Blast Off Time For MusclePharm: $12 Million Offer

Blast Off Time For MusclePharm: $12 Million Offer is Complete

BUSINESS : 2/26/2013 @ 9:59AM | 4,093 views

MusclePharm (MSLP), one of the leading healthy lifestyle companies in America providing specialty supplements for athletes of all genres, from professionals down to those long past their prime like me, has succeeded in raising $12 million in new equity. It was an impressive show of confidence that this offering was fully subscribed so quickly. The company has used the proceeds of the offering to pay down all of its debt and rid itself of nearly all of its dilutive warrant obligations,- leaving its balance sheet in pristine condition. This incredibly fast growing company which, in its less than five-year history, has been long on sales but short on profitability, is perfectly poised to turn things around in 2013. Although 2012 revenues came in at $78 million, an impressive 370 percent gain from 2011 sales of $17 million, the company has continued to bleed red ink. Ex-pro football player, founder and CEO Brad Pyatt has avoided a key pitfall that undermines many a small business owner. Many entrepreneurs are loath to significantly dilute their ownership. The concept that it is far better to own a smaller piece of something with great growth potential versus a significant amount of something that is weak and underfunded has been elusive for many executives in Mr. Pyatt’s position. Mr. Pyatt looked trouble in the eye and exhibited his perspicacity-realizing that without more capital, all that he had worked for might go down the drain. Years of narrow gross margins and perhaps a bloated overhead structure had placed MusclePharm in a perilous working capital position. Each share of the completed offering of Series D convertible preferred stock at $8.00 is convertible into two shares of MusclePharm common shares. After the full conversion common shares will have increased from three to six million shares and Mr. Pyatt will have diluted his ownership by 50 percent.

As mentioned in my previous article, the lead investor in this offering was billionaire pharmaceutical investor Dr. Phillip Frost, the current chairman of Israeli drug giant Teva Pharmaceuticals. Dr. Frost doubled his original subscription commitment in the offering to $2.9 million, or nearly a quarter of total funds raised. As the company has grown in size, so has its clout with its manufacturers. Renegotiated supply agreements will radically improve company gross margins and Mr. Pyatt has also made significant overhead reductions. A new distribution center will save money both through centralized fulfillment and reduction of delivery times- creating opportunity to turn over inventories more frequently. For a more complete synopsis of operational savings, see my previous article.

Behind all the numbers are products that obviously work, and, regardless of intentions, Mr. Pyatt has created a cult-like following. I viewed a number of You Tube videos that left me thinking that MusclePharm is like a religion of the healthy. The company strives to address not only muscle building but also weight loss and general fitness through daily nutritional supplement regimens. There is a state-of-the-art fitness facility at the company’s Denver corporate headquarters where professional athletes from near and far come to train and work with MusclePharm scientists. All MusclePharm merchandise is rigorously tested for safety and efficacy and new products are always being formulated.
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So What Could MusclePharm Be Worth

So let’s revisit some valuation metrics now that the company officially has a clean, debt-free balance sheet and is poised for profitability. In its recent 8K report, Mr. Pyatt publicly announced a conservative (in my opinion) 2013 revenue guidance of at least $100 million. Given the past year’s triple-digit revenue growth, the new streamlined fulfillment capabilities, vast networks of distribution, as well as cash from the offering for expansion, I predict sales for this year will reach at least $120 million. The main publicly-traded comparable company was formerly NYSE-traded Schiff Nutrition International which this past November agreed to a buyout by British consumer products maker Reckitt Benkiser Group for $1.4 billion. The prior 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 MusclePharm at this time given its current lack of profitability. Schiff had five year average gross margins of just under 41 percent. Even more relevant they registered average five year pre-tax margins of 10.1 percent and net profit margins of 6.4 percent. If, and it means if, MusclePharm registers $120 million in 2013 and achieves a 6.4% after-tax margin this performance would translate to a profit of nearly $7.7 million. On a post-offering six million fully diluted shares, this hypothetical performance would equate to a valuation of about $1.28 per share. Pre-acquisition, for the trailing six years, Schiff Nutrition traded at an average P/E of 16. At that multiple, MusclePharm would achieve a market cap of $123 million-equating to a share price of $20.50 at a reasonable 1x sales. MusclePharm’s profile, however, is far different from Schiff’s. MusclePharm is in a very fast growing niche of specialized supplements promoting high performance as well as healthy living while Schiff is in a more slow growth traditional vitamin market. So why then was a British conglomerate eager to pay five times sales and compete in a bidding war with German Pharmaceutical giant Bayer AG for the prize of the lumbering Schiff Nutrition? The answer probably lies in the operating synergies gained from simply adding the Schiff product lines into their already existing distribution and fulfillment systems while concurrently slicing or eliminating significant percentages of Schiff’s own system. The planned synergies from the acquisition, assuming they can be achieved, may make this deal accretive for Reckitt in as few as three or four years…..which brings us back to MusclePharm.

Mr. Pyatt has a stated goal of reaching $500 million in sales. I predict that, within three years, if MusclePharm can reach revenues of $200 million and maintain after-tax profit margins of 5-8 percent the company will attract the attention of some of the giant suitors in the consumer products space. Coca-Cola (KO) or Pepsi (PEP) might easily pay several times revenues for a product that could easily be put in their distribution systems. This is the same economies of scale argument I made above. A company like MusclePharm could also grow faster under the global umbrella of a KO. Also manufacturing costs for MusclePharm would likely fall with Coca-Cola as payment guarantor. With MusclePharm as a $200 million company, it would signal to a buyer that they have a firmly established brand and are likely here to stay. Another possible marriage partner may be the smaller Dr. Pepper Snapple Group; market capitalization –wise, it is less than a twelfth the size of Pepsi and a twentieth of Coca-Cola. Perhaps they might pay more as the acquisition could “move their needle” more quickly, meaning it could show up more meaningfully in their earnings sooner than in the financials  of behemoths KO or PEP. If an acquirer paid three time revenues on $200 million, this would equate to a purchase price of $600 million or $100 per share on the current base of six million shares. In three years, assuming management awards stock options I assume will be granted, let’s predict that there are 6.4 (hopefully fewer) million shares outstanding, so the buyout price now gets reduced to $93.75 per share.

What Can Go Wrong

When the share offering was first announced, MSLP spiked from a little over $4 per share to nearly $8.00 in fewer than ten trading days. The stock has since settled in the $5.50 range. The hype is over, and shareholders rightly are now waiting to see whether this commitment to profitability is the real deal. There is always a chance that Mr. Pyatt can’t show the discipline necessary to make the company into a sustaining cash flow generating business. Additionally, maybe MusclePharm turns into a passing fad. Right now as lead nutrition supplier for the red hot Ultimate Fighting Championships, MusclePharm with its highly visible logo is everywhere in the media, so brand awareness is high. Many a high flying brand has crashed and burned with frightening speed. Also, the supplement business is very competitive and new innovations and claims of better mousetraps are always trying to knock the top dog off the pedestal. In my conversations with Mr. Pyatt, his confidence is palpable…..but actions will speak louder than words. Good luck to him.

Disclaimer: I have no positions in MusclePharm , but have not ruled out purchases in the future.

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