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MusclePharm: Fast Growing Small-Cap With 100%+ Upside Potential

June 06, 2014 | About:
Shadow Stock

Boris Marjanovic

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MusclePharm (MSLP) is a fast growing nutritional supplements company currently trading at a substantial discount to fair value.

Once the stock gets uplisted to NASDAQ later this year and begins receiving more analyst coverage, the shares will likely move higher.

The company is also a strong acquisition target as a result of continued industry consolidation, there is a high probability it will get acquired at a significant premium within the next 12-18 months.

Overall, I believe MusclePharm is an asymmetric risk/reward opportunity with 100%+ upside potential.

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Business Overview

MusclePharm Arnold Schwarzenegger Series Supplements

MusclePharm Arnold Schwarzenegger Supplements

MusclePharm develops, manufactures, markets, and distributes nutritional supplement products for athletes and other health-minded individuals.

The company’s product portfolio consists of more than 30 products sold under three different company-owned brands: MusclePharm Hybrid and Core Series (targeted towards athletes), Arnold Schwarzenegger Series (bodybuilders), and FitMiss (women).

MusclePharm Supplement Products

MusclePharm products are sold in more than 110 countries and available in over 35,000 retail outlets globally, including Dick’s Sporting Goods (DKS), General Nutrition Centers (GNC), Vitamin Shoppe (VSI), and Vitamin World.

The company was founded in 2008 and listed on the OTC exchange in 2010.

Management Team

CEO, President, and Chairman Bradley Pyatt founded the company in 2008 along with business partner Cory Gregory (Vice President).

Mr. Pyatt has more than 15 years of experience in the sports fitness and nutrition arena. He studied kinesiology exercise science at the University of Kentucky and later played in the NFL for teams such as the Indianapolis Colts and Miami Dolphins.

Mr. Pyatt owns roughly 2.5% of the company, and all directors and management as a group (nine persons) own about 6%.

Although I like what management has done with the company in recent years, I do think that the executive compensation is somewhat excessive.

Mr. Pyatt’s total compensation in 2013 was $4.4 million, and the total key executive compensation (seven persons) was nearly $16 million (~14% of revenue).

However, given that over 80% of this compensation was in the form of stock awards, it does give management some skin in the game because it allows them to participate on the downside.

Extraordinary Growth

According to the Nutrition Business Journal, the nutritional supplements market in the U.S. was estimated to be roughly $31 billion in 2013, and is projected to grow at 6-9% annually through 2017.

Moreover, although global data is not readily available, it is estimated that the global nutritional supplements market exceeds $100 billion.

The market has reached its present size due to a number of factors, including increased interest in health and wellness, increased awareness of the health benefits of dietary supplements, a growing population of older adults, successful new product introductions, and a trend towards preventative measures and healthy living.

I believe MusclePharm is well positioned to benefit from these favorable trends in the nutritional supplements industry.

During the last several years, MusclePharm has been among most popular and fastest growing supplement companies in the world.

Its annual revenue growth exceeded 200% over the last three years, reaching $111 million in 2013.

Even more impressive, MusclePharm’s growth shows no signs of slowing down.

The company’s 1Q14 results blew away all expectations, causing management to raise its full-year 2014 revenue guidance by nearly 17% to $175 million.

Figure 1: Revenue Growth Trend (2010-2014)

Figure 1: Revenue Growth Trend (2010-2014)

Source: Blitzkrieg Capital and company reports

Management’s long-term goal is to turn MusclePharm into a billion dollar supplement business.

In order to achieve this, the company will continue introducing innovative new supplements to drive future growth. Currently the company has 10 products in development, some of which will be launched in late 2014.

One of these new products is the DROPZ energy drink that will be sold in convenience stores across the country.

DROPZ is a healthier alternative to other energy drinks on the market today and will likely be a huge success.

MusclePharm is also attacking the ready-to-drink market with its new Coconut Protein Water, which will mainly be sold at Costco (COST).

Moreover, the company’s new Arnold Schwarzenegger supplement line (seven products) has been the most successful supplement launch in the industry’s history.

It already makes up nearly 30% of revenue, and I expect it to contribute 45-50% once it begins being sold at Costco and other major retail outlets.

MusclePharm’s growth will likely slow down going forward, but I believe the company can still achieve a long-term annual growth rate in the 15-20% range.

At this rate, the company will likely achieve its $1 billion in revenue goal within a decade.

Superior Marketing is a Competitive Advantage

MusclePharm’s spectacular growth can mostly be attributed to its superior marketing strategy.

The company’s special partnerships with the UFC and Arnold Schwarzenegger exposes the brand to millions of potential customers around the world.

The UFC, for example, is broadcasted in over 150 countries and territories (~820 million households), giving the MusclePharm brand an enormous amount of exposure that few competitors can match.

The company’s marketing advantage was further strengthened with its recent partnership with bodybuilding and fitness icon Arnold Schwarzenegger.

This new partnership allows the company to create products that will appeal to a larger market than previous MusclePharm products.

In addition to these two partnerships, MusclePharm has sponsorships and endorsements with other athletes and sporting organizations.

All of this gives the company one of the strongest marketing advantages in the entire supplement industry, and this will likely continue to be the main growth driver going forward.

Stock Significantly Undervalued

MusclePharm achieved profitability for the first time during 1Q14 with net income of $2.7 million compared with a net loss of $7.4 million during 1Q13.

Management expects full-year net income to be roughly $6.2 million (mid-range of guidance), which I believe is a very conservative estimate that the company will likely beat.

Given this improving profitability, I believe the stock is significantly undervalued at the current enterprise value of only $95 million, or 15x estimated 2014 earnings.

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Taking into account the company’s impressive growth and significant potential for margin expansion, I believe the stock could easily support a 30x earnings multiple (still below the industry average).

Adding back $3.5 million of net cash on the balance sheet, we get a fair value of roughly $190 million ($18.00 per share), giving us an upside potential of approximately 100% from the current price.

NASDAQ Uplisting is a Catalyst

MusclePharm’s uplisting was delayed due to an SEC investigation concerning some related-party transactions and certain other disclosures for the periods of 2010-2012.

However, management believes this investigation will be closed out in 2Q14.

Once this occurs, the company intends to uplist its stock onto NASDAQ.

This uplisting will be a major catalyst for the stock because it will result in a significant inflow of new demand for the shares from large institutional investors.

I expect the stock to surge once the uplisting is announced later this year.

Strong Acquisition Target

Apart from the stock being undervalued and the upcoming NASDAQ uplisting catalyst, I believe MusclePharm is a strong acquisition candidate.

Industry consolidation has been a major trend in the nutritional supplements industry over the past decade.

This activity has included

  • Post Holdings’ purchase of Dymatize
  • Reckitt Benckiser’s purchase of Schiff Nutrition
  • Glanbia’s purchase of BSN and Optimum Nutrition
  • Abbott’s purchase of EAS
  • Carlyle Group’s $3.8 billion capture of NBTY, the maker of Nature’s Bounty, MET-Rx, and Solgar supplements

I believe MusclePharm is the next major supplement company that will get acquired.

The company’s spectacular growth, the strong popularity of its supplements, and its exclusive partnerships with the UFC and Arnold Schwarzenegger, make it a very attractive acquisition target for a large conglomerate trying to expand into the fast-growing nutritional supplements industry.

There is a very high probability an acquisition will occur within the next 12-18 months because MusclePharm is among the last major supplement companies that has not bought out, leaving few options left for a potential acquirer.

Additionally, supplement companies that are in the $100-200 million revenue range are the most attractive targets.

Given that MusclePharm will be in the high-end of this range by the end of this year, an acquisition is very likely sometime in 2015.

Historically, supplement companies are typically acquired for about 1.7x revenue.

I believe MusclePharm could fetch a similar amount, implying a fair value of about $300 million (based on estimated 2014 revenue of $175 million).

This is more than a 200% premium to the current market-cap, which further suggests that MusclePharm is substantially undervalued.

Figure 2: Past Acquisitions of Supplement Companies

Figure 2: Past Acquisitions of Supplement Companies

Source: Blitzkrieg Capital, Reuters, and Bloomberg

Key Risks to Consider

Key downside risks to my investment thesis include:

  1. MusclePharm has incurred net losses in the past and may not achieve sustained profitability in the future.
  2. There is customer concentration risk with the company’s top two customers accounting for roughly 29% of revenue in 1Q14. However, this is down from 44% during the same time last year and will likely continue to decrease.
  3. At roughly 14% of revenue, key executive compensation (seven persons) is too high and needs to come down.
  4. The SEC investigation has not uncovered anything serious and will likely be completed in 2Q14, however, if it takes longer than expected it could delay the NASDAQ uplisting.
  5. MusclePharm is an extremely volatile stock, investors who fail to buy and sell at the right time could suffer losses.

Summary and Conclusion

MusclePharm’s robust growth and ramping margins make the stock a bargain at the current market price.

The NASDAQ uplisting later this year will be a near-term catalyst that will propel shares higher.

I believe the uplisting will also increase the likelihood of the company getting acquired by a large conglomerate looking to expand into the fast growing nutritional supplements industry.

Although the stock is somewhat volatile, investors with longer-time horizons are likely to realize significant gains.

Valuation points to upside of 100%+ over an 18-month time frame.

Disclosure

Boris Marjanovic is long MSLP.

This post was first published at old school value.


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