Description

SmartBalance  (SMBL), a former SPAC, is testing  the 52 week lows last reached a year ago, and is down more than 60% from the highs reached in 2007

Background

A recent Standard and Poor’s report on Smart Balance describes it as “a marketer of functional food products, distributing a line of “heart-healthy” and “low-fat” foods, including buttery spreads, popcorn, peanut butter, cooking/salad oil sprays, mayonnaise, milk and other grocery items.”

The core brands are Smart Balance and Earth Balance, that were developed around a technology patented at Brandeis University that has allowed Smart Balance to be the only brand that has no trans-fats, or bad cholesterol that also tastes good.

CEO, Steve Hughes has had an interesting career.  He has been the architect of tremendous brand growth at Conagra, Dean Foods and Tropicana, where he was responsible for the launch of the Silk line of Soy Milk:  VIC members may remember that Steve Hughes was the CEO of Celestial Seasonings, a brand that came from nowhere to take the tea world by storm, and which was acquired by Hains for 18X ebitda and 3X revenues, and still has a substantial market presence. 

Subsequent to Hains, Hughes formed a SPAC, Boulder Specialty Brands, to acquire a brand, like Celestial Seasonings which would allow him and his team to work their marketing magic. While his initial focus was coffee related companies that could be acquired for $100 million or so, he ultimately had to put together an extra financing to acquire the Smart Balance business for $490 million in 2007.

Here are some summary financials:

Capitalization

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Income Statement

*Reported and defined by the company as “operating income before non-cash expenses”.

Since the acquisition, Hughes has stepped on the accelerator, paying down over $100 million of debt through cash flow and the conversion of warrants. The balance of the cash generated from operations is being spent on growing the business.  If you believe that this cash spent has a positive ROI, then what should make you even happier is that this is a business that can grow using pre-tax dollars – which do not show up on the bottom line until the company decides to throttle back growth.

Realizable value.

Hughes’ playbook is to do the same with this company as he did with Celestial Seasonings.  From a current run rate of $30-35 million in ebitda, the goal is to reach sales of $500 million in by 2012 and cash operating income of $100 million (20% cash operating margin.)

If he gets to that level of revenues and cash flow, a takeout multiple similar to the Celestial Seasonings buyout would make this stock at least a 4X from here. 

Can he do it?  A fortune article published not so long ago is skeptical:   See: http://snurl.com/sy4gb Can Steve Hughes make Smart Balance a $ 1 billion brand? 

But the company brings some substantial and interesting advantages:

·         The management team is experienced and highly motivated, competing against less motivated management in large corporations, often in a tired category.

·         The Smart Balance brand has been established in the mind of the consumer in as a healthy choice.  Incumbent brands has carry a huge amount of inertia in terms of repositioning themselves in the consumer mind.

·         The Smart Balance brand, like Nike, appears to be elastic, successfully stretching into multiple food categories beyond Its initial buttery spreads.  These extensions include milk, cream cheese, sour cream, pop corn and peanut butter.   When they launch a new line in a different category, sales seem to have a halo effect.

·         Ability to develop a substantial food service business with small portions in multiple categories, freeing the company from the power of  the major retail distributors in this segment and allowing more avenues to develop the brand.

·         Asset-lite model business model

·         Ability to raise prices in an inflationary environment

So the basic thesis here is that the buyer of this stock is getting SmartBalance at a substantial discount to eventual takeout value.  Paying up for growth? Yes, but if value and growth are joined at the hip, then this is on the growth end of things:  Perhaps the right way to describe it is a “beaten down growth stock”.

Selected food and beverage take-out multiples:

The above transactions took place in a different environment (2003 – 2007), and who knows where the “new normal” falls out.  One element of the pre-2008 landscape that we believe remains unchanged is the ability of small companies to develop interesting new products that the majors then end up buying:  Smart Balance is a prime candidate for this

Why is it cheap?

The market appears to have gotten the jitters over SMBL for a number of reasons:

-          Recent sales growth weakness from IRI data.

-          National milk roll out not going as fast as expected – leading to fears that it may not work

-          Plans by Unilever / I can’t believe it’s not butter (ICNB) to go transfat-free by March 2010, taking away one of Smart Balance’s central marketing claims.

Catalyst

Catalyst(s)

Hughes and his team continue to execute on their plan

Restart of the milk rollout after some fine tuning (if it has actually stalled)

Positive IRI data (all business growth is lumpy – but investors need evidence that growth is not permanently stalled.

Unilever / ICNB move to no trans-fats has a minimal, or even a positive effect on Smart Balance sales.