SodaStream: A Great Short, Once Every Store Is Fully Stocked

There has been a lot of speculation lately about the health of the IPO market and whether it is signaling that the bull market that has seen the S&P 500 index double since early 2009 is in its late stages. Whether it be hot U.S. technology and internet IPOs (watch LinkedIn today as an example) or wannabes in China and India, there is no doubt that many of these new issues are overheated. One of the more interesting ones in my view is SodaStream (SODA), the maker of carbonation systems used to make your own soda and flavored water at home. If you have perused a Bed, Bath, and Beyond or Williams Sonoma lately, you have probably seen their display. What once would have been reserved for the pages of SkyMall in your airline’s seat compartment has now apparently gone mainstream in the U.S. and the company is pushing into new markets all across the globe. You can now buy a SodaStream soda maker at 40,000 retail outlets in 40 countries.

Not surprisingly, SodaStream stock has been roaring since its late 2010 IPO. After reporting strong first quarter earnings, SODA soared 23% or $10, to close at $54 per share on Wednesday. That huge move higher gave the company a market valuation of over $1 billion. Crazy? Probably, but let’s not underestimate how many retail locations globally SodaStream may be able to get its product stocked in. That is why I say this might be a great short opportunity, but not quite yet. As long as SodaStream is signing up new retailers, they will likely be able to post some impressive sales numbers simply from initial inventory stocking.

However, the long-term viability of the business model will depend on how many units those retailers are able to sell, and how many buyers actually continue to use the product regularly (SodaStream gets 50% of its revenue from consumables — CO2 refills and flavor mixes). Getting soda makers out the door of your manufacturing factory is one thing, building a loyal customer base for years to come is quite another. How many kitchen appliances get used once or twice and then find gather dust in the back of the pantry? Can’t you picture a SodaStream home soda maker in such a situation?

So how many soda makers are consumers actually buying? Not that many, even though the company reported unit sales of 592,000 for the first quarter of 2011. With 40,000 retail outlets peddling the product, that rate of sales equates to about 1 soda maker sold per week, per retail location. At that sell-through rate, it is easy to see that constant restocking really won’t be required. Given that this product has a ways to go before I’m convinced it will become a mainstay in consumer kitchens worldwide, I will be monitoring the situation closely. As SodaStream expands into new countries and signs on new retail distributors, I have no doubt they can grow sales substantially initially, but the thing to watch is how many potential retail outlets there are, and how fast they penetrate those markets. Once the SodaStream product line has found its way onto most retail shelves, it will have a much tougher time performing well and keeping that shelf space.

With a market value already exceeding $1 billion (for comparison’s sake, the third largest soda company in the world, Dr Pepper Snapple, is worth about $9 billion), SodaStream’s stock could easily reach nosebleed territory and make for a great short once the initial stocking sales momentum calms down. I don’t know if I would call this a fad (are they really that popular to begin with?) but I think in a year or two from now the fizz will have flattened tremendously. Time will tell.

Full Disclosure: No positions in the stocks mentioned at the time of writing, but positions may change at any time

Actually, Ballmer and Chambers Haven’t Been Running Microsoft and Cisco Into the Ground

With Microsoft’s just announced $8.5 billion acquisition of Skype and recent troubles at long time tech darling Cisco, their respective CEOs are taking a lot of heat in the financial media lately. The assaults usually start by comparing stock price returns over the last decade or so, mainly because such data makes it easy to point the finger at the top brass. It is true that Microsoft stock is trading at the same price as it did way back in 1998 (don’t forget this excludes dividends, many reporters do) but that fact alone is not reason to conclude that the CEO has failed their shareholders.

The fact of the matter is that CEOs have control over certain things and no control over others. Their stock price’s starting valuation at a certain point in time is something they have no control over. Most of these 10-year stock price comparisons work to proof a point because the ten-year period just happens to begin near the peak of the internet and tech bubble of the late 1990’s, a time when most tech stocks fetched 50 or 100 times earnings. Not surprisingly, if you bought tech stocks at those valuations, you have a horrible investment on your hands, but that is true regardless of who was CEO.

So how can we fairly determine how well a CEO has done creating shareholder value? Earnings per share, plain and simple. Many CEO’s fail because they look at overall sales to determine how well they have done, but you can grow the size of your company without making shareholders a dime, so that is an irrelevent statistic for investors. Stock prices are based on two things; valuation multiples and earnings per share. Simply put, the market determines the former and the CEO plays a huge role in the latter.

So, how have Ballmer and Chambers done in the context of earnings per share growth over the last decade? Contrary to media reports, not that bad. I assembled the chart below which shows how fast earnings per share have grown at seven different large technology companies for the ten-year period from fiscal 2000 through fiscal 2010. The results may surprise you.

As you can see, Microsoft and Cisco have not been run into the ground by Ballmer and Chambers over the last decade. In fact, given that the long term average corporate earnings growth rate has been 6% annually, most of these tech companies have performed quite well.

Not surprisingly, Apple leads the way in terms of average annual earnings per share growth and Oracle, despite Larry Ellison’s huge pay packages over the years, has done very well too. Former internet stock analyst Henry Blodget over at Business Insider wrote this morning that John Chambers has failed as CEO at Cisco, largely basing his view on the stock’s performance, but the numbers don’t really support that. Again, a CEO really can’t influence P/E ratios that much. Opinions about a company’s future prospects are largely based on recent history, so if a CEO has done well in the past, the odds are good that their stock’s P/E will be above average, which ironically will hurt stock performance in the future.

While Microsoft is not near the top of the list above, Ballmer has kept pace with other rivals such as HP and IBM, so calling him a complete failure seems unfair. One could certainly argue that he could have done a lot better given the hand he was dealt, but the numbers still show he is about average in the tech world and above-average compared with all of corporate America.

The real surprise from this analysis is the clear loser of the group, Intel. The chip sector is definitely cyclical, more so than the hardware, software, and services industries which dominate this list, but Intel has unquestionably been the dud in the group, growing earnings at about half the historical rate of 6% for all U.S.corporations. If any management team should be criticized in large cap tech land, it should be the folks who have been running Intel.

All in all, a very interesting exercise.

Skype Deal Doesn’t Help Microsoft Jump Up on a Large Cap Tech Buy List

Large cap technology stocks are cheap, really cheap. Some of them haven’t traded at current valuations ever in their history as publicly traded companies (Cisco, for example). Microsoft (MSFT) is often included on such a list, and for good reason (the stock is dirt cheap), but the company rarely gives investors confidence that their strategy is right in the ever-changing tech world. Very smart investors like David Einhorn have added Mister Softee to their portfolios but the stock continues to be dead money in the mid to high 20’s. Today’s announced deal to buy Internet calling giant Skype for $8.5 billion does little to change the landscape for the stock.

Microsoft’s biggest problem is that it really doesn’t innovate very much anymore. Using the massive cash generation from Windows and Office, the company has merely copied their competitors in other areas. Their online services division continues to bleed red ink as Bing, Live, and other initiatives are simply me-too product offerings. The Zune music player was a complete bust and there is little reason to think the Windows Phone operating system will get any traction. The X-Box gaming system has been the company’s lone success outside of its core products, but with only a couple of competitors, that was an easier market to make progress in. And with the consoles facing new competition, that market is only going to get more difficult.

If anything, this Skype acquisition is interesting in that it signals a potential shift in strategy. Rather than continuously trying to build a Skype-like product that stands little chance of gaining traction against Skype and Google Voice, Microsoft has decided to just buy one of the giants in the space. Although the price tag seems excessive at $8.5 billion (and very few would argue that point), they likely had to overpay to wrestle it away from other bidders. In my opinion, it makes more sense for Steve Ballmer to overpay for Skype than plow hundreds of millions of dollars into a Microsoft clone that will be dead on arrival. In fact, Microsoft investors should hope that the company stops sinking billions into its unprofitable internet services division and uses that cash to buy other well established companies. There will still be a risk that Microsoft will tinker with Skype and any other future acquisitions, which would increase the odds that they lose their leadership position, but there is far more money to be made with Skype than with Bing, as one example.

As for the stock, this Skype deal does little to change my view that Microsoft is near the bottom of the list in terms of attractive large cap technology companies. I don’t dispute the stock is very cheap, but capital allocation has not been a strong suit of the company in recent years (and that is putting it mildly), and as a result, investors should have little confidence that Microsoft is on a path to building up more large, profitable business units. And with the continued assault from Google and others on their Windows and Office monopolies, that is what Microsoft must do if they want to see their stock price get out of the doldrums.