Name That Trade – Watered Down $SODA

by Enis October 30, 2014 11:03 am • Commentary

SodaStream is a controversial stock that we have followed closely in the past year.  In fact, we actually had a profitable trade in SODA in the spring on the long side, though we quickly exited once we became concerned about the constant rumor-mongering surrounding the company.  Here was my rationale on selling my long stock position:

SODA is up nearly 10% today after an Israeli news site reported that SODA had held early stage discussions to sell a 10-16% stake in the company at $52 to a strategic buyer (such as PEP or DPS).  However, the nature of the report sounds suspicious, as it offers details that would normally not be disclosed until after a deal was struck, and the premium seems a bit extreme for a company that has reported a string of poor results.

Stifel analyst Jim Duffy called the article’s speculation “unsubstantiated and unlikely”.  That is our take as well.  Today’s bounce comes after a straight line selloff in the stock over the past couple of weeks.  SODA is slated to report in early May, but we do not want to hold through that event given the last 2 bad misses.  With today’s bounce, we’ll take off the long stock / short call position for a profit.

ACTION – Sold SODA long stock at $41.35 and bought to close Apr19th 45 Call for $0.25, yielding a $1.95 gain in the stock and a $2.05 gain in the short call position, for a total gain of $4.00, or about 10.2% (original cost basis on long stock of $39.40).

Since the spring, SODA has actually been cut in half, as its U.S. revenues have fallen off a cliff.  It’s been quite a surprise to see just how quickly the U.S. business has reversed course after steady revenue growth from 2009-2013, but demand for soda-making systems in the 3rd quarter was down 60% year-over-year in the U.S, a drastic drop.

Given those horrific results, SODA is now trading just above its IPO price of $20:

SODA monthly chart, courtesy of Bloomberg
SODA monthly chart, courtesy of Bloomberg

The stock is in the same place even though revenues are 150% higher than at the time of the IPO, and 2014 EPS is expected to be in line with 2010 EPS, at around $1.25 for the year.  Of course, the investment proposition is much different when it’s a high-speed growth story as it was in 2010, vs. an iffy turnaround story as it is today.  

What’s the value proposition for SODA?  What initially attracted us to the stock was its unique position as a brand name beverage maker, with a history of strong revenue and earnings growth.  The second half of that thesis has clearly changed, but SODA is now only a $450 million market cap company that still has a very recognizable brand with wide product distribution worldwide.

As for the negative case, the incessant rumors about potential takeouts leaked by Israeli newspapers throughout 2014 has not smelled right all along.  CC made a great point to me early this year that a takeover of SODA by a large multi national beverage maker was very unlikely as long as the company’s West Bank factory was a source of controversy.  Well, SODA is closing that factory and moving operations to a new plant in southern Israel, part of a new turnaround plan for the company.

SODA management detailed the “Growth Plan” on yesterday’s earnings conference call (you can read the whole plan in the pdf at this link).  The plan reads more like a startup pitch than a corporate initiative, which speaks to the depth of SodaStream’s current struggles.  Management detailed the shift in focus towards emphasizing sparkling water rather than soda, in order to cater to the more health-conscious choices consumers are making.  Management even mentioned on the call that current SodaStream products are actually used more for water than soda anyways:

As a matter of fact, already today despite our soda positioning 70% of the beverage volume generated by SodaStream worldwide is for sparkling water.

The growth plan even includes re-branding the products to focus more on Stream rather than Soda:

Screen Shot 2014-10-30 at 7.57.39 AM

SODA’s re-positioning to focus on sparkling water rather than cola and soda products is an admission that the current product lineup has lost favor with customers, particularly in the U.S.  But a totally new business plan, which includes changing the product, its branding, its marketing, its distribution, and the employees in charge of executing these changes, is a very risky strategy for a highly scrutinized public company.

Given that high level of risk, and the long time period needed to execute on its plan, SODA is not a name we’re interested in buying here.  Its valuation reflects many of the challenges, trading at only 1.2x book value and a forward P/E of 14x.  However, the risks to the business are significant enough that next year’s EPS could be 0.50 instead of the projected 1.50, in which case the stock is still quite overvalued.

As for using options for a potential trade, implied volatility is still at the high end of the 2 year range:

[caption id="attachment_47442" align="alignnone" width="600"]30 day implied volatility in SODA, courtesy of Bloomberg 30 day implied volatility in SODA, courtesy of Bloomberg[/caption]

Moreover, given that the timing of the turnaround is uncertain, buying calls or call spreads does not seem like a reasonable strategy at the moment.  Management also acknowledged on the call that a pickup in growth is expected in the second half of 2015 as the new product rollout takes times:

Going into next year obviously we will have some ramp up period and eventually we expect to see growth in all regions during the year. Second half will be is – will probably be stronger than the first half after we are up and running with full scale and with the new product line

Management’s detailed new growth plan also suggests that any near-term takeover from a company like PepsiCo is likely off the table. (But that doesn’t mean never)

We are going to keep an eye on SODA given the cheap valuation and the company’s historical success.  However, from a timing standpoint, this doesn’t seem to be the right time to enter a new position in the depressed beverage maker.