Description

Investment Thesis: BETR is an over-levered, one-hit wonder brand within the ready-to-eat (RTE) popcorn category that is at an inflection point after riding a fad within a nascent category.  With the backing of private owners, BETR’s Skinny Pop brand (93% of sales) was the beneficiary of first-mover advantage and its “better-for-you” branding that garnered market leading margins from an asset-light business model. However, with no clear long-term competitive advantage (minimal IP, contract manufacturing, commodity product), large CPG players with significant marketing budgets have introduced brands that have rapidly taken market share through rigorous promotions, resulting in margin headwind. Street analysts, most of whom participated in BETR’s IPO, are consensus bulls on the name and have myopically modeled continued top-line growth and sustainability in margins. Private equity owner TA Associates has been jettisoning stock below the IPO price, most likely an admission of the minimal long-term value of the business. Although the author does not take a strong point-of-view on BETR’s new acquisition, Tyrrells, as financials are opaque – yet this was most likely done as a defensive move to diversify a product offering under pressure, resulting in one of the most levered balance sheets in the food and beverage space. Recommend short with a weighted probability price target of $10.00.

Fact Pattern / Catalyst Path / Signposts:

• 8/8/2016: BETR announces the acquisition for Tyrrells, a UK based potato chip manufacturer, for $393M or 16.5x EBITDA; the deal was nearly an all-cash transaction, funded with a senior term loan and 2.1M of BETR shares.

• 5/20/2016: 10M share secondary that was $11.25; sellers were predominantly TA Associates (PE owner); note that this is ~$7/share below the IPO price at $18

• 5/3/2016: BETR acquires Boundless Nutrition, makers of Oatmega protein snack bars

• 8/4/2015: IPO of BETR at $18/share

Potential secondary offerings by private equity owner: TA Associates still owns 33M shares or about 44% of S/O; this is a significant overhang that will most likely improve borrow once they hit the market.

Brief Business Description: BETR is an asset-light marketer and distributor of “better for you” snacking products, of which their RTE popcorn brand, SkinnyPop, is over 93%+ of sales with Paqui (natural tortilla chips) and Boundless Nutrition (Oatmega nutrition bars) making up the remainder of sales at a lower margin. Customers Costco and Sam’s Club represent 31% and 18% of sales, respectively.

• SkinnyPop (93% of sales): RTE Popcorn product that commands 16% of market share, second to Frito Lay’s Smartfood (NYSE:PEP) with 26% market share. SkinnyPop has grown tremendously in its short life span, from revenues from $27M in 2013 to over $200M YTD.

• Paqui (~3% of sales): Natural tortilla chip brand that was bought for $11.4M in April 2015.

• Boundless Brands (Oatmega): manufactures and distributes Oatmega protein snack bars which was bought in April 2016 for $20.8M.

Brief History

TA Associates purchased a 74% stake in Skinny Pop in 8/2014 for $320 million. Within eight months (April 2015), the company had already hired Goldman Sachs to sell the stake to a bidder in a dual track process. However, when no bidder materialized, Skinny Pop took on nearly $200 million in debt and ended up paying dividends to shareholders (including TA Associates) of $80 million. As TA was attempting to sell the company, Skinny Pop then acquired a tiny tortilla chip maker for $12 million, thus becoming a diversified snack innovator and changed its name to "Amplify Brands." (note sarcasm). With this new complexion, the company filed for an IPO with Goldman as the underwriter and with 100% of the shares being offered to the public coming from selling shareholders (none of the proceeds raised went to the company with 82% of the shares came straight from TA).

Why the Opportunity Exists:

BETR is a clear Street consensus buy with all nine sell-side analysts covering the stock with buy ratings, most likely motivated by the banks’ recent involvement in the IPO and subsequent secondary offerings. Given the company’s torrid pace of top line growth driven by Skinny Pop’s first mover advantage within a nascent category, BETR has gotten a free pass on having no clear, long-term sustainable advantage. There is clear mis-modeling of BETR’s growth prospects, with sell-side estimates “goal-seeking” to management’s guidance in addition to myopically growing top-line and profitability almost into perpetuity. Few analysts are building their models bottoms-up by operating metrics (or by the various brands), and therefore, are not fully underwriting what the company has to achieve to meet their forecasts. In addition, with the minimal float (30M shares of 75M) given TA’s existing 44% ownership, my sense is that as TA unwinds its position through secondaries (most likely after Tyrrells closes), borrow will be more easily available for those betting against the stock. Note that short interest is 21% of the float.

1. SkinnyPop top-line growth and margins are unsustainable, fraught by continued competitive pressure from well-capitalized players who have pursued aggressive merchandising strategies to successfully grab market share.

SkinnyPop has enjoyed tremendous growth since its inception, nearly tripling its revenue base since the full year of disclosures in 2013 and growing market share from 1% in 2012 to 16% in the latest quarter with nearly 55% gross margins. However, that torrid pace of top line growth in addition to profitability are most likely at an inflection point as large, well-capitalized players like Frito-Lay (PEP) and other smaller brands (HAIN’s Angie’s Popcorn) vigorously fight for share. We have already seen this data come through in the latest market share trends as Smartfood has grown its market share almost 700bps over the past 18 months while Skinny Pop has been stagnant at 17%.

Yet, the ongoing battle to maintain market share has clearly come at a cost to Skinny – mostly from deterioration in margins, both in gross margin from ongoing promotions and EBITDA margins from step-ups in marketing and infrastructure spend.

2. Skinny Pop’s premium pricing has been under pressure and will most likely converge as Smartfood continues its aggressive merchandising in addition to other well-heeled players playing for a market share grab.

As mentioned above, Skinny Pop is competing in a category that is growing at a nice clip with an attractive margin profile, which is clearly attracting well-capitalized competitors. In early 2011, Skinny Pop was nearly 50% higher on an average EQ dollar price to Smartfood and 2x the price of Angie’s Boomchickapop. With Smartfood gaining the lion’s share of the market through aggressive merchandizing, Skinny Pop has been reducing its price while only maintaining its market share (as show above).

Through a pay-wall service, we actually have seen some of Skinny Pop’s core SKUs like the Original flavored 0.65oz reduce its selling price by nearly 20% on Amazon since mid-2014.

In addition, Frito-Lay’s SmartFood has shown little sign of relenting, increasing its percentage of sales that are on promotion from 19% in 2012 to over 40% in 2016 while gaining 700bps of market share, per above. Contrast this with Skinny Pop’s stagnant market share of 17% over the past 18 months while still having to promote nearly 50 cents to every dollar sold – clearly this is not a great setup for sustainable growth.

Side note: channel mix will cause margin deterioration.  As a side note for modeling purposes, Skinny Pop already has the highest penetration of the highest margin channel, which is the club channel (Costco, Sam’s Club) where Skinny Pop can benefit from its customers’ wide distribution network. Currently, Skinny Pop has nearly 54% of the market share of this channel (ex. Costco) and has 50% of its sales in this channel. According to a large food and beverage investor, selling through the club channel can be nearly 600bps more accretive to margin than selling to grocery, naturals, or drug stores. Going forward, we should expect some gross margin compression not only from product mix (Paqui & Boundless), but also through the channels in which the company is distributing its products. Per the Q2’16 call:

The setup is compelling as sell-side analysts are “off-sides” on modeling BETR. Sell-side analyst forecasts seem cursory, especially in light of the aforementioned headwinds that BETR faces. In many cases, the Street is mechanically straight-lining top line growth in addition to maintaining strong gross and EBITDA margins. Most analysts are not modeling BETR’s business bottoms up with few even modeling the Paqui or Oatmega brands

BETR is desperately trying to diversify away from its one-hit wonder product into adjacent BFY snack categories. However, these acquisitions are lower margin and are similarly situated in extraordinarily crowded and competitive snack categories with low probability of sustained growth.

Paqui. Amplify recently launched its new BFY chips called Paqui and announced targeted sales of $50-$100M over the next 3-5 years. The roughly $400M market for natural tortilla chips is effectively controlled by Hain’s Garden of Eatin’ (18% market share), Tostitos (9%), Snyder Lace’s Late July (9%), and General Mill’s Food Should Taste Good (9%) – in addition to a very large private label presence (20%). This was launched in Q1’15 has seen little to no excitement in social media outside of some people experiencing their extremely hot their ghost pepper flavored chips; furthermore, the SKUs that Paqui are even offering are the “fringe” specialty flavors (Habanero, Roasted Jalapeno) that do not typically drive velocity.  

Per below, we can see how crowded this space is by said large competitors. For the most part, these brands have typically 2 to 3 items on the shelf with the rare occasion of having four. This landscape is extraordinarily difficult to penetrate and gain market share. Pacqui started off with three items and back in 2014, but given the lackluster reception by customers in addition to the fringe SKU offered, my suspicion is that the brand will most likely settle below two items carried.  Please see per below the top brands in the natural tortilla space (in addition to the appendix for a more comprehensive list):

We have already seen management stumble with the rollout of the products although achieving exceptional distribution thorough its existing SkinnyPop channels (growing to ~30% ACV).  Per the Q2’16 call, BETR already lowered expectations from Paqui and has admitted the brand is performing below expectations:

Furthermore, during the Q2’16 call, management reiterated 2016 sales guidance for the base business – but this time, included contributions from Boundless Brands, implying that sales from Paqui are below plan. So far, we have seen this in the numbers as Paqui is most likely a $3M million dollar business, up from ~$2M in 2015.  If for whatever reason, management cannot get this brand back on track, there is little tangible asset that would serve as downside protection.  Over 75% of Paqui’s purchase price is the intangible asset trade name – per below:

Oatmega.  Similar to Paqui, Oatmega participates in a very competitive landscape – arguably, more so than tortilla chips and RTE popcorn.  In this roughly $4bn market, which has grown mid-single digits, there are over 20 top brands backed by large competitors, most of whom have excellent distribution channels already. Please view chart below which highlights the competitive landscape within the market.  Not only do the top 11 Brands control the vast majority of the market, they are also backed by large food companies or private equity owners (as shown in parenthesis).

Outside of KIND, Quest, and Clif there have not been many players that have increased market share over the past four years. Actually, the vast majority of them have either deemed less than 100bps or lost market share over the same period. This does not bode well for a brand that lacks significant marketing or branding behind it.  Since the beginning of 2015 Oatmega has only won 40bps of market share while still achieving distribution of 30% ACV. Although Oatmega is admittedly doing better than Paqui, I believe achieving the $50M-$100M in targeted retail sales -- which is the same size as well-known brands as Luna, Pure Protein, Think Thin, PowerBar, Zone Perfect, and Kashi – will be monumentally difficult.

BETR is on weak grounding from a balance sheet and cash flow perspective given the sweetheart deals with private equity partners in addition to being ~5.7x levered after the Tyrrells deal.

Almost all of assets of the company are intangible or goodwill ($335M of the $375M of total assets or 75% of assets). The entire company is effectively one giant brand acquisition vehicles with no real assets, minimal PP&E, low cash levels and low inventory levels. The company has no production facilities and outsources all of the manufacturing on a contract basis. This realization is extraordinarily important when contemplating the pace and rigor behind additional brands or SKUs. Paqui's rollout took almost a year from when it acquired the brand in April 2015 until it launched the product in Q1 of 2016. The rollout of new products will be slow, and the growth of the company will be hamstrung from the fact it has to contract out all manufacturing and have almost no balance sheet capacity to even make new acquisitions.

Valuation

In terms of ascribing value to an effective one-hit-wonder, you can think of a “steady state” scenario in which Skinny Pop achieves similar distribution as Smartfood and grows with the market (assuming that Skinny Pop is not winning incremental market share from smaller competitors; Smartfood has been the main beneficiary of that dynamic recently).  Please see analysis per below in which I assume the following:

• Skinny Pop achieves ACV distribution just shy of SmartFood in addition to winning new shelf space with an incremental 1.25 items per store.

• Given my assumption that Skinny Pop will have to drive further promotion and marketing spend behind this growth, I have taken net margins down 150 basis points.

• Net, net - there’s approximately $0.75 EPS from a Skinny Pop alone.  Assume a 3x revenue multiple on this business, which given where transaction comps have traded for branded assets, I think is more than generous.  This implies approximately ~$10.00 of value.

Given where the stock trades today, we are paying roughly $450M in equity value for three concepts (Paqui, Oatmega, Tyrrells), two of which are not close to demonstrating any sustainable business model and have less than $15M in total revenue. Similarly, Tyrrells has to be extraordinarily accretive (which is not in the foreseeable future) for the math to work as this was mostly debt financed.  In sum, this is a very expensive call option for outsize growth.

In terms of the comps, there is a wide range on a P/E basis (ranging from 18x-30x 2017 EPS) and EV/EBITDA (7x-16x 2017 EBITDA, excluding Monster).  Most sell-side analysts are fairly mixed on applying a EV / EBITDA or P/E but the takeaways are as follows:

• P/E multiple. This is not a relevant metric, in my opinion, given the lack of comparability in business models across the universe of food and beverage companies in addition to the varied capital structures.  In particular, I actually do not give BETR much credit for the high conversion of free cash flow as the company is effectively a one hit wonder vs. a real business that can incubate and build a strong product offering. In other words, these margins are not “structural.”

• EV/EBITDA. BETR trades at 15.0x 2017 EBITDA (PF for Tyrrells), which is north of the vast majority of multi-billion dollar CPG juggernauts with the median multiple at 11.5x  for the universe of relevant comps. Again, I question applying a multiple similar to multibillion dollar franchises with a stability and diversity of their product offerings, economic moat, and strong brand equity.

• P/S.  On both a relative value and on a transaction comparable basis, BETR trades any massive premium at 5x sales.  Outside of Monster Beverage, BETR trades at least 2x premium to the rest of the comps with the vast majority trading even wider.  More importantly, upon review the transaction comps in the appendix.  Of the >100 deals in the food and beverage space in the last few years, only a handful exceeded >3x sales.

Catalyst

• Potential secondary offerings by private equity owner: TA Associates still owns 33M shares or about 44% of S/O; this is a significant overhang that will most likely improve borrow once they hit the market. Tyrrells deal closed on 9/2 so assuming TA is not restricted anymore, should be in the near-term.
• Accelerated deterioration in gross and EBITDA margins