MusclePharm: Substantially Undervalued And Strong Acquisition Target

| About: MusclePharm Corp. (MSLP)
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MusclePharm’s growth continues to exceed expectations; new product launches will drive future growth.

The stock is trading at a 100% discount to fair value; uplisting to NASDAQ is a near-term catalyst.

The company is a strong acquisition target due to industry consolidation, could fetch over $300 million.

Even with MusclePharm (OTCQB:MSLP) shares up more than 20% since the company's 1Q14 earnings announcement, the stock is still substantially undervalued. I believe the long-awaited NASDAQ uplisting is very likely to occur later this year, and will be a near-term catalyst that will propel the stock higher. Moreover, MusclePharm is a strong acquisition target as a result of continued industry consolidation. The company will likely be acquired at a large premium within the next 12-18 months. For investors that can handle the short-term price volatility, MusclePharm is one of the best investments in the small-cap space.

Business Overview

For those not familiar with the company, MusclePharm develops, manufactures, markets, and distributes sports nutrition products for athletes and other health-minded individuals. The company's product portfolio consists of more than 30 products sold under three different company-owned brands: MusclePharm Hybrid and Core Series (targeted towards athletes), Arnold Schwarzenegger Series (bodybuilders), and FitMiss (women). MusclePharm products are sold in more than 110 countries and available in over 35,000 retail outlets globally, including Dick's Sporting Goods (NYSE:DKS), General Nutrition Centers (NYSE:GNC), Vitamin Shoppe (NYSE:VSI), and Vitamin World.

Growth Exceeding Expectations

MusclePharm's long-term goal is to become a billion dollar sports nutrition business. Although this is a very ambitious goal, given the company's spectacular growth in recent years, I believe it has what it takes to get there. MusclePharm's revenue has grown at more than 200% per annum over the last three years, reaching nearly $111 million in 2013. Even more impressive, this growth shows no signs of slowing down any time soon. The company's 1Q14 results blew away all expectations and caused management to raise its full-year 2014 revenue guidance by nearly 17% to $175 million.

Figure 1: Revenue Growth Trend (2010-2014)

Source: M&E Research and company reports

MusclePharm currently has 10 products in development that will drive future growth, some of which will be launched as early as 4Q14. One of these new products is the DROPZ energy drink that will be sold in convenience stores across the country. DROPZ is a healthier alternative to other energy drinks on the market today and will likely be a huge success. MusclePharm is also attacking the ready-to-drink market with its new Coconut Protein Water, which will mainly be sold at Costco (NASDAQ:COST). Moreover, the company's new Arnold Schwarzenegger supplement line has been the most successful supplement launch in the industry's history. It already makes up nearly 30% of revenue, and I expect it to contribute 45-50% once it begins being sold at Costco. These are just a few key initiatives that will drive growth going forward.

Substantially Undervalued by Mr. Market

MusclePharm achieved profitability for the first time during 1Q14 with net income of $2.7 million compared with a net loss of $7.4 million during 1Q13. Management expects full-year net income to be roughly $6.2 million (mid-range of guidance), which I believe is a very conservative estimate that the company will likely beat. Given this improving profitability, I believe the stock is significantly undervalued at an enterprise value of only $93 million, which is less than 15x estimated 2014 earnings. In my opinion, this multiple is too low considering the majority of companies in this industry typically trade for 35-40x earnings. This valuation discrepancy is most likely the result of MusclePharm trading on the OTC exchange, which prevents most large institutional investors from buying the stock. Since MusclePharm is one of the most popular and fastest growing sports nutrition companies in the world, I believe the stock could easily support a 30x earnings multiple. This would imply a fair value of roughly $190 million (or $18.40 per share), giving us an upside potential of approximately 100% from the current price.

NASDAQ Uplisting is a Catalyst

MusclePharm's uplisting was delayed due to an SEC investigation concerning some related-party transactions and certain other disclosures for the periods of 2010-2012. However, management believes this investigation will be closed out in 2Q14. Once this occurs, the company intends to uplist its stock onto NASDAQ. This uplisting will be a major catalyst for the stock because it will result in a significant inflow of new demand for the shares from large institutional investors. I expect the stock to surge once the uplisting is announced later this year.

Strong Acquisition Target

Industry consolidation has been a major trend in the sports nutrition industry over the past decade. This activity has included Post Holdings' purchase of Dymatize, Reckitt Benckiser's purchase of Schiff Nutrition, Glanbia's purchase of BSN and Optimum Nutrition, Abbott's purchase of EAS, and also the Carlyle Group's $3.8 billion capture of NBTY, the maker of Nature's Bounty, MET-Rx, and Solgar supplements. I believe MusclePharm is the next major supplement company that will get acquired. The company's spectacular growth, the strong popularity of its supplements, and its exclusive partnership with the UFC and Arnold Schwarzenegger, make it a very attractive acquisition target for a large conglomerate trying to expand into the fast-growing sports nutrition industry.

There is a very high probability an acquisition will occur within the next 12-18 months because MusclePharm is among the last major sports nutrition companies that has not bought out yet, leaving few options left for a potential acquirer. Additionally, sports nutrition companies that are in the $100-200 million revenue range are the most attractive targets. Given that MusclePharm will be in the high-end of this range by the end of this year, an acquisition is very likely sometime in 2015. Historically, sports nutrition companies are typically acquired for about 1.7x revenue. I believe MusclePharm could fetch a similar amount, implying a fair value of about $300 million (based on estimated 2014 revenue of $175 million). This is more than a 200% premium to the current price, which further suggests that MusclePharm is substantially undervalued by the market today.

Figure 2: Past Acquisitions of Sports Nutrition Companies

Source: M&E Research, Reuters, and Bloomberg

Key Risks to Consider

Key downside risks to my investment thesis include: (1) MusclePharm has incurred net losses in the past and may not achieve sustained profitability in the future; (2) MusclePharm's top three customers account for roughly 45% of revenue, a loss of any one of these customers could have a material adverse impact on the company; (3) MusclePharm must continue introducing new and innovative products in order for its brand to stay relevant; (4) the SEC investigation has not uncovered anything serious and will likely be completed in 2Q14, however, if it takes longer than expected it could delay the NASDAQ uplisting; and (5) MusclePharm is an extremely volatile stock, investors who fail to buy and sell at the right time could suffer losses.

Summary & Conclusion

MusclePharm's robust growth and ramping margins make the stock a bargain at the current market price. The NASDAQ uplisting later this year will be a near-term catalyst that will propel shares higher. I believe the uplisting will also increase the likelihood of the company getting acquired. For those who can handle the short-term price volatility, I believe this is a great investment with huge upside potential.

Disclosure: I am long MSLP. 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.

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