When Sodastream(NASDAQ:SODA) reported its Q2 earnings it beat market estimates on both top(slightly) and bottom lines. However this wasn't the only surprise the company reported, a closer look into the reported figures revealed that the increase in sales came with a large cost of cutting margins, which went down sharply. A further evidence of the trend was the significant increase in the company marketing expenses in order to increase sales. On the C/C later the CEO guided that the company plans on cutting its A&P spending for the remaining of year.
The last surprise was the alarmingly low cash balance of the company along with a new debt loan which was added during Q2. The actual numbers were $36 mil in cash and equivalents vs $38.5 mil of debt. At first it does look too worrying. However, when we examined the past year the picture gets gloomy, over the year the company's operating cash flow was a mere $27 mil. Up until the recent report the company has managed to finance its growing operations with its existing cash balance.
Since its last stock issuance in 2011, the company has managed to rapidly increase sales and invest in a new factory and maintain its cash reserves above its bank debt. However in the recent quarter the trend has changed. A look at its Cash flow statement reveals that despite reporting a net income of $9 mil the company has produced only $0.6 cash from its operating activities, one can argue that 2013 was much worse. However in 2013 the company had a large one off orders from mainly HSN and Bed Bath & Beyond which affected significantly on its balance sheet and there was no mention of a significant follow up order in Q2.
Moreover, when comparing Q1 and Q2 cash flows(Q1 is a weaker quarter due to holiday season peak sales of Q4) it seems as the company has substantially increased it trade receivables and is required to bridge the payable/receivables gap partly by a new loan which can be seen in the financial segment of it cash flow statement.
Further example of its low liquidity can be found in a recent publication here indicated the company is suffering from y/y negative FCF. While we might not agree completely with the conclusions of the article regarding its Accounting methods of CO2 cylinders, the fact is that the negative FCF over such a prolonged period is nevertheless alarming.
The company's recent report made us wonder about its current situation and all the latest rumors regarding its acquisition. We understand the company is facing large CAPEX in 2014 and probably in 2015 due to its new manufacturing facility and recent acquisition in Japan, therefore we see this as a further catalyst for the rumored acquisition.
The rumors initially started closely after the KO/GMCR initial deal, under the assumption that the major players in the soft beverage industry will follow suit. We believe there in no smoke without fire so, we think that the KO/GMCR deal certainly put SODA as the "prettiest bride" in the room, and that there were some sort of initial talks either by the major players or investment banks on their behalf. At first glance it might look as the major were the ones interested in Sodastream however its recent Q2 report revealed that it might be Sodastream who is in a need of an acquisition and maybe the reason the major players(PEP,DPS,SBUX) decided to walk off the table.
Another month has passed and a new rumor popped out, this time it was a private equity fund, looking to take Soda private.
Lately, it seems that there isn't a week goes by without a new headline pops out and mentions Sodastream, is in talks to be acquired.
We believe as no deal could emerge with the existing interested parties the company started to look for elsewhere to take their place, to support its current plans:
- Move to a new manufacturing facility.
- Completion of Stage 2 of the new manufacturing facility (estimated ~$40 mil).
- Support its expansion plans in Western and Eastern Europe.
- Expand to new markets such as Mexico(#2 Soda consumption), South America and China.
- Restore its declining sales figures and battle with KO/GMCR in the US market.
Sodastream will need a substantial amount of cash in order to support its current strategy and speedup its expansion plan in order to stay ahead of the upcoming competition, therefore it seems that the new rumor of a P-E acquisition, seems reasonable.
As with current $36 mil in cash, rising debt and negative FCF, Sodastream cannot sustain its current plans.
Why Would P-E firm would be interested?
We believe the recent publications have valid grounds, as Soda currently fits a P-E company acquisition due to the following reasons:
- The company is trading at the range of 50% below its 1 year peak level (~ $70), despite record sales(and is quite cheap, forward P/E ~15).
- The company continues to present a y/y growth (absolute numbers), despite major setback in the US market.
- Further growth potential to new markets.
- The company is operating at a respectable gross margin of above 50%(currently).
- The company has little to no debt, though substantial injection might be necessary to support its current strategy.
We would to give the recent acquisition of a small Israeli company named EDEN Springs(MEYD.TA) by Rhone Capital in mid 2013 as an example. The deal was made at a valuation of around €240 mil, including a €170 mil debt(with no premium).
Why did Rhone made this purchase?
Eden Springs is Europe's leading provider of water and coffee solutions for home and workplace.
Eden offers a one-stop shop for these home and office drinks solutions.
Eden springs was a profitable company with a growing operations in Europe who was looking to expand. The expansion plan required significant investment in marketing ,equipment and acquisitions, but unfortunately for EDEN the company was buried with debt. EDEN was eyeing expansion in Eastern Europe, where demand for mineral water is growing. Rhone's acquisition plan was to restructure its companies to eliminate all debts between them, before expanding further.
One year after the acquisition the company is continuing its expansion plan in Europe and has only recently announced an additional acquisition from Nestle Waters Direct which is expected to increase its annual turnover by 30%. As the company is held privately no financial figures could be obtained.
With no two deals are alike we believe Sodastream is currently very attractive to a number of P-E firms mainly due to its relative debt-clean balance sheet and solid growth numbers.
We believe the EDEN deal is a more suitable comparison for the current rumored Sodastream buyout deal rather than the KO/GMCR deal due to the nature of the rumored buyer and current Sodastream relatively thin financial position. In addition Sodastream has a history of P-E ownership as it was previously owned by Fortissimo Fund from Israel, who managed to transform a dying company into an established and respected brand it is today.
Sodastream, is a growing company with a solid and growing market base in EU, a growing presence in Asia Pacific and CEMEA and a struggling market in the US. Overall the company is expected to report an 6 consecutive year of growth and is expects growth to continue as it expands further.
We believe the company was too conservative with its current guidance of an annual growth rate of %5. As the company is already reacted to the declining US sales and adjusted its marketing strategy and focus on health & wellness campaign, backed by growing health awareness in the US. The company has proved its ability to quickly react in a similar situation, when it faced stagnating sales in the German market, and today Germany is the company's leading sales zone thanks to its No Schlepping campaign.
While we believe the US market sales recovery will be much harder to achieve, and will take much longer than the relative quick reaction of the German market, therefore the full recovery in the US market is not expected before H1 2015, as it will face a very stiff head-to-head competition with KO.
Despite the problems it in the US market, the company has managed to establish a profound presence in its currently biggest market, Europe and present a 15% y/y growth. While facing plenty of headwinds caused by macroeconomic and political events that affect the EU market(stagnation, unemployment and boycott).
In addition, the company is continuing to expand its presence in Asia and Pacific, while growth comes with a price, as can be clearly seen in its quarterly fillings, Sodastream managed to record a 12% y/y increase.
The company is in the final stages of construction of its brand new production facility and expects the completion of the 1st stage of its by November 2014, which will provide the full production capacity of its current sales. The new facility will resolve the "occupied territories" dispute that is currently affecting the company due to the location of its current manufacturing facility in Mishor Edomim(EU has been very harsh for all manufacturing export to Europe that origin in the "occupied territories"). Once the move is complete we believe it will contribute a significant cost saving for the company due to the current boycott in EU for manufacturing originating in the "Occupied territories" the location of its current main facility, thus baring additional cost and manufacture either by 3rd parties or at a higher cost base.
In addition, the company has a strategic partnership agreements with major kitchen appliance manufacturers, to further increase its sales:
- Samsung which will distribute its Carbonated refrigerators powered by Sodastream.
- Kitchen-Aid with its own soda-makers manufactured by Sodastream.
- Groupe SEB (Tefal) as an official gas supplier for its own Soda maker.
The company was approved of a 20% tax redemption on its investment in the new manufacturing plant, based on the Israeli Law for the Encouragement of Capital Investments.
In addition, the company is currently negotiating for an additional redemption of up to 12% with the government officials, the additional redemption was approved by the previous government however was never officially signed.
Sodastream is a growing profitable company that continues to deliver Y/Y growth despite weakening sales in the US. Sodastream has already taken an necessary step to try and recover the US sales decline. The company is in the final stages of completion of the its new manufacturing plant(most of which has already been accounted for). The company has a solid and growing presence in EU and Asia -Pacific and a growing customer base in CEMEA(especially in the Czech republic region).
Low debt, although significant injection might be needed to support the completion of the 2nd stage manufacturing plant and further expansion plan.
How much would they pay for Sodastream?
Given the nature of P-E business, buy cheap, it's hard to see any premium to current levels. Given the EDEN example we provided there seems as the deal should be done at market price level. However, there is a difference as Sodastream is a profitable company with a 6th consecutive years of sales growth carrying zero to little debt(most of which is covered by its current cash reserves). With the company currently trading at a forward P/E ~15 it sure looks cheap so a premium is not out of the question. It is our belief that the premium is what is keeping this deal from going forward. Bloomberg reported that the deal would be around $40 p/s valuing the company at $828 mil, or about 20% above Friday's closing price. We believe that would be our top range for a possible takeover deal, although, a lower premium is not out of the question. With its current low liquidity we assess the deal should be closed before year-end.
Disclosure: The author is long SODA.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.