Sparkling IPOs: SodaStream, The Fresh Market

Includes: SODA, TFM
by: Renaissance Capital IPO Research

Two companies planning to approach the public market this week are retailers hoping to attract investor interest on the increasingly popular consumer trend of healthy living. Headquartered in Israel, SodaStream International (NASDAQ:SODA) is the world's leading provider of home carbonation systems, which allow customers to make their own sparkling water and all-natural soda. The company offers soda makers ranging from $79 to $199, as well as consumable products, such as CO2 refills, reusable bottles, and over 100 added flavors including cola, root beer, grapefruit and lemonade. With an average household penetration of 5% to 15% in its established Western European markets, SodaStream is now turning its focus to the US, where it recently began a nationwide launch at retailers such as Bed Bath & Beyond (NASDAQ:BBBY), Macy's (NYSE:M) and Crate & Barrel. The company, which was acquired in 2007 by Israeli private equity firm Fortissimo Capital, plans to raise $90 million and list on the NASDAQ under the symbol SODA. J.P. Morgan (NYSE:JPM) and Deutsche Bank Securities (NYSE:DB) are the lead underwriters on the deal.

The Fresh Market (NASDAQ:TFM) is a North Carolina-based gourmet food retailer that operates 100 small-box stores in the eastern and Midwest regions of the US. With premium perishable foods and an average store size smaller than that of most supermarkets, The Fresh Market boasts an efficient and profitable store model and is planning to expand coverage in the US to support up to 400 additional stores. The family-owned company plans to raise $250 million and list on the NASDAQ under the symbol TFM. BofA Merrill Lynch (NYSE:BAC), J.P. Morgan (JPM) and Goldman, Sachs & Co. (NYSE:GS) are the lead managers.

SodaStream and The Fresh Market are two out of six IPOs scheduled on the IPO Calendar this week.

SodaStream: Adding pop to your portfolio?

Post IPO Market Cap: $354 million

LTM Sales: $174 million

LTM Operating Margin: 9.9%

SodaStream has the leading share in a unique market, and its recent US rollout will likely result in rapid top line growth as the company adds to its expanding list of participating retailers. If the company's product is able to gain even modest traction in the US, SodaStream's annual sales growth rate could easily accelerate from 11% since 2007 to management's target of 20%. Additionally, with an attractive razor/razor blade model, SodaStream should see further margin expansion as it sells more of its higher-margin, recurring consumables (CO2 refills and flavor packs) to an expanding base of installed users.

The major risk to SodaStream's vision of transforming the $234 billion global carbonated beverage industry is the resistance it could face from both retailers and consumers to changes in the status quo. For example, a handful of US retailers have declined to participate in SodaStream's cylinder exchange program, which allows customers to turn in their empty CO2 cylinders in exchange for full ones, paying only the price of the CO2. In addition, the average US consumer may be unwilling to make the switch from convenient store purchasing to a do-it-yourself approach, particularly if the cost savings for basic cola is likely to be marginal at best.

The Fresh Market: A refreshing retail growth story

Post IPO Market Cap: $912 million

LTM Sales: $941 million

LTM Operating Margin: 6.9%

With its store base expanding at a 15% CAGR since 2005, The Fresh Market has steadily grown its top line to reach $862 million in 2009. While same store sales turned marginally negative in 2008 and 2009 owing to the economic downturn, results have turned positive year to date with same store sales up 4.1% in the 1H 2010 and 5.1% in the 3Q 2010. Operating margins have shown solid improvement even during the recent downturn, having risen from 4.9% in 2007 to 6.2% in 2009 and are on track to rise even further in 2010.

Importantly, The Fresh Market has consistently generated impressive cash flow from operations ($64 million in 2009 on a fully-taxed basis), giving it strong financial flexibility to support planned store openings in untapped markets. Its new stores target a 100% cash-on-cash return by year three and typically generate $8 to $10 million in first year sales.

Competition is a source of concern for The Fresh Market, which must contend with major players such as Whole Foods and Trader Joe's as it expands into unfamiliar territory. Furthermore, though the specialty grocer plans aggressive growth, it still exhibits some small company characteristics, such as an undeveloped marketing strategy, geographic concentration (Florida, North Carolina and Georgia are home to almost 50% of its stores) and reliance on a single logistics provider for 56% of purchased merchandise.

The Outlook

Though both consumer-oriented companies must prove their ability to transition into new markets, their strong track record of profitable growth bodes well for the future. Additionally, retail IPOs have performed strongly over the past month alongside the consumer products and supermarket sectors, which could provide technical tailwinds for these small cap growth stories. However, investors will likely remain selective as they face an increasing array of IPO options, with a total of 14 companies slated to price over the next two weeks.