Still or Sparkling?
What a surprise to find not just one but two water-focused companies on the active IPO calendar! We started our work on SodaStream International (sparkling) and before we were finished Primo Water Corporation (still) hit the road. Both companies are focused on the consumer market and offer an alternative to lugging bottles of beverages home from the supermarket and then having to recycle or otherwise dispose of the empties. However, the similarity ends there as SodaStream is really a consumer appliance company and Primo is more like a water distributor. Let's examine both in more detail and see which one offers the sweeter, more satisfying drink.
SodaStream makes a carbonation system (pictured, lower right) available in different models and uses proprietary CO2 cartridges and pour-in flavors to make a range of carbonated beverages on demand. The company tugs on all the right positioning strings during their presentation with an emphasis on their "green" credentials and attractive "razor/razorblade" business model. We'll come back to it, but the appliance only works with a special SodaStream CO2 cartridge that cannot be refilled.
Of course, the fundamental question for potential investors in SodaStream is whether or not consumers are really interested in making their own carbonated beverages at home. It's been tried before and those old time spritzer bottles have been around for decades. There are also some hidden factors that go into successful use of the product like having pre-filtered and pre-chilled water. There's evidence to suggest that it's at least an interesting novelty that can be a decent product niche. There are, after all, plenty of kitchens with a bread maker or a rice cooker or a juicer even though these are products that are not "necessary." However, the difference between niche and mainstream will figure greatly in how the SodaStream story unfolds because, for better or worse, the company believes that it's time to "swing for the fences."
Most of the reviews of the system itself are pretty positive and there appears to be a segment of the population that is tired of paying for and carrying home cases of carbonated water. Generally it seems that this is a more affluent household than average. One persistent criticism is about the cartridges, which have been called expensive and downright hard to find. Experiences with the syrups that the company sells are mixed. Some flavors (like cola) appear to be virtually undrinkable while others (like root beer and Pete's Choice) get rave reviews. Any syrup or flavoring may be added to soda after carbonation so consumers need not purchase them from SodaStream, although many do so.
The company faces a balancing act between making money from their proprietary cartridges and the rate of consumer adoption. Anecdotal evidence suggests that SodaStream isn't a real money saver versus buying bottles, especially in bulk. Many (if not most) of the purchases of the system by consumers seem to be when they are on sale, often for 1/2 price. For example, most of the systems are listed at sale prices on an ongoing basis at sites like Williams-Sonoma.
The way the "carbonators" work is a bit confusing. It's an exchange-based system, which means that when yours is empty you are supposed to be able to exchange it for a full one and a fee of $30 (for a large one) at any outlet; but, effectively, there are not enough outlets to make this practical which means it has to be done via mail. Since it's an exchange, this means each customer really needs to own two carbonators so that during the mail exchange process they still have one to power their SodaStream - and this means purchasing a "spare" for a one-time cost of $50. So this adds a bit of complication and cost to the model. Some consumers will be happy to go through it; others won't. In my opinion, $50 for a bottle of CO2 and $30 for a refill seems high.
From a price per liter standpoint, the SodaStream solution appears to be about the same cost as a single-use CO2 system or buying in bulk at the store (~$1/liter.) Of course if you fancy high end labels like San Pellegrino and want to create your own special flavors, cost will not be an issue.
From a numbers standpoint SodaStream is delivering about 10% EBITDA margins at a $180M revenue run rate. It's hard to know the right mix between growth and margins at this point. We think the company is going to need to trade some things off to balance growth and profitability. Our initial Intrinsic Valuation model suggests the shares are worth $16 to $19 in the market today. That's in line with the proposed $18 to $20 filing range and doesn't incorporate any "Israeli discount," which is often applied to companies like SodaStream that rely on channel sales and have limited US operational history.
Primo is a simpler story. It comes down to selling your water in exchangeable 3 and 5 gallon bottles that go into a dispenser rather than your one, two or three liter bottles. No fizz here, simple distribution. On the surface the story doesn't sound very interesting. Why would you want to own a water distribution company? There's more to the story and it's worth getting to know. We see many retail models shifting and water may be ready to do the same.
What Primo is really doing seems to us more like business process outsourcing than distributing water. They have a consumer-focused strategy in terms of making stylish dispensers and giving the consumer what they want with no contracts or hassle. But the key to the expansion story is that Primo allows large retailers like Walmart offer their customers water with less effort and with better margins. Because the bottle racks can be placed away from the main shelves, the retailer can gain sales without giving up any shelf space. At the same time, everyone involved can earn a few green points by improving recycling, lowering costs and reducing waste.
Before getting into the more complicated part of the story it's important to note that the management team behind Primo is the same group that started, built and sold Blue Rhino, which pioneered the branded propane exchange market. An exchange model meant that any retailer would be able to get a slice of the propane refill market and consumers would be able to exchange an empty tank in more places and at different times of the day (most propane refill operations are 9 to 5.) Blue Rhino had a successful IPO and did fairly well in the market before being acquired by Ferrellgas for $340M. It's worth noting that this was just a bit over 1x sales.
If the story ended here it would be pretty simple. However, coincident with the IPO, the company will be acquiring the refill business of Culligan Water from the private equity firm that bought them. (For anyone not familiar with Culligan, they are the leading installer of in-home water treatment solutions and would be considered a substitute competitor but their systems are rather expensive and therefore not for everyone.)
Primo plans to implement a dual strategy of offering not just the exchange but also the refill model for consumers and retail locations. This adds an interesting wrinkle to the story in that consumers can refill their container at a much lower cost of $0.40/gallon versus the $1.30/gallon for an exchange. Although Primo will get a lower price per gallon of water, the gross margins figure should be substantially better than the exchange model. If the company were trying to force this in the market we'd be skeptical, but it appears that retailers, notably Walmart, want to embrace this dual model. Obviously, one major advantage of the refill approach is that bottles of water don't have to be hauled around in trucks.
The mix of the two models makes coming up with a solid Intrinsic Value estimate a bit of a challenge. We've worked through a few scenarios and can only say at this point that the proposed filing range seems a little bit aggressive. Investors will probably not pay a huge multiple for this business until they see a better growth dynamic or can believe in a better margin story. The cash flow and EBITDA should be supportive of the stock price once it settles somewhere, probably in the $9-10 range.
Both deals have a few too many moving parts for my taste. However, Primo is more grounded in terms of management experience, the business model, and the market opportunity. So at the right price, say $8, we'd find Primo a pretty tasty drink.
SodaStream is more exciting but carries more risk in terms of the management team, market acceptance and business operations. If we were advising this company, we'd have had them relocate the headquarters and most of the operations to the US a year ago in preparation for this offering. The good news is that *if* they can make this product stick to a meaningful enough portion of the market (affluent foodies?) and enjoy repeat purchases of CO2 and flavorings, the operating margins and potential upside is much better than Primo.
As non-technology deals, we probably won't provide on-going coverage of these companies but we will add them to the archive. Water is at least interesting, and if Primo can end up being a business process outsourcing solution in terms of our thinking, we might keep an eye on them. Too early to tell.
- Fizz With Flair, SodaStream's Penguin (luxist.com)
- Wells Fargo Drops Out of Primo Water's IPO (online.wsj.com)
- Make Your Own Soda (thegreenists.com)
- Is Home Carbonation the Next Big Green Thing? The Return of Soda Stream (treehugger.com)
- Review: SodaStream Gets Fizzy Water Right (fivepercent.us)
- Parisians Get Free Sparkling Water on Tap (inhabitat.com)
- Sparkling Drinks Spark Pain Circuits (lockergnome.com)
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