How I Screwed-up with SodaStream and Where do we go from here?

I‘ve always strived for self improvement.  A key foundation to self improvement is knowing yourself, including your weaknesses and devilish-side.  One should also strive to be authentic and honest not just to society, and family but to ourselves.

With that said, I want to tell my readers how I screwed-up investing in SodaStream (SODA).  As a writer and avid reader of Seeking Alpha, I’ve run into too many writers who are “know it alls” – you know what I’m talking about.  Even if one has humility, the problem is our view becomes biased once we take a position in an investment.  But in order to become a better person and investor, I believe we need to view our actions in a critical manner.

I discovered SodaStream back in 2011, soon after its IPO on the NASDAQ.  The company’s strong growth spurred its stock to more than double less than a year after going public.  This and an interesting story and business model also attracted the likes of Jim Cramer and the talking heads of Wall Street.

I was instantly attracted to the company because of its interesting and perhaps faddish product (the DIY Sodamaker).  But what closed the deal for me was its attractive business model, which was essentially the razor razor-blade one.  I had already made a successful investment in Keurig Green Moutain (GMCR).  Both companies used the simple, yet highly effective razor business model. So I figured that SodaStream too would benefit from that model’s strong operating leverage.

I have written several articles on SodaStream but the full analysis was published in summer of 2011. In it was listed several pros and cons (i.e., risks investing in the company).  I did identify most of the risks with the exception that U.S. traction could slip. And that’s exactly what happened. Either the company didn’t educate the U.S. market properly (which I indirectly bulleted as Business Execution Risk) or U.S. consumers weren’t ready for a better and healthier way of attaining soda.

I have always been a big believer of licensing technologies and partnering with other companies, especially if you’re trying to make a name for yourself.  However, this is much easier said than done.  SodaStream has made agreements to sell name brand syrups but never from the Big 3; and it didn’t partner with a big investor as Coke has done with Keurig Green Mountain on the next-generation cold-beverage maker. The key risks from my full analysis report (2011) are listed below (right side).

http://1.bp.blogspot.com/-8e2QhYGRGkw/Tj7snMLwxRI/AAAAAAAAAus/X4kkLJgIj9s/s1600/Executive+Summary.jpg

Investing in the markets, all markets, is a risky endeavor.  Don’t let anyone, especially professionals fool you! Even fixed-income investments are dangerous, especially ANYTHING yielding 3% over the 10YR treasury rate.  If fixed income is risky, you can imagine how much riskier small-caps investments are!  With that being said, I invested in SodaStream knowing it was a risky venture. Given that it was a new industry niche, there was little available information, especially information that could be verified by third parties. The company said that U.S. consumers used 2x more syrups than its mostly-European customers, according to a consultant it had hired. Unfortunately, I had little outside information verifying this.  Though, I understood the business, the company and what could go wrong, including some of the “known knowns etc” as Donald Rumsfeld famously stated.

If I knew the risks, one might ask “why did I screw up”?  Well, upon deeper analysis it’s now clear that I was overconfident from successfully investing in Keurig Green Mountain and had invested a larger amount than I should have.  (I believe one should invest very small amounts in small companies.)  That large investment skewed my thinking, and created an attachment to the company and its attractive story.

A friend once advised me that successful investing in a portfolio should employ Risk Management.  (Enterprise) Risk Management is typically known as something big banks do to reduce risk in their loan portfolio. However, I believe this is key in successfully monitoring new and especially existing investments.  Effective Risk Management doesn’t care how much you like the company or it’s story.  You stress the portfolio to determine how it would do under a downside scenario.  This doesn’t have to be complicated.  It could be as simple as keeping a market weight investment, or 5% investment for each name, and reducing the investment allocation of individual names depending on the size (revenues) of the company.  So for a portfolio with S&P 500 names and just one small-cap name, one would have 5% investments in the S&P names, and maybe just 2% in the small-cap. This is easier said than done, and is helped enormously by having a “committee” of two or more examining the portfolio to ensure you haven’t broken your own rules.

Returning to SodaStream, I saw the company was getting stretched and mentioned to several friends how its financials were breaking every rule that we had learned in the Certified Financial Analyst designation program. In fact, I was so concerned that I published an article entitled SodaStream’s slippery slope to Adulthood in January 2014.  I also wrote numerous comments on SODA’s Seeking Alpha page citing its bloated inventories, low cash, etc.  The shares had declined from nearly $75 midyear to $53 by year-end. I could have sold then but I didn’t.  It was too late.  I was emotionally attached to the company.  You may be thinking “ah this will never happen to me.”  Well, we’re human, we have feelings, and we make mistakes.  This happens to everyone. The ONLY thing you can do is be aware of the above and your actions.

So where does SodaStream go from here?
SODA’s shares are hovering at just $21, near their all-time low.  At first glance they look like a bargain as Enterprise Value to Sales are about 1.0x, and then there’s the periodic takeover rumors.  However, I believe their is way too much risk in this company.  Given that revenue growth is now negative in what was supposed to be a hot U.S. market, the likelihood is high that there will be an inventory, factory as well as service network (i.e, distributor) write-down.  The company announced Third Quarter 2014 earnings on 10/29/14 and much of the report leaves me pessimistic.  Inventories are rising as well as debt and cash flow.
However, the stronger operating cash flow is typical when revenue growth slows. Readers can click here for the press release.

It is doubtful that an acquirer would want to buy a company that’s in a turn-around stage. Once the company’s business regains traction I believe its prospects could brighten. The company will now be marketing itself as a health & wellness brand given that its syrups have better ingredients such as no high-fructose corn syrup (or asparteme), and less sugar than store-bought soda.

I hope readers have found my experience helpful and encourage all of you to write-down your rational for investments and in life decisions.  Have a great 2015 !

 

Is SodaStream an Irresponsible Corporate Citizen

courtesy of Jweekly.com

Over the last few months I received quite a bit of hate-mail regarding SodaStream’s inclusion in this website. There have been boycotts in its largest markets including Sweden and the United States, and more recently TIAA-CREF removed it from its Social investment portfolio.

Essentially the company presents itself as a socially responsible organization helping the world reduce soda bottle waste, as well as promoting health & wellness as its syrups don’t use high-fructose corn syrup.

However, at the same time, SodaStream’s main production site is in Mishor Edomin, the industrial park of Ma’aleh Adumim, an illegal Israeli settlement in the West Bank. The main arguments against SodaStream are then:

  1. its use of illegal land
  2. its mislabeling of origin
  3. treatment of workers

I believe the most important of these is actually the last.  Israel motivates companies like SODA to invest facilities in these illegal settlements with tax rebates, etc.  The positives are that jobs are created for people that desperately need them.

Unfortunately, it is not certain if Sodastream’s employees are treated fairly with Israeli citizens as they may be exploited as is done in Bangladesh. In fact, there are some workers in the Mishor Edomin facility that claim they are working in “slave labor” like conditions including 60 hour work-weeks.

We will watch this issue closely and revert back to our readers when we receive further clarity.

SodaStream’s Slippery Slope to Adulthood

Recently SodaStream (“SODA”) reported third quarter earnings ending Sept’13.  As many readers of this website are familiar with, SODA sells DIY soda that you can make at home. Its machines are used to “fizz” water or make soda but people are learning how to fizz most anything including wine.

The company yet again beat consensus earnings estimates but investors were rattled when:

  1. the company didn’t boost guidance
  2. it reported weak flavor sales (up just 7% y/y)
  3. and adjusted EPS rose just 3%

The chart below, courtesy of SodaStream, shows (in light purple) the slowing growth of Quarterly Flavor Unit Sales over the quarter.

Consequently, SODA shares declined to $52.50, and were off from their 52-week high of $77.8.  The high price was emphemeral as SODA’s shares were victim to undocumented takeover rumors during the Summer.

Click to enlarge: Source: GoogleFinance


Financial Highlights:
As you can see from the company’s financial highlights below, revenues grew a healthy 29%, boosted by strong (albeit lower margined) Soda Makers.  However, investors remain concerned over the 7% gain in Flavor Units, which is sharply lower than its historical growth. The anomaly appeared to occur in the United States, a region the company’s depending on for growth.

Management claims the disappointing Flavor growth was due to changes in inventories at its retailers (“sell-in”) compared to the actual sales from those retailers to end-customers (“sell-through”).  Management stated that sell-through growth, which can be obtained using a service called NPD, was higher than sell-in growth.

SodaStream: 3Q Financial Highlights

Something similar to the above occurred in 2011; however, what worries me is that the company’s Operating Cash Flow has taken a big hit in the process.  SODA is no longer in its “infancy” growth stage and should be growing cash more rapidly. However, this is not the case (see Nine-Month cash flow statement below).  Though, SodaStream did see higher Operating Cash Flow during the latest three month period.

Equally troubling is a sharp decline in cash since Dec’12.  As you can see below, cash & equivalents declined to just $39mm.  What you cannot see on this table is that the company took out $20mm from its bank line. Without that, Sept’13 cash would have been just $19mm.  Some observers note that the company is spending lots of money on a new cutting-edge production facility.  However, upon closer examination, it appears that weak working capital management is to blame.

Where things are going well…
On the positive side, SodaStream continues working closely with its retailer customer-base such as Wal-Mart.  In fact, some of the large increase in Inventories that negatively affected Operating Cash Flow may be attributed to a Christmas program at Wal-Mart.  Also, the company has linked with several name-brand companies to sell their flavors including Kraft, Countrytime, Crystal Light, V8, Cambell’s, etc… The latest is OceanSpray flavors which can now be “sparkled” with SodaStream.  See the video teaser.

I think one of the most exciting characteristics of SodaStream is its innovation, some of which operates “behind the scenes.” For example, this summer Samsung started selling a fancy refrigerator that dispenses sparkling water (powered by SodaStream).  The water (and soon soda) can easily be dispensed from the outside of the fridge door. A side benefit is that the fridge door is likely to be opened much less, saving electricity in the process.

Source: Samsung

Remember, SODA isn’t an ordinary company but an extraordinary company revolutionizing the way we make and drink soda.  In the process, less waste is produced and users consume significantly less sugar than conventional sodas.

As a reminder, SODA’s business model is the “Razor-Blade” one. As such, it is still in its early growth stage (but not infancy) in the U.S. while it is in the maturity stage in Europe. Consequently, SODA is still selling lots of low-margined (about 30% gross margin) Sodamakers in the States. However, as the company matures, a higher proportion of revenues will be attributed to CO2 bottles and Flavors. Some analysts believe that SodaStream’s gross profit margin may be approaching 90% on those CO2 bottles.

SodaStream hopes to become a billion dollar in sales company by 2016 with 56% gross margins and over 15% net margins. The key will be maintaining customers (which would lower Ad & Promotional expenses) whom will purchase the higher margined CO2 bottles and flavors.

Source: SodaStream presentation: Aug’13


Conclusion:

The “take-away” from SodaStream’s 3Q’13 earnings report isn’t that its business model may not be working but that cash flow will likely build-up slower than first thought. This will, in turn, lower projected share-price estimates if one uses the Discounted Free Cash Flow model to calculate the intrinsic value of SODA.

While we like SodaStream as a company and as an investment, it is always a good idea to objectively seek out pros and cons including largest risk factors for any potential investment.  Such thinking, we hope, will allow investors to make better long-term decisions.

Disclosure: the author is long SODA.

Should SodaStream look East ?

In a recent Wall Street Journal article link the paper quotes Coke CEO Kent’s plans to spend $4Bn over the next three years to expand bottling plants, marketing, etc. in China.

For now, SodaStream’s concentrating in the United States (i.e., the Americas).  And for good reason.  Whether you call it a secular trend, or just a fad, no one can deny that SODA’s Americas’ growth is fantastic.

Source: SodaStream, Socially Responsible Investing

So then, everything must be Hunky-Dory at SodaStream.  Or No ?

SodaStream shares lost their fizz after they beat the Street’s estimates for 2Q’11.  Which makes me ponder what would have happened if they DIDN’T beat the Street!  CEO Daniel Birnbaum later (8/18/11) appeared at a mini roadshow speaking with Jim Cramer, but the damage was already done (see stock chart).

Source: GoogleFinance

Several analysts and Seeking Alpha members were disappointed that SodaStream didn’t raise its 2011 guidance.  After all, at this rate, revenue growth would implicitly be expected to slow down to c.20%.

The lack of color in this outlook picture is surely reason for pause.  So, what’s going on in Western Europe ?  Well, according to Birnbaum, everything’s Kosher.  He basically said:

  • Indicators of Americas and Europe are fine
  • In fact, Europe will benefit if its economy slows, as it’s a value proposition

Whoa, whoa, whoa.. REALLY…?

  • To me, SodaStream’s still a consumer discretionary product, in fact, Birnbaum doesn’t want to market it as a value-product.  The deal is, you can’t say that it’s a higher-valued/differentiated item (see company presentations) then later say it’ll sell well because it has a strong value proposition.  In fact, in my earlier analysis, I proved that SodaStream does not significantly reduce soda costs.  See SA article Should SodaStream go Single?
  • More evidence that weakness in Europe will effect SodaStream’s business comes from Linda Montag and Yasmina Serghii-Douvin of Moody’s.  They expect European soda demand to remain lethargic, especially in the ever-expanding countries with troubles (e.g., Greece, Spain, Portugal, Italy).  As proof, they give the example of Greece’s 2010 slowdown (one of the first) which significantly reduced soda volumes at Coca-Cola Hellenic Bottling Co.
  • Recall that SODA’s Western European revenues declined in 2009 attributed to significant business and inventory management problems at one of its Nordic distributors.  A portion of the problems were directly related to the Financial Crises.
  • SODA would also be hurt if the EURO, which has held up remarkably well in the $1.40/EUR area, declines.

Despite all the talk about the hot Americas/U.S. business, the fact is that much of SodaStream’s revenues still come out of Western Europe (see chart below).

Source: SodaStream, Socially Responsible Investing

Also note that given the geographic proximity and close economic ties, Eastern Europe will undoubtedly be affected by a slowdown in Western Europe.  So where does that leave SodaStream?

So then, maybe SodaStream should be looking East !

Going back to my opening comments, maybe, just maybe, SodaStream should focus its energies on the East.  Wait, wait, you say that “SODA’s already in Asia.”  And to that I respond, not really….

Yes, the company is doing a small amount of business in Asia-Pacific (see above chart).  However, drilling-down it appears nearly all of it is actually in Australia and New Zealand.  Should we really call those Anglo-Saxons examples of what it means to be Asian?

Instead, I suggest SodaStream delve into China and Japan.  Japan’s consumer-profile is somewhat similar to Europe and the U.S., and we all know they love robots and other gadgets.  In fact, management did mention their intention to enter the Japanese market by this year’s end.   Also, I strongly believe that SODA should enter the Chinese market, especially since Coke and Pepsi are already educating its consumers.  Besides, the trajectory of soda consumption is salivating.  See chart courtesy the WSJ.

Of course, entering China and Japan has its own share of problems.  Birnbaum, cited difficulties with language, regulations and advertising contracts in Japan.

In China, the largest issue will be protection of intellectual property rights and lack of full control of local entities.  Remember…those CO2 carbonators SodaStream “sells” to you actually come with a license agreement, which effectively empowers SodaStream to collect 70-80% gross margins.

I welcome constructive comments and criticisms.  So long as we’re listening with open minds, I believe we will all benefit from them.

Disclosure:  the author is long SODA