SODA : Recent thoughts and possible stock manipulation

January 17, 2012

Recently, SODA inked a deal with KFT, in which SODA will begin selling carbonated versions of some of Kraft’s beverage brands, including the Crystal Light and Country Time Lemonade brands. The stock immediately spiked around 10%, probably prompted a rush of short covering, of which I am a tiny part of. I covered because when a stock with a 50% short interest releases positive news, a short squeeze is a very real possibility. Again, I am reminded that shorting stocks is very much a timing game, much more so than being long. Still, I have no complaints, having a profit of around 10% overall from my SODA short because I shorted initially in the upper $40s, despite covering one-third of my position at a loss in the $60s.

My core thesis that SODA is a faddish niche product is, I believe, intact even in the face of the recent announcement. As far as I am concerned, anyone who wants fizzy versions of Crystal Light or Country Time Lemonade can simply add the Kraft powders to soda water instead of paying SODA’s markup as a middleman. It should be noted that SODA’s machine is simply an inconvenient and laborious way of generating carbonated water, easily available cheaply in ready-made form at any supermarket. Of more concern is the fact that Costco has started distributing Sodastream machines. This was of some concern to me, since I believe that the lack of places at which to exchange SODA’s carbon dioxide canisters is a major stumbling block in their bid to reach the mass market. But as far as I can tell, Costco is simply selling the machines and not exchanging the canisters.

In addition, there are some signs that SODA is being manipulated, likely by call writers. For the past several months now, SODA has reached a peak in price in the middle of the month, shortly before options expiration Friday, and then proceeded to decline towards the end of the month, only to begin the cycle again in a new month. Academic research has suggested that stock prices tend to be pinned at a point where the total value of options contracts (both calls and puts) is the lowest, a hypothesis dubbed the Max-Pain theory. Both large and small stocks can be subject to option manipulation; the common factor is avid interest among retail investors, who tend to buy lots of call options at rich premiums for these stocks. Since the major danger in this strategy is that the stock may skyrocket, causing massive losses to call writers, stocks with poor fundamentals are reasonably good candidates for this strategy.

As the stock has now declined to near reasonable prices, I have switched to a more opportunistic mode of trading this stock, shorting highs and then covering at the end of the month.

Disclosure : I have a short position in SODA.

 

{ 2 comments… read them below or add one }

John Hunter January 17, 2012 at 8:03 am

I think there is part of Sodastream’s appeal that you are missing. The product is very popular in Europe and it is not a gimmick nor primarily a cost issue. It is an environmental issue. Europeans drink a lot of carbonated water, not flavored. It is their primary drink at meals, more so than plain water. They are also very environmentally conscious. So they do not like buying sparkling water at stores because of the environmental impact: both in the bottling (even with recycling) and the energy used to transport the water. The first R in Reduce, Reuse, Recycle is not Recycle.

My wife is German and she immigrated to the US about 15 years ago. She loves sparkling water and we used to buy it at the store but she gave it up because of the environmental impact. She was thrilled to get a sodastream and uses it almost daily. She’s also happy to buy the refurbished gas cartridges at $15/per from Bed Bath and Beyond. We don’t buy any of the syrup, but I anticipate we’ll be buying cartridges for some time. Haven’t looked closely enough to see how much the valuation depends on syrup vs gas refills, but I just wanted to point out that part of this market is not fad, nor is it especially price sensitive because for people like my wife, the ecological impact trumps the cost factor every time.

valuegeek January 17, 2012 at 3:48 pm

I do not dispute that Sodastream’s machines appeal to a small segment of Americans, namely the soda afficionadoes and the environmentalists (see my first article on SODA). However, a good product does not necessarily mean a good stock. Cisco makes routers that are highly regarded and crucial to the Internet. In 2000, CSCO traded above $50. Today, CSCO trades at $20, despite sharply higher revenues and earnings. Valuation matters. I am bearish on SODA because its business model is very weak. Its profits from the machines are marginal, the bulk of its profits are from the syrups and carbonators. The syrups are optional. There are cheaper substitutes for the carbonators (again, refer to my original article), and in any case you cannot obtain the carbonators except at Bed Bath and Beyond, which means an extra grocery run per month. Analysts think that sales of the machines will convert into cash flow from syrup and carbonator sales at the European rate. This is likely wrong for the following reasons. 1) Europeans are far more environmentally conscious. 2) Transportation is more expensive in Europe due to gasoline taxes, so bottled sparkling water is more expensive. 3) Europeans have more leisure time and are more willing to spend time pumping gas into water. 4) Most importantly, the European conversion rate are at a peak right now due to novelty. It is likely to decline sharply as competing substitute carbonators kick in, as is already happening in Sweden, and as people simply stop using the machines out of boredom or frugality. Carbonated water is a luxury.

You will note that after SODA’s stock dropped sharply to the $30s in August 2010, short interest did not decline, as would be expected, but instead has more than doubled from 3M short to around 6-7M short, or 50% of float. I haven’t had the time to examine SODA’s latest filings in detail (I will probably do it if SODA ever trades above $45 again), but I suspect that the numbers there will show that the European conversion rate has begun to decline, to the extent that the bears now find SODA a good short even in the mid 30s. In the last 2 years, SODA has managed to fund is cash-consuming expansion via share sales. This has likely come to an end, and in the near future, SODA will face a “show me the money” moment and have to dramatically slow its expansion and start converting its machine sales into cash flow. And then we will see the true rate of conversion. If SODA is relying on environmentalism breaking out in America for a high conversion rate, I think its in trouble.

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