Mauro Tibone, EBX Columnist

Sodastream – Fizzing Up, Or Bubbling Over?

Mauro Tibone, EBX Columnist

Establishing that the concept has been around for quite some time does not help answer the question that many investors have in mind about Sodastream: ‘Is this a fad, or could this be a disruptor of long established bottlers such as Coca Cola & Pepsi?’ A few retail investors-oriented research firms touting Sodastream stock seem inclined to believe that there is little in the way of an almost inevitable multi-year expansion.

Israeli-headquartered Sodastream International is a leading enterprise developing, manufacturing and selling home beverage carbonation systems worldwide. Its business model appeals very much to investors in that it resembles the razor/razor blades, which made the fortune of companies such as Gillette, whereby high-margin consumables are sold to repeat customers.

In Sodastream’s case, the carbonation system is sold in the USA at prices ranging from 69$-200$ depending on design and features, while refill CO2 canisters after first purchase can be swapped when emptied for new ones at around $15. The company’s turnover is further fuelled by the distribution of a great variety of syrups, many of them licensed by well-know brands, sold in bottles or mono-dose caps to dissolve in carbonated water.

The concept of a home made carbonated drink is know from a long time, as it originated with G. H. Gilbey, a gin distiller who came up with the first system in 1903. Although the first commercial systems were already marketed in the 1920s, the first home systems were sold only in the 1950s and became very popular in the 1970s and 1980s.

The bull case is predicated on seemingly simple premises: geographic expansion through a broader distribution network (especially in the USA), product innovation and increasing market penetration thanks to multiple partnerships with well-known consumer brands offering an ample choice of drink flavourings.

As a corollary to that, either Sodastream’s market valuation is too cheap, if compared to the low-single digit growth expected from the majors, or it will become a take-over target for anyone keen to expand in this promising market. The answer is not a straightforward one, as we all know that its previous success has not withstood the test of time.

Sodastream’s model is appealing to many consumers for the convenience it provides for making your own fizzy water and flavoured sodas at home, without the trouble of carrying often much weight. Moreover, higher awareness nowadays for environmental issues allows Sodastream to build on a greener company image than its competitors, thanks to its lower carbon footprint due to less recycling required.

Sodastream CO2 canisters carry a proprietary valve, which allows control of their distribution network and price. The logistics of taking back empties and selling (technically leasing) back to customers the filled ones do represent a barrier to new competitors. On the other hand it is an issue for customers who have routinely to rely on the closer distributors for the swap, but also for small retail outlets, which do not enjoy the economies of scale of larger distributors to deal with this process.

Canisters can refill between 60-130 litres, according to the company, depending on how much fizz is used. If we add the cost of flavourings it is probably fair to say that the cost a Sodastream drink is about the same (or slightly higher) as a major brand large bottle, without taking into consideration the quality of tap water.

Sodastream generic branding for soda syrups, with the exception of a few licensed deals, does not provide yet as much brand recognition as the global brands. More marketing investment on this front should probably be required to strengthen its brand awareness, but that would also inevitably pose a cash flow problem.

Competition from the likes of Pepsi and Coca Cola could become much more fierce in the future. Global brands have deep pockets and it would be wrong to assume that they will not make any move against Sodastream should they keep on grabbing more market share.

In fact, Coca Cola is rapidly introducing Freestyle Soda machines across many establishments in the USA, competing directly with Sodastream. Other initiatives such as the recent original launch of a Coke bottle made of ice represent a clear sign of environment awareness and innovative thinking from the major brands.

Even relatively unexpected competitors, like Green Mountain Coffee Roasters in the USA, have recently identified the ‘make your own soda market’ as a target and are launching their own carbonated system. In Europe, it is no coincidence that an intense Sodastream marketing campaign in Italy is coinciding with rising competition from companies undercutting their lucrative refill canisters at much lower price points.

One further threat could also come from DIY carbonator systems. Such homemade devices could bypass a pricier refill with Sodastream for a fraction of what the company is charging. A simple Internet search can provide ample choice to choose from amongst different DYI systems, which allow using even bigger and cheaper CO2 canisters.

Sodastream is unlikely to be a fad, in fact, it’s been about too long to be truly called a fad, but any growing business with high margins and relatively low barriers to entry, sooner or later attracts new competition. Not only they have to compete for space in the kitchen with other appliances, but they also have to fend off possible competition from other domestic appliances manufacturers or global brands likely to enter the market.

A takeover is still possible, as speculated in early June when the stock rose above $80 on rumours that Pepsi could make a move for Sodastream. Such a move appears unlikely though, given the strains it would bring for the relationship with bottlers. In all likelihood the share price drop following the recent market rumours down to below $60 reflects the elevated uncertainty of an imminent takeover.

Logic would dictate that such move would be more likely to come from a large appliance manufacturer or a food brand willing to expand in a different segment, rather than a global beverage brand, which could cannibalise its own sales.

Regardless of any business scope an acquirer should also be prepared to swallow a meaningful geopolitical risk, given its significant manufacturing base in the Occupied Territories beyond the Green Line, which marks Israel border.

Sodastream stock is probably fairly priced at current levels around $60, as the European business is somewhat under some pressure and less likely to grow as fast as in the past, while a rapidly expanding distribution at supermarket and store chains should provide ample opportunity to expand its footprint in North America.

During its first meeting with investors in May 2013 Sodastream set a bold $1 billion turnover target in 2016, exciting many investors eager to ride a growth stock which is bolstering its top-line revenues, having recently signed partnership deals with Honeywell and Samsung.

Regardless, margin guidance in the past has provided high stock price volatility like in 2011 and encouraged the sceptics to heavily short Sodastream (as demonstrated by a very high short interest, to the tune of 37% of free float).

Recent quarterly results have provided Sodastream’s bullish investors reason to feel better about its top and bottom line growth. Nonetheless, while enthusiasm is high on forward guidance expansion, many investors remain somewhat wary and continue monitoring margin trends and free cash flow generation, rather than earnings and profits alone.

As such, Sodastream valuation multiple remain relatively compressed if compared to low-growing global brands such as Coke and Pepsi. Their free cash flow yield is at about 5-5,5%, while Sodastream has still to show a positive yearly cash flow return to shareholders, let alone paying any dividends.

A stark reminder that sales and profit growth alone does not always equate to a higher market capitalization; the market can usually read through fizzy and bubbly numbers.

Contact the Editor Responsible for this Story:

Brian Maguire – brian.maguire@europeanbusinessexpress.com

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