Description

Background

New Age Beverages Corporation (“NBEV”) was uplisted to the Nasdaq in early 2017 from Pink Sheet obscurity, underwritten by Aegis Capital and Maxim Group, and appeared on our radar when it was swept up in Weed Mania 2018. This was in late September as the frenzy shifted into the secondary phase of the cycle and speculators found junk story stocks with questionable ties to the cannabis industry to chase (IGCC, LEVB, DTEA, and YGYI are other examples). NBEV is a hodgepodge of little-known beverage brands covering all the trendy health food buzzwords of the day: energy drinks, coconut water, green teas, kombucha and now CBD beverages. The highly promotional CEO, Brent Willis, would have you believe NBEV is a rapidly growing player riding a wave of healthy lifestyle trends. The reality is that NBEV has burnt investor money acquiring brands with little to no consumer traction, which aren’t only failing to meet the company’s lofty growth expectations, but are witnessing stalling demand and declining margins despite the industry tailwinds.

A quick aside about the CEO. Brent Willis has left a path of capital destruction in his wake as he’s bounced around since the financial crisis. From May 2006 to March 2008 he was CEO of Cott Corp, another beverage company, where several production delays mixed and a tough environment got him booted after just two years; the stock experienced a 70% decline during his tenure. From June 2013 through April 2015 he served as CEO of Electronic Cigarettes International Group (ECIG), which saw its stock price decline from roughly $8.40 to $0.35. ECIG shared some eerie similarities with NBEV, as a trendy consumer-facing product that Willis made overly optimistic claims about. The business also utilized a similar roll-up strategy to NBEV, going on an acquisition tear in 2014 to create a portfolio of products that would impress the Street. ECIG filed for bankruptcy last year. Lastly there is XFit Brands, where he has been Chairman since 2014. XFIT sought to capitalize on fitness gear and apparel trends and has fallen approximately 99% in the last 3 years, now trading for less than a penny.

The Business

NBEV has two operating segments, the core drink Brands and Direct Store Delivery (“DSD”). The later is essentially a logistics platform that distributes and markets brands outside of the NBEV portfolio, primarily in “Colorado and surrounding states”. As of the third quarter of 2018, the DSD segment comprised 78% of total revenue and 136% of gross margins (the Brands segment had negative gross margins in the latest period). Although DSD appears to be the company’s bread and butter with gross margins in the low to mid 20s, it has been a flatlining business (trailing twelve-month revenue of $36.9M vs. $37.6M for FY 2017) and management emphasizes the drink Brand segment when hyping the growth story.

On the Brands side, NBEV develops and distributes labels such as XingTea, XingEnergy, Aspen Pure, Coco-Libre, Bucha Live Kombucha and Marley Mate. If you think you’re old or out of touch with the “kids these days” because you haven’t heard of these brands, rest assured you’re not alone, no one has. For instance, “Bucha Live” is routinely touted by management as one of the companies fastest growing lines, but if you search for most popular or most healthy kombucha beverages online you will find articles listing 10-15 brands and yet Bucha Live does not make the cut. Using Instagram as a proxy for consumer popularity, the kombucha segment leaders: GT’s, Health-Ade and KeVita have 137K, 117K and 44K followers, respectively. Bucha Live has gathered 428. That’s without a “K”.

Rapid Deterioration

The FY 2017 conference call was a bit of a victory lap for management, after completing some acquisitions and inorganically doubling revenues vs. 2016. NBEV posted $52.2M of net revenue for the year, with combined gross margins across the two segments of 23.8% and positive Adjusted EBITDA of $5.4M (but not adjusting for a $2.5M gain on a sale leaseback transaction). Management even stated that they expected to achieve the following on an ongoing basis:

·       Gross margins > 35%

·       Operating expenses < 25% of net sales

·       EBITDA margins > 10%

If we stack this guidance against the company’s following three quarters we see all three targets were missed in all three quarters:

Despite management’s optimistic guidance, the cracks were already beginning to show in NBEV’s growth story, as sequential revenue growth reversed in Q3 and Q4 of 2017 (-0.4% and -25.3%, respectively). They also mentioned getting a larger credit facility with PNC to support the continued product roll outs, more on that to come…

Fast forward to the Q1 2018 earnings release and we see sequential revenue growth of just 2.8% and no where near the margins previously predicted by management. The miss was attributed to “working capital constraints, severely constricting inventory levels”. It is disclosed that the previously mentioned credit facility with PNC is yet to be finalized and clearly causing management consternation. Management actually goes further, suggesting they could have gotten the much-needed financing from another source, but were “swinging for the fences” to obtain the lowest cost of capital possible, which can only be found at the largest banks, who naturally have more hoops to jump through. Apparently, delivering their “50% gross margin” to customers clamoring for product was less important than saving a few hundred basis points on their credit line for a quarter or two. Also curious is that despite blaming lackluster growth on “severely constricted” inventory levels, inventories actually rose to $7.4M in Q3 2018 from $7.0 in Q4 2017. Lastly, it should be noted that gross margins fell to 22.6% from 23.4% in the prior quarter, easily missing the 35% target set by management, let alone the new 50% thrown around on the conference call.

Q2 2018 was a similar story with revenues falling year-over-year and gross margins being crushed nearly 10 points to 13.2% companywide. Working capital issues were blamed for both top and bottom line underperformance again. Apparently after 5 months of diligence PNC still could not get comfortable with NBEV’s financials or the terms they were demanding. However, in early August they were finally able to get a deal done with Siena Lending Group for a $12M revolver.

When in doubt…pivot to weed!

Once again, the Q3 conference call highlighted the strain working capital was placing on the company. Although a short-term financing agreement was secured in June (never mentioned on the call), Willis repeatedly blamed inventory problems for the 0.9% sequential revenue decline and 12.0% decline over the prior year period. Inventories rose to $10.M from $9.5M during the quarter (now up nearly 50% from Q4 2017). Gross margins for Brands on the quarter crashed to -23.3% along with topline declines of 22.6% quarter-over-quarter.

This call was held November 14^th, after the stock had witnessed a nearly 500% gain in September on the back of weed mania. NBEV was the beneficiary of this retail investor wave thanks to its alleged emerging CBD beverage products. Although CBD or cannabis was never mentioned in any company filing to date, they were able to cobble together a quick press release during the cannabis hysteria in September claiming they were already developing products in test markets and would be rolling out soon. Michael Cunningham, Senior Vice President of Sales, did a fantastic job of adding fuel to the speculative fire on the Q3 call:

Now I'm supposed to stop here as Brent didn't want me to do this because he didn't want to overshadow the focus on our core brands, but I have to bring this up. We need to talk about CBDs. I am personally leading the charge of all discussions on CBD for New Age. Formally or informally, every retailer wants in. Every retailer is talking with New Age Beverages.

If that doesn’t get the Robinhood users to slam the BUY BUY BUY button I don’t know what will; and while NBEV is the 34^th most owned stock at Robinhood with over 45k accounts long from the excitement this fall, this conference call led to an insignificant change, retail has tired of the story and already reached its limits. I found it interesting that the Q2 conference call didn’t mention “CBD” once. Which means in August, when they sold 8M shares for $1.28 per share, a month before NBEV sextupled based on their supposed “first mover advantage” in the CBD beverage space, management couldn’t find a reason to discuss the product line at all, even for a raise! They did manage to capitalize on the craze though with both an at the market offering and another primary led by Roth Capital Partners, netting the company over $53M. The offering was at $3.50 and has left investors heavily diluted.

With 73M shares outstanding and a stock price of $4.42, NBEV trades at a $322M mkt cap, or $244M EV ex cash + debt. TTM Adjusted EBITDA (according to management) is -3.1M and GAAP cash flow from operations -11.1M. The company’s lead book runner, Roth, expects revenues to rise 22% in 2019 to $62.6M but still do not forecast GAAP profits. They slapped a $7.00 price target on the stock based on the optionality from the CBD market and “health sciences opportunity”. We, however, cannot see revenues rising materially given the company’s track record and lack of traction with consumers. Additionally, there is no reason to believe NBEV is in any position to capture the CBD opportunity. Although the CEO went out of his way to bait day traders and algos with a list of every cannabis company and U.S. consumer staple corporation on the conference call as potential partners, we don’t see how NBEV would add value to these producers and distributors. They are a tiny distributor with 0 cannabis production or processing capability.

The Trade

While the operational history and lack of quality assets suggests a substantially lower stock price over time, considering the 30-40% borrow rates I think the compelling opportunity is in the options, where there exists deep liquidity. Specifically, I believe that implied volatility on the March/June contracts is mispriced as the stock is looking backwards at the wild volatility it experienced this fall. While there are still large daily gyrations in the stock, the reality is that there is significant retail bagholders creating overhead supply and more importantly, the float/ outstanding shares has significantly expanded, this is a different company, share structure and environment than the one that ran to $10 in September and October.

People will have to decide for themselves which strikes to use but generally both at the money or far out of the money calls are compelling. I also think selling ATM or OTM puts to make a straddle/strangle has merit given that the large amount of cash on NBEV’s balance sheet means the stock is probably still in the $2-$3 range for some time as it limps along on bluster and poor operations. At $4.40 today, a $4.5 June straddle is ~$3.20. To realize 75% of the price of the stock on a 7-month straddle is usually a sign of a stock that exhibits either a massive upcoming binary event (like a biotech) or some type of fraud that is likely to collapse 80%+ soon but is near impossible to short due to enormous borrow rates. NBEV is a sketchy company, but it doesn’t fall into these categories. The volatility is simply backward looking to when 150% vol was more than reasonable but now mispriced. The primary issue with the short thesis on a reasonable timeframe, given the unstable borrow, is NBEV’s approximately $80M cash pile, which they will likely use to acquire more worthless assets that may be good for a quick pops in the stock price and general maintaining a bid for some time. However, with the right option position this can be turned around in your favor.

Catalyst

Further disappointment in the core Brands, despite obtaining working capital

Market realizing NBEV doesn’t have a CBD portfolio and larger players don’t need to deal with them

Theta decay as only upside comes from day traders hyping the news of the day for very short term pops (see farm bill yesterday as an example of the limits of these future pumps)