if one ever cares to read the back label of ingredients in pre-packaged seltzer water they would probably be surprised to see the sodium content. Sodium in seltzer water? Yes, unfortunately most would not have suspected this ingredient to be included in bubbly water, but invariably it is. The same ingredient is also in your sodas as well. Many people think it's all about the sugar, but take a gander at the sodium content in your store bought sodas and it will likely prove to be a real eye-opener.

The CO2 business and how the consumer uses the home carbonation products by SodaStream and other manufacturers was a key investment thesis for Tilson in deciding to take a position in SodaStream. By understanding SodaStream's extensive supply and distribution chain as well as the pricing structure established, he determined that the competition looming for SodaStream would ultimately have to find a way to beat or meet SodaStream's CO2 cost equation. My most recent research regarding the competition directly answers Tilson's suggestion and offers that the competition from Bevyz, SodaBoss, Hamilton Beach, Cuisinart and Bublimo do not meet or beat SodaStream's pricing structure for CO2. Most of these competitors are roughly double the cost of SodaStream's CO2 on a per liter basis. Keep in mind, that CO2 is just part of the economic moat for SodaStream.

Tilson's surveys determined that most users of home carbonation systems were avoiding store bought sodas or soda altogether. If we expand upon this notion from the respondents in the survey, it could only make one wonder if competitors of SodaStream are forming partnerships with beverage companies under the gross misconception that consumers are buying home carbonation systems for flavored sodas.

In discussing the threat of competition facing SodaStream in the coming years, Tilson doesn't pull punches. Tilson says:

"As evidence of Sodastream's moat, look no further than the recent Green Mountain (NASDAQ:GMCR)-Coke (NYSE:KO) partnership: the best these two much larger companies could come up with is a vague announcement of a competing product, Keurig Cold, that won't be ready for another year or two (I'll take the over) - classic vaporware in my opinion."

In all fairness, I did warn you that he was quite frank in his viewpoints regarding the competition. But Tilson may be correct, after all, Keurig did not introduce its coveted Keurig Cold brewer at the International Home and Housewares show which is a critical step when launching a new product into the market.

Moreover, as it pertains to competition, Tilson isn't only looking at soda makers; he is also looking beyond the counter top space unlike the Keybanc analyst which I will get to a little later in this article.

The reason Tilson is looking beyond the soda makers comes directly from his survey results regarding the tendency for the consumer to purchase or not to purchase a soda maker. Out of the 140 respondents answering the question, "How Likely Are You To buy A SodaStream", at least 10% discussed an obstacle preventing them from purchasing a SodaStream was related to counter space issues. Here are just a few of the comments in the survey results:

  1. "Do I really need one more appliance?"
  2. "There are very few kitchen appliances that you really need."
  3. "It will sit and take up space after the first 6 months easier to buy Pelligrino"
  4. "One less appliance in kitchen"
  5. "Takes up too much space in my kitchen!"
  6. "Don't want more countertop clutter."

Most respondents in the survey did not know that SodaStream soda makers are generally non-electric, but the point of the consumer remains valid as it pertains to the competitive landscape. Most competing products coming to the market in the next 6-18 months are going to be electric and will need to have a designated counter top space. This could be a major deterrent for sales of such electric soda makers. Furthermore, this point of view does resonate with sales of SodaStream soda makers. The SodaStream Revolution soda maker is an electric soda maker and garners the fewest sales out of the mass market soda makers for SodaStream. With electric components come higher prices as well, further curtailing demand. With that said, at least the Revolution can be unplugged and stored in a cupboard or pantry for use at a later time. But the competing soda makers coming to the market in the future will likely have water tanks and cooling mechanisms that will not only make the machine heavier and less portable, but likely more expensive. These products will require some amount of maintenance given the components and functionality of the systems. SodaStream's soda makers require almost no maintenance.

Moreover, and probably the most important point regarding SodaStream's moat and addressing counter top concerns, Tilson offers investors insight into the future of home carbonation through refrigerator systems. Like many hedge fund managers, Tilson establishes relationships and builds resources through thoughtful dialogue with market analysts and participants. One such resource Tilson established clued the fund manager in on the burgeoning Samsung (OTC:SSNLF)/SodaStream partnership which launched a year ago. The Samsung Sparkling Refrigerator powered by SodaStream was a great addition to both parties product line and advanced the soda maker technology to the finish line while addressing the consumers' needs. If the consumer wants a sparkling beverage at the touch of a button, now they no longer need a counter top appliance to do so. The Samsung/SodaStream refrigerator meets this demand head on and effectively delivers the highest level of technology and convenience to the consumer. Tilson's resource was cited in his report as saying, "some quick math suggests that every 500,000 of those Samsungs that get placed globally could be worth $25 cents per share of EPS to SodaStream in a few years assuming two refills per year-something to keep an eye on." With that math I can suggest the following based on surveys and sales data compiled by Capital Ladder Advisory Group: Consumers whom purchase the Samsung refrigerator powered by SodaStream are averaging, 3 refills in 9 months of ownership, above the estimate offered in Tilson's report. Given the higher then industry average price for similar refrigerator systems, Capital Ladder Advisory Group data shows that consumers purchasing these refrigerators are purchasing with intended usage related, in part, to the sparkling beverage dispenser application and therefore usage patterns and CO2 refill sales are higher than with lesser expensive platforms or technologies. Given the success of these types of sparkling water refrigerators, Samsung will launch a new model with a different price next year. Samsung likes the product so much that it wants to introduce a commercial Samsung/SodaStream refrigerator in its chef's line of products.

Seeing what Samsung and SodaStream are doing, it can only serve to speculate that more sparkling beverage refrigerators will be coming in the future. They will likely be powered by SodaStream as well. Through SodaStream's existing partnership with Whirlpool (NYSE:WHR), it may be a safe bet that Whirlpool has a refrigerator that will dispense sparkling, flavored water coming soon as indicated in recently published patents.

With Samsung already selling thousands of sparkling beverage refrigerators and more to be developed and sold in the coming years, the refrigerator platforms could become the norm and not the exception. Additionally, this greater convenience and practicality of refrigerator systems could lead to the obsolescence of competing brewer platforms for the at-home use.

In no way, shape or form is the home carbonation business as easy as one would think. If it were that easy, Coca-Cola and/or PepsiCo (NYSE:PEP) would have built up this business decades ago. If I've said it once, I've said it a thousand times, "Anybody can build a soda maker, nobody needs a soda maker and not just anybody can sell you that CO2 which makes the soda at a reasonable price". Somewhere in that less-than-complex statement is the equation that the competition has to figure out in order to put a dent in the SodaStream business. Is using a 1970s Proctor & Gamble (NYSE:PG) patent, which Keurig Green Mountain has been working with, the answer to the equation? Probably not, but maybe it will make a nice complement for the home carbonation category. After all, there's room for more than one company in this growing category.

The simple cost equation is solely related to the cost of carbonation. SodaStream, to date, has been able to reduce the cost of carbonation to roughly $.25 per liter using a 60L CO2 cylinder. Through advanced technology, the company has also been able to emit the best volume per liter of carbonation on the market. Other market entrants will need to compete with this cost where others have failed, including Cuisinart. I only bring up Cuisinart because after failing with its initial product design and platform (product discontinued in early 2014) the company has partnered with Bevyz to produce and distribute the Bevyz at-home beverage system. Cuisinart failed because of its inability to match SodaStream's cost equation and overall benefits. The Bevyz partnership will hopefully fare better, but again it will have to overcome some important obstacles to be discussed in the future.

Whitney Tilson's report only validates the understanding that SodaStream's business is not a fad, and if it were, Coca-Cola and Keurig Green Mountain have a lot of explaining to do for investors. Investors can perform similar survey research if they so desired simply by reading product reviews off of various retail e-commerce sites. (NASDAQ:AMZN) is probably the best gauge of consumer sentiment toward SodaStream's top selling products. Most SodaStream products receive a 4 out of 5 star rating on Furthermore, product reviews are more favorably skewed toward positive reviews than negative reviews by a ratio of roughly 4:1.

There was one aspect of Whitney Tilson's report on SodaStream that investors might find interesting. In the report Tilson says the following:

"By the way, it is quite reassuring that the West Bank thing didn't come up more in the survey since you were polling a more educated/informed group than the general population. I am not as informed on Israeli politics as maybe I should be, but my sense from the Sodastream Investor Day and reading some non-financial articles is that Sodastream pays competitively and treats people well in their factory, and regularly promotes non-Jews in the factory. You can argue whose land it is, but if they are being an ethical employer and paying well in an area that suffers from poverty and unemployment, I don't see what the problem is. But it's always been noise in the background for the stock."

This is where we come to our conclusion and circle back to Keybanc's recent analyst notes regarding the home carbonation category. Keep in mind, while reading the analyst's notes that he's discussing technology and to a lesser degree convenience. Akshay Jagdale notes to investors are as follows:

Green Mountain Coffee Roasters faces new competition from Bevyz, a privately held company that is expected to launch its first At-Home beverage system that serves hot, cold, sparkling and still beverages all in one small machine. The launch is expected on March 15th.

Bevyz is the only system/company we know of that is attempting to commercialize an At-Home beverage system that produces hot, cold, sparkling and still beverages in one. We tried a broad range of products in a private viewing and came away impressed by the technology and were surprised by the small footprint (11.5" x 12" x 14") of the machine. From a technology perspective, we see Bevyz as a strong #2 player in home carbonation behind GMCR; however, we believe it will take multiple years for the company to build a sizable installed base, and further technology advances are required for the system to become mainstream.

Following our meetings with Bevyz, we continue to have a positive view of the home carbonation category. We believe the GMCR/KO deal validates our positive thesis of the category and establishes GMCR as the leader. Although we appreciate SODA's strong marketing and distribution capabilities and first mover advantage, for the stock to work and its system to be become more mainstream, we believe it is critical for leading beverage brands to partner with the Company, which we now think is less likely given that we rank SODA behind GMCR and Bevyz from a technology perspective. The GMCR/ deal and the strong alliances Bevyz has built with some of the leading players in the global beverage industry (both equity stakes and product tests) seem to point to GMCR and Bevyz as the emerging leaders in the home-carbonation industry, in our opinion.

First, how does a company emerge as a leader with no installed user base? Second, let's take a look at SodaStream's licensed partners. Wait, before we do that; did you know that the Bevyz Fresh brewer isn't capable of delivering a cola beverage and it only carbonates at one level, medium. SodaStream's partners include Kraft Foods (KRFT), Campbells (NYSE:CPB), Welch's, Ocean Spray, Del Monte, Skinny girl, Country Lite, Sunny D, Eboost, Samsung, Breville and Whirlpool. More partners will be announced as well. I'm thinking that SodaStream has a pretty strong alliance on the beverage and hardware side of the category equation. It bares contemplation as to why Mr. Jagdale failed to recognize SodaStream's partnership with refrigerator systems. After all, wouldn't a refrigerator system that could produce a cold, carbonated beverage be the ultimate solution for the consumer given all that we know about this category. How much clutter does one need on the counter to enjoy a beverage?

Any child can operate a refrigerator, but many can't reach to the countertop and operate a Keurig. The liter bottle soda makers by SodaStream seem like a much more viable option if one doesn't have a carbonated refrigerator system. The bottle is right there on the table for all to use. Therefore, the ultimate question relates to the practicality of a home carbonation system. Imagine sitting down for supper. You have a Keurig Cold machine so you pop in a pod and brew a single glass. That's great for a single person or even a couple. Now you sit down to eat and drink and finish that glass of soda, but you're still thirsty and not quite finished with dinner. Do I want a single glass of soda when I sit down to supper or a liter bottle on the table from SodaStream? I don't know about you, but I don't see myself going back and forth to the single-serve machine to pop in another pod; that process is pretty inconvenient if you ask me and is proven to be less desirable based on consumer surveys. Now use the same scenario for the average American family of 3-4 individuals. This process of filling and refilling, by way of a single serve system, seems like quite the hassle for a simple glass of soda doesn't it.

I will give the competition the nod on technology. They are certainly using a lot of it, but the fact is that non-electric razors continue to outsell electric razors for very good reasons; they are practical and cost effective, two of the factors that Keybanc might have overlooked. There has always been a market for electric shavers and non-electric razors and there will likely always be. The fact is that for all the technology in those electric shavers, it never amounted to the displacement of regular razors and razor blades. Non-electric razors outsell electric razors every single day of the week and twice on Sundays.

Disclosure: I am long SODA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.