Billionaire Pharmaceutical Entrepreneur Makes Bet On Fast Growing Supplement Manufacturer Muscle Pharm

Muscle Pharm Corp. is a creator and manufacturer of nutritional supplements for athletes. With monikers like Assault, Battle Fuel, and Combat, these vitamins, protein supplements, and amino acids are designed to promote among many other things, strength, muscle endurance, fat loss, and fitness maintenance. As I have been taking vitamins for many years I am always on lookout for new things. Although by no means a bodybuilder, I have lifted weights as part my fitness regimen for many years. At my age in the gym I don’t want any cheese, just let me out of the trap…..working with depreciating asset, I’m just trying to slow the pace of decline.

Anyway, I decided to investigate this little company that in the hyper competitive supplement industry is becoming more ubiquitous by the day. Here are a few discoveries. Muscle Pharm was founded in 2009 by an ex NFL wide receiver/punt return specialist. It is a public company currently listed on the “pink Sheets” (OTCBB), symbol MSLP. The company has hemorrhaged money since inception and should report significant losses for year-end 2012. Examining the financials, the company has negative cash flow, negative net worth, and unsustainably narrow gross margins. On the surface it doesn’t make for a sanguine outlook. However, I also discovered that sales over the last four years had been growing by orders of magnitude. From sales of less than $1million in their first year of operation, the company will report sales of $78 million in 2012 translating to a compound growth rate of almost 300% annualized.  Until today, the company had a market cap of less than $13 million or about 16% of sales. Although a very cheap multiple, it doesn’t really matter if a company can’t right the ship and at some juncture gain profitability…….and that is just what this enterprise is attempting to do.

On January 17 the company filed an 8-K announcing details of the sale of 1.5 units of series D convertible preferred stock raising $12 million (before underwriting fees) in equity for the company. Today the company issued a press release announcing the closings of 511,625 shares at the $8.00 offer price bringing in gross proceeds of about $4.1 million. Interestingly, the lead investor in the share raise was billionaire pharmaceutical entrepreneur Dr. Phillip Frost catapulting him to one of the largest holders of MSLP stock. Dr. Frost was chairman and CEO of IVAX Corp. which was sold in 2007 to Israeli giant Teva Pharmaceuticals for $7.4 billion where Dr. Frost currently serves as chairman of the board. More closings are expected to take place over the next several weeks.

I took things a step further and had conversations with company founder Brad Pyatt. It turns out Mr. Pyatt has recognized the exigencies of his situation and is acting proactively and implementing a number of positive steps.

The current secondary offering by Mr. Pyatt and management took some courage to stomach. It will ultimately increase outstanding common shares from just less than three million to six million fully diluted shares outstanding. They are effectively selling fifty percent of the company for $12 million. Mr. Pyatt’s pro rata share of the company ownership will be reduced by half. It is a sagacious manager who can realize that it is better to own a smaller piece of something potentially very large versus a bigger part of a capital constrained smaller entity. And big this company may become. Mr. Pyatt is projecting calendar year 2013 sales in excess $120 million and has a goal of reaching $500 million in revenues within four years. The major footprint for the distribution system to achieve these figures is already in place. Currently MusclePharm products are sold in 120 countries and 10,000 U.S. retail outlets with a goal to reach 20,000 in the next 16 to 24 month. Large national chains like GNC, Dick’s Sporting Goods, and Vitamin Shoppe as well as over 100 online stores such as Amazon.com , Bodybuilding.com, GNC.com, Vitacost.com, SupplementWarehouse.com, and LuckyVitamin.com to name but a few, all carry the a full line of the MusclePharm brand.

The most important thing to come from my conversation is Mr. Pyatt’s plan to rapidly turn MSLP to a profitable enterprise. With sales that should well exceed $100 million in 2013, Muscle Pharm has achieved enough scale to renegotiate supply deals with their manufacturers. In 2012 overall gross margins averaged 17%. More favorable terms in 2013 will immediately bring gross margins between 28 to 30%. This alone could add $12 to $14 million to the pre-tax bottom line. Mr. Pyatt has also laid out a plan to reduce operating expenses by 14% which should amount to a savings of over $2 million. Included in this austerity are salary reductions averaging 32% for top executives. Cutting salaries is a breath of fresh air that to me indicates management is aligning interests with shareholders.  MSCP recently leased a 152,000 square foot distribution center in Tennessee located in proximity to their manufacturers, giving the company complete control over product fulfillment. Previously, the company was dependent on third party for deliveries which often led to bottlenecks resulting in inefficiencies. Ability to ship quicker, translates into faster sales cycles or more inventory turns. Mr. Pyatt estimates savings that could increase gross margins by an additional 2%.

The proceeds from this equity offering will restore MSLP to financial health. $7 million will be used to pay off all debt and accounts payable. The balance sheet, henceforth, will be in pristine condition. Other uses of funds will be for international expansion and to increase the US sales force. Any residual will be for working capital purposes. Other shareholder friendly measures have been completed. During 2012 99% of all outstanding warrants have been converted leaving less than $20,000 of these derivatives on the balance sheet. Fully diluted share count for year end 2012 should be about 3 million. Mr. Pyatt has made a commitment to avoid any future dilutive derivative transactions. Finally after an earlier reverse split, the company is eligible for and has applied to be listed on the NASDAQ exchange. The company believes, and I think rightly, that the NASDAQ will give them more exposure to institutions both as potential buyers of MSLP and to pick up research coverage creating much more publicity for the company.

So what could a company in a fragmented industry with few publicly traded companies available for comparison be worth? There has been one recent transaction that provides valuable data for reasonable assumptions. In November 2012 Schiff Nutrition International signed an agreement to be acquired by British based consumer-products maker Reckitt Benckiser Group for $1.4 billion outbidding German drug and chemical maker Bayer AG. Latest twelve months revenues for Schiff were $285 million which equates to a purchase price of almost five times sales. This metric is probably not appropriate for Muscle Pharm at this time given its current lack of profitability. Schiff had five year average gross margins of just under 41%. Even more relevant they registered average five year pre-tax margins of 10.1% and net profit margins of 6.4%. If, and it means if, MSLP registers $120 million in 2013 and achieved the same 6.4% after tax margin that would translate to a profit of nearly $7.7 million. Pre-acquisition, for the past six years Schiff Nutrition traded at an average P/E of 16 times. At that multiple MSLP would achieve a market cap of $123 million equating to an MSLP share price of $20.50 or a reasonable one times sales. It should be noted the stock rallied $1.53 or over 37% to close at $5.60 on news of the success of the share raise and Dr. Frost expressing his optimism with his pocketbook.

Ultimately, the success of MSLP rests with the products it develops. Its supplement “Assault” recently won the prestigious 2012 Bodybuilding.com “Pre-Workout” formula product of the year. There were over one million votes cast and 235 other entrants. Along with many other accolades, MSLP had previously captured first place in the Bodybuilding.com “New Brand” of the year. Manufacturing laboratories are certified by the (NNFA) National Nutritional Food Association’s GMP or Good Manufacturing Practices Program assuring pure ingredients in proper concentrations. All vitamins and supplements are legal, containing no banned performance enhancing substances. MSLP employs a team of scientists who are constantly testing athletic performance while enhancing and creating new MSLP supplement lines. All this happens at state of the art training facilities located at MSLP headquarters in Denver, Colorado. Professional athletes travel great distance to train here. MSLP sponsors a number of athletes including NFL quarterback Michael Vick. Watch for coming announcements of another very famous athlete joining the MSLP stable. MSLP is the official “Nutritional Supplement Provider” for the UFC (Ultimate Fighting Championships) commonly referred to as “cage” fighting. They are also the lead sponsor for Reebok’s “Cross Fit Games”. All of this says that Mr. Pyatt takes his work very seriously and that he is committed to providing the best.

I asked Mr. Pyatt how he came to the “vitamin” industry. He reflected that he had always taken supplements growing up but it was in the eighth week of his NFL rookie season when he broke his back that things changed. He came under care of Dr. Eric Serrano who through a regimen of nutrition and supplements orchestrated Pyatt’s rehabilitation. Pyatt says he came back stronger than before his injury surprising his coaches and credits Dr. Serrano with this “miracle”. Mr. Pyatt’s initiation to the supplement business was not a smooth one. In 2003 Mr. Pyatt invested in “Hard Nutrition” which after a number of fits and starts failed. Mr. Pyatt was left with near worthless stock and a lot of debt. On February 2, 2008 Mr. Pyatt declared bankruptcy. It was a difficult time. Within months Mr. Pyatt asked an old customer of Hard Nutrition, Mr. Corey Gregory to help finance a new venture and Muscle Pharm was born.

Time will tell, but the more information I uncovered, the more credible this story became. Mr. Pyatt has created a culture of health and fitness. Let’s hope this is just the beginning.

Disclaimer: I have no position in Muscle Pharm (MSLP) and no plan to initiate any

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