SodaStream ("SODA" or the "Company") is a classic one product fad business. SODA manufactures and sells a device that enables consumers to carbonate drinks at home. After finding success in a couple niche markets in Europe, the Company went public in November hyping its growth potential in the US. With a market cap of $873M (77x 2010E EPS, 50x 2010E EBITDA and 4.6x 2010E sales), SODA is significantly overvalued and is facing challenges that are eroding margins and growth. Near-term catalysts include: 1) the realization that growth potential is limited; 2) continued contraction in margins and declining FCF; 3) an additional capital raise in 1Q; and 4) the expiration of the lock-up for 67% of the shares outstanding on 5/2. There is a borrow on the stock available.

Investment Highlights

Flawed Business Model: The Company contends that its razor-razorblade model leads to a recurring revenue stream from the sale of higher margin consumables (flavor packets and refilling CO2 cartridges). Yet one CO2 cartridge is good for 60 liters of water and can be filled by any third-party refiller (as is continuously happening in Europe). Sales trends also contradict SODA's story as new machine sales have increased from 31% of revenue in 2007 to 45% in 2010. This supports the fad-like growth of the product and declining contribution of consumables. It should be noted that the Company does not possess any meaningful patents or exclusive distribution rights.

Uncompetitive Product: The Company's products range in price from $80 for the low-end 'Jet' to +$200 for the 'Premium Penguin.' Even SODA's lower-end system is uneconomical, costing $0.75/ L (assuming no cost of water) versus Poland Springs at $0.74/L (Costco, WalMart price). The economics associated with this DIY system become even less compelling when compared to more appropriate generic bottled water alternatives. It seems hard to imagine that there is a market at all for its higher-end product as a cost conscious consumer who make soda at home would not purchase a +$200 item like this in the first place. Existing competitors like 'Fizz Giz' (yes, that is seriously the name) sell a product that yields the same output but is smaller and more versatile for only $30. There was also a fad tablet product that carbonated beverages that lasted a short time.     

SODA's system itself is clunky and often messy to operate. If the bottle is not properly sealed to the dispenser it sprays liquid. The Company's system can also only fill a specific type of bottle that it sells, unlike its competitors' systems that can interchangeably fill any conventional bottle. The flavor packets SODA sells are all generic while competitors offer Coke and Pepsi flavors for the same price. These factors significantly limit SODA appeal and the potential sale of consumables to existing owners. Clearly this seems like the type of novelty gift you receive, use a handful of times and then let sit to collect dust.     

Limited US Demand:  Unlike consumers in certain regions of Europe, Americans do not regularly drink carbonated water but prefer a still, bottled option. Americans certainly do consume carbonated soft drinks, however, a number of more appealing (relatively) DIY soda options already exist in the market. Overall it is very unlikely that large consumer of Coke or generic sodas would start making it themselves at home. The flavor is not even close. A home carbonated beverage becomes flat much faster and tastes quite different. It is also hard to find refill packets as most grocery stores do not even carry them. Kohl's, one of SODAs first and broadest retail distributors, no longer even sells any of the Company's products. CO2 cartridges need to be sent away to SODA or brought to an un-affiliated re-filler. The convenience that SODA emphasizes is not a reality. Regardless, the Company has been selling machines in the US since 2002 with modest success. It seems unrealistic that suddenly now it will somehow generate massive sales in the US market as its stock price implies.  

Margin Erosion:  Gross margins have been contracting from 55% in 2008-2009 to 53% in 2010 while SG&A has been up substantially (though somewhat understandable in an expanding business), cutting op margins to 7% in 2010 vs 10% in 2008-2009. New growth, particularly in the US, is coming from third-party distributors causing a hit to gross margins (SODA is headquartered and manufactures its products in the politically tenuous West Bank).

Weak Cash Flow Profile & Inventory Build: CF from ops-capex was -$4.4M versus net income of $2.8M in 3Q'10 despite very limited capex. Inventories have been growing more rapidly that COGS, 66% vs. 58% with inventory turns declining to 2.2x in the last quarter. As SODA continues to extend itself it is likely that margins and cash flow deterioration will accelerate.  

Valuation

Based on the recent share price of $43 and S/O of 20.3M), SODA's market cap is $873M+net debt of $42.6M=$916M EV. CapIQ and several other data providers have the wrong share count, understating the market cap by ~50%. Even the DB and Oppenheimer analysts somehow undercount by 2M shares. To justify its existing valuation under the current margin profile SODA would need to grow sales at +25% per year through 2018. Soon valuation has to become part of the investment process. Sales growth declines over the next couple quarters and as investors begin to appreciate the poor CF profile and fad-like nature of this business, SODA will see its multiple contract substantially. If the Company traded in-line with established high-growth retail names like UA and LULU its stock would need to decline ~50%.   Even if the share price declined 77% to $10 it would still be trading at 14.5x 2010E EBITDA-capex and 18x 2010E EPS.

Risks

Growth Exceeds Expectations: The US growth story somehow perpetuates itself and the stock grinds higher. This is mitigated by the fact there is already a tremendous amount of growth priced into the stock at current levels. The Company is close to fully penetrated in Europe with growth in the mature stage and competitors entering/refilling SODA canisters (the highest margin revenue source). Thus SODAs success is highly contingent on its ability to generate large scale adoption in the US market. Bulls site the precedent success of the Brita and Keurig expansion, yet SODA has already been selling into the US market for over eight years.

Decent management: The CEO formerly ran Nike Israel and seems to be capable. He could keep the story going for the near-term.

Limited Float: Relatively thin float of 6.3M shares increases the risk of a squeeze or buy-in.