IPO Wars: Fresh Market Vs. SodaStream International

By Will Ashworth | November 05, 2010 AAA

Five U.S. IPOs have gone to market so far in November. Two of them - The Fresh Market (NYSE:TFM) and SodaStream International (Nasdaq:SODA) - have seen their stock prices surge in initial trading, up 46% and 52.6% respectively. Investors lucky enough to have secured shares in the offerings are well advised that such continued price appreciation is highly unlikely. For the rest of us not so lucky, this article will determine which IPO is the better of the two, and whether either is worth buying now that the horse is out of the barn.
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Use of Proceeds
The first criteria we will use for assessing any IPO is what the company intends to do with the proceeds. The Fresh Market's selling shareholders, who include the founding Berry family, will receive $310 million while its long-term debt remains at $94 million. Considering a secondary offering by the founders is probably forthcoming, there's no reason why it couldn't pay down its debt. The Fresh Market gets a failing grade here.

As for SodaStream International, its executive officers and directors sold no shares into the offering, and as a result, the additional shares issued dropped their ownership stake from 72.6%, prior to the IPO, to 46.5% after. They put personal interests aside, and that's a good thing. The company will use the $98.9 million in net proceeds to eliminate its outstanding debt of $35.1 million, in order to purchase a manufacturing facility near an existing market at a cost of $34 million, and the remaining $30 million or so for working capital. This is a much better use of IPO funds.

The advantage goes to SodaStream.

Valuation
Both stocks are up significantly after only a few days of trading, and as a result it looks as if underwriters exercised their over-allotments. The Fresh Market's market cap as of November 5 is $1.54 billion, while SodaStream International's is $607.1 million, which translates into trailing 12-month price-to-earnings ratios of 51 and 58 respectively. These are both incredibly high. Perhaps on a forward-looking basis, they aren't so outrageous.

The Fresh Market's revenues for nine months ended September 26, 2010, were $685 million, up 13% year-over-year. Revenues for all of 2010 should be around $974 million, and assuming the same growth in 2011, $1.1 billion next year. With a net margin of 3.7%, earnings per share should be 85 cents for a forward P/E of 37.8. That's a little better. We'll apply the same approach for SodaStream International's revenues and earnings. In the first six months of 2010, revenues grew 50%. It's safe to assume that's 50% revenue growth for all of 2010 and 25% growth in 2011. By the end of next year, revenues should be around $269 million with earnings per share of 95 cents for a forward P/E of 33.6.

Considering SodaStream International's revenues and earnings appear to be growing faster, advantage number two to the manufacturer of beverage carbonation systems.

Business Models
While it's easy to treat The Fresh Market as just another supermarket, it's obviously not your average store. When compared to competition like Whole Foods (Nasdaq:WFMI), Kroger (NYSE:KR) and Wal-Mart (NYSE:WMT), its operating margin at 6.2% and return on assets at 12.8% stand out among the crowd. The Fresh Market's growth strategy is to increase its store base, grow comparable sales and improve operating margins. On the first and last points, it's doing a great job. The same-store sales situation on the other hand is a bit murky, having achieved negative results in both 2008 and 2009. However, as long as it keeps generating those wonderful margins, the negative numbers aren't a serious concern. What might be though is the deterioration of its comparable store sales per square foot. Until it shows it can reverse this trend, it's safe to be hesitant in fully endorsing its retail operations. Overall, however, it appears to have a strong retail franchise.

I thought soda carbonation machines went out of style in the 1950s, but SodaStream International is proving that everything old is new again. The combination of an environmentally friendlier way to enjoy soda, long-term cost savings making it yourself and a healthier alternative (two-thirds less sugar than regular soda) appears to be gaining headway in Europe, where it generates around 68% of its overall revenue.

The Americas currently account for just 13% of sales, and unless the company fumbles its distribution execution in the States, its revenues should rise exponentially. The business model has excellent recurring revenue. First, you buy its basic $79 starter kit that includes a plastic carbonation bottle and an exchangeable CO2 cylinder, capable of producing 30 to 130 liters of carbonated beverages. Then you're going to want to buy one of the 100 or more flavors they sell to provide your soda with a little taste. Eventually, your CO2 cylinder runs out and you're back to an authorized dealer to exchange your empty cylinder for another full one (much like propane) and the soda making begins anew. For the six-months ended June 30, 41% of revenues were soda maker starter kits and the remaining 53% were consumables like CO2 refills and flavors, which carry a higher margin. It's much like the Gillette razor and blade model.

Ten years ago, I wouldn't have given this business much hope. Today, the timing and technology is better.

The Bottom Line
Both of these businesses look great. However, their IPO valuations were priced for perfection, and the quick jump out of the gate certainly doesn't help. I wouldn't recommend buying either at today's prices, but would wait until they have a let down. However, if I had to pick one to continue rising, SodaStream International is the way to go, as it has a more compelling business model.

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