Should You Follow Whitney Tilson Into a Badly Beaten SodaStream?

SodaStream (NASDAQ: SODA  ) is a new favorite of hedge fund manager Whitney Tilson, despite being a short favorite among retail investors. The battle of whether SodaStream's model is sustainable -- and if it's a fad -- is legit, as the company operates with a much different business model versus peers Coca-Cola (NYSE: KO  ) and PepsiCo (NYSE: PEP  ) . Yet, given its six-month stock loss, and the value that's created in uncertainty, is SodaStream now worth the buy?

Tilson gets bullish
SodaStream operates in the business of manufacturing and selling home soda makers, CO2 canisters and refills, and many flavors/brands that include soda, Kool-Aid, Country Time, Crystal Light, energy drinks, and sparkling water. Given the fact that 52% of the stock's float is short, it's clear investors believe the company's products are a fad or cannot compete long term against its larger beverage peers. However, Tilson begs to differ.

Kase Capital Management fund manager Tilson said in a recent note, "[O]ne of the mistakes shorts are making is that, perhaps subconsciously, they're basing their analysis of Sodastream on the company's nascent business in the U.S. This is understandable...but it's a serious mistake because...Western Europe is by far the most valuable part of Sodastream's business." 

In many regards, Tilson is right, as SodaStream has seen slowed growth in the Americas, only 16% last quarter; but Europe has thrived, growing by nearly 40% last year. Still, SodaStream is a relatively small business in both markets -- each market accounted for 43% of SodaStream's total revenue last year -- as research firm Capital Ladders estimates that SodaStream has penetrated just 1.4%-1.6% of U.S. households.

Unlike Coca-Cola and PepsiCo, there is still a great amount of growth potential for SodaStream, as none of its markets are fully saturated. However, there is naturally great uncertainty that comes with such a business, which then leads to the question of whether the risk is worth the investment reward. 

Aside from discussions of whether SodaStream is a fad, investors also fear the prospects of Coca-Cola's recent investment and partnership in Keurig Green Mountain. The partnership will produce Coca-Cola brands in Keurig Green Mountain's Keurig Cold product, which won't be available for another year or two. Still, SodaStream is the only large at-home soda maker using CO2; and to many SodaStream longs, Coca-Cola's investment in Keurig is more an act of desperation to fight its falling market share.

In Coca-Cola's last quarter its total revenue declined a whopping 3.6%. Moreover, its quarterly earnings growth declined 8.4%. In regards to PepsiCo, its beverage business didn't do much better, as organic volume increased just 1%; but it was saved by its equally large snacks unit, which grew 3%.

Therefore, SodaStream might never grow to become a $100 billion-plus company, like Coca-Cola and PepsiCo; but with a market cap of $850 million, it doesn't have to in order to return large gains. This is a company that grew total revenue by 29% in 2013 and has grown aggressively in each year since 2009.

With that said, an aggressive growth business typically trades with a larger multiple than enormous non-cyclical companies. The reason is because investors are betting on the future, or taking into consideration what the growth company can ultimately become. Yet, strangely, SodaStream trades at just 21 times earnings and 1.5 times sales. In comparison, Coca-Cola and PepsiCo trade at 20 and 19 times earnings, respectively, showing that SodaStream's premium is especially small considering its growth.

Final thoughts
In retrospect, SodaStream's lack of a premium is likely due to the number of investors shorting the stock, as stocks with high short interest tend to trade at discounted prices. Ultimately, fundamentals always win, and if SodaStream can produce long-term sustainable growth, it stands to return enormous gains.

With that said, Tilson completed a series of surveys showing that 72% of the 167 surveyed SodaStream owners claimed they use their machine at least once a week. This was complemented by the company's CO2 and flavored-soda growth of 24% last year. Clearly, this shows that consumers not only own the machines but are also using them. Given this fact, combined with its valuation and total growth, SodaStream definitely appears to be worth the risk.

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  • Report this Comment On March 24, 2014, at 4:46 AM, Interventizio wrote:

    Unfortunately, if an investor like Tilson is wrong on this call, only the 0.x o his portfolio is going to be affected, whereas a retail investor is going to be hit for a much larger portion of his portfolio.

    Takeaway: know that before you follow the lead of a big investor.

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