Why I'm Not Buying Amplify Snack Brands' IPO

Summary

• Concentrated shareholders will own around 75% of the newly public company.
• BETR will not receive the proceeds from the IPO.
• The company faces a number of risks in a highly competitive industry with low barriers to entry.

Amplify Snack Brands (NYSE:BETR-OLD) is scheduled to start trading on or about August 5, 2015.

The bull case for the upcoming IPO is simple: The company, which owns two brands in the "better for you" or "healthier" segment of the snacks industry is growing sales and market share in a growing market. Its SkinnyPop Popcorn brand competes in the $966 million ready to eat popcorn market (i.e, it doesn't include products that you stick in the oven or microwave). The market segment has grown at a compound annual rate of 14.6% since 2010. It grew 22.6% in 2014. SkinnyPop commanded a 12.1% share in 2014, nearly doubling its market penetration from the prior year. During the same period, net sales increased from $55.7 million to $132.4 million. The company's gross margin was 56.1% in 2014 and 55.1% in the quarter ending March 31, 2015.

The company earned $0.07 per share in the quarter ending March 31, 2015, up from $0.02 from the same quarter in 2014. With an expected price range of $14 to $16 per share in Amplify's IPO offering (the stock may be substantially higher or lower when it starts trading), the latest audited per share figure annualized gives BETR a P/E of 50 to 57.14.

That seems a reasonable price to pay for such growth, especially since there is ample room for expansion. SkinnyPop's distribution points have increased from 49 in 2013 to 136 in 2014. The average for the top 25 salty snacks brands, however, is 919, according to Amplify. Add to this increased same store sales, the introduction of new flavors (87% of 2014 sales were of the original flavor), and expansion into foreign markets, and you have the makings of a long term growth story.

But I'm not buying. Here's why:

Concentrated Shareholders Risk

The latest proforma sales (for the three month period ending in June 2015) increased around 33.5% over the same quarter last year. The earnings, however, told a different story. While gross profits were up around 32%, net income was down almost 80%.

The company attributed this discrepancy to an increase in amortization of intangible assets and Founder Contingent compensation expense. In a related matter, the company paid a special dividend of $59.8 million to its owners in December 2014. It paid another $22.3 million in May 2015. The company borrowed to finance both distributions.

It makes sense for shareholders to reward themselves, but this debt burden will be borne by new shareholders who did not benefit from the transaction. It makes me question how management will treat minority shareholders in the future.

And minority is what investors who buy Amplify shares at the IPO and afterward will be. After the IPO, insiders will own around 75% of the outstanding shares. Their (controlling) interests will not necessarily align with the owners of the other 25%, especially in light of the company's debt financed special dividends. Should these concentrated owners decide to unload their stakes in the future, the stock might face headwinds for a long time.

IPO Proceeds not Going to Amplify Snacks

Moreover, there are two basic kinds of IPOs. The most common is one where the company keeps the proceeds (minus banker fees and so on) when it comes to market. This money is often used to pay down existing debt or to fuel expansion-things that usually benefit the new shareholders. That is, new investors buy the company's shares and the company does something useful with that money.

The second kind of IPO is when existing shareholders keep the proceeds and the company gets nothing. Amplify's IPO is of this second type. There's nothing unethical about this, but it's something to keep in mind.

For example, compare Amplify to fictional company XYZ, where XYZ has an IPO of the first type. Suppose XYZ sells 15 million shares for $15 each. The company now has $225 million in the bank (minus IPO fees). XYZ can use this money to pay down debt, buy a manufacturing facility, acquire another brand, and so on.

Now suppose Amplify's 15 million share offering also goes for $15 per share. Amplify's bank account stays the same. Its concentrated owners pocket the $225 million. If Amplify wants to expand it will have to rely on its sales, and, more likely, on new debt and/or dillutive equity issuance.

All else being equal, I'd rather invest in XYZ.

Watch Out for Those Corn Prices

Amplify has significant raw materials risk because popcorn (for SkinnyPop) and corn (for Paqui) are the principal ingredients in its products. Poor popcorn or corn crops due to drought, disease, and other factors will raise prices, which will hurt Amplify's margins and earnings-especially because the company uses harder to procure organic corn for its tortilla chips. This might not happen anytime soon, but it will happen.

An additional risk related to raw materials is that SkinnyPop relies on one third party manufacturer for all its products. Should something go wrong at this facility or a dispute develop between Amplify and the co-packer, it could spell disaster for the company.

Few Barriers to Entry

Amplify has no economic moat. Compared to other industries, it is relatively easy to start a snack brand. With third party manufacturers making most products, all a start up really has to do is market a brand. As the "better for you" snack industry grows, Amplify will face an increasing number of competitors. It is hard to see how its market share growth is sustainable. As competitors multiply, Amplify will face pricing pressure. This will hurt sales, margins, and earnings.

(On a personal note, I tried to find SkinnyPop Popcorn at my local Stop & Shop. SkinnyPop's website said the store had it, but I couldn't find it. When I asked an employee, he showed me two other, competing brands--PopChips and Boom Chicka Pop--that had, to me, nearly identical products to SkinnyPop. Right next to them was Stop & Shop's private label Nature's Promise selling a similar organic popcorn product for a much lower price than the other two. There was no room on the shelf for SkinnyPop.)

The company's newly acquired Paqui tortilla chips brand (it remains to be seen how this purchase will affect sales and earnings growth) competes not only for shelf space but also for customers with behemoths like Pepsi's Frito-Lay (PEP), not to mention the growing number of "better for you" store and artisanal brands. Most of these products are interchangeable and compete on price. Furthermore, not only does Frito-Lay have similar offerings (non-GMO, organic, all natural ingredients, etc) it has the scale to price out the competition.

Concentrated Distribution Risk

Sam's Club and Costco (COST) accounted for over half of SkinnyPop's sales in 2014. Should either of these companies decide not to carry SkinnyPop, this will have a material effect on Amplify's earnings.

Conclusion

All of the above is not to say that Amplify Snacks won't be a great performing stock. It could very well make some new shareholders very rich. But that will be subject to the vagaries of the market. For my part, I'd rather buy Amplify's products (if I ever find them in the store).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.