The Alkaline Water Company Inc. (OTCQB: WTER)

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The Alkaline Water Company Inc. (OTCQB: WTER)
Coca-Cola, Dr. Pepper’s New Deals Imply WTER Stock Trading At 80 Percent Discount to Fair Value
Coca-Cola just valued ‘Suja’ at 7.1x sales, while Dr. Pepper Snapple Group put a 5.7x sales multiple on an
investment in ‘BodyArmor’, a sports-drink maker. The Alkaline Water Company (WTER), which is the
only publicly-traded maker of bottled alkaline water, is trading at just 3x trailing twelve month sales and 1.4x
projected sales for fiscal 2016.
In fiscal 2015, WTER grew sales 570% and anticipates growth to top 170% this current fiscal year.
If WTER were valued in line with peers, we believe fair value would be 5x current market price.
Coca-Cola (KO), PepsiCo (PEP), and Dr. Pepper Snapple (DPS) – or ‘The Big 3’ as they’re also known – missed
the forest for the trees with carbonated drinks and are scrambling to acquire fast-growing non-carbonated
beverage makers. Paying 7.1x and 5.7x sales for Suja and BodyArmor, respectively, are just the most recent
examples of the premiums The Big 3 will pay for future growth.
Bottled water is the fastest growing beverage segment – and by extension alkaline water may be the fastest
growing sub-segment. We believe WTER is 12-18 months away from posting sales that would indicate they
are the leader in the alkaline water vertical and potentially attract investment or an acquirer at a substantial
premium to where its shares currently trade.
The Big 3 Missed The Forest For The Trees
In a recent article, The Wall Street Journal wrote that the world’s largest beverage companies – Coca-Cola,
PepsiCo, Dr. Pepper - are unprepared for the generational shift taking place in their industry, a shift towards
healthier options and away from carbonated soft drinks where their product portfolios are heavily
concentrated.
Figure 1: Consumption of Bottled Water Will Overtake Soda by 2017
Financial results from The Big 3 support this thesis; soft drink consumption is down and consumers have long
been shifting to non-carbonated drinks like teas, bottled water and juices. Other losers include mid-caps
SodaStream (SODA), in the midst of a transition from soda-maker to sparkling water, and Green Mountain
(GMCR), whose focus on cold beverages has forfeited market share to Heinz, JM Smucker and Starbucks.
Figure 2: Growth Coming From Non-Carbonated Drinks
Consolidation among beverage companies is akin to what’s going on with food giants. Kraft (KHC) controls
80% of packaged macaroni and cheese sales and Heinz controls 60% of ketchup sales. United, the Kraft Heinz
Company will bring in $22.2 billion in sales. Similarly, Coca-Cola (KO), PepsiCo (PEP) and Dr. Pepper Snapple
(DPS) dominate beverages with nearly 90% market share. This explains why whenever a small company gains
traction with a [beverage] product, one of The Big 3 – Coke, Pepsi or Dr. Pepper - usually ends up acquiring
it, and paying a hand and a leg for continued dominance.
From an investors’ point of view, growth in mega-cap companies like Coca-Cola will never be proportionate to
a small, fast-growing independent beverage company because of sheer size difference. Therefore, risk-tolerant
investors can anticipate greater alpha – or return on invested capital – if the independent beverage company
they’ve invested in grows to own a few percent of a burgeoning beverage segment, eg. alkaline water. Suja,
BodyArmor, VitaminWater, and countless others serve to illustrate the point that between The Big 3 – who
have amassed $27B in cash – paying 5-7x sales to avert a competitive threat to their 90% market share is
an afterthought.
Investors who capture the arbitrage between what an acquirer would potential pay to own a fast-growing
beverage name, say 5x sales, and what the market has valued that name at, say 3x sales, could potentially
exploit a market inefficiency – or a temporary period where the market has got the valuation absolutely wrong.
We believe this is the case with WTER.
Coca-Cola Pays 7.1x Sales for Suja; Same Deal Would Value WTER 100% Higher At Current Price
Coca-Cola invested $90 million in exchange for 30% of Suja, an organic juice maker, as part of a deal that
will give the drink giant a path to ownership in three years. CEO Jeff Church says the cold-pressed organic
juice segment is a $2B market; Nielsen says beverages sold in the produce section rose 13% since July 2013.
Suja was launched in 45 stores in Southern California during the fall of 2012. Three years later, the brand is
sold in approximately 10,000 outlets, with exclusive products offered at retailers Target, Kroger and Costco.
Suja’s 2015 revenues are expected to come in at $80-$90M, which would only account for ~5% of the overall
cold-pressed juice market. With their nationwide distribution network, Coca-Cola could maximize upside in
the cold-pressed juice market and add a fast growing product in the pipeline.
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Figure 3: Suja Revenue Growing Triple Digits
Coca-Cola valued Suja at $300M, which would mean the giant paid 7.1x 2014 sales and 3.5x forward 2015
sales. If WTER were valued in line with the same multiples, the company would trade at $0.20 – a 100%
premium to current price - based on fiscal 2015 sales and $0.26 based on fiscal 2016 sales - a 160% premium
to current price.
DPS Pays 5.7x Sales, After BodyArmor Clinches 1.5% Market Share
Gatorade had a 77% share of the $6.81 billion sports drink market in 2014; Powerade held 20%, according
to Euromonitor. To stay competitive with the other two beverage giants, Dr. Pepper Snapple paid $20 million
for an 11.7% stake in BA Sports Nutrition, the maker of sport drink BodyArmor. This suggests BodyArmor has
roughly 1.5% share of the sports drinks market and growing thanks to sponsorship from superstars like Kobe
Bryant (basketball), Mike Trout (baseball) and Andrew Luck (football).
Figure 4: BodyArmor Sales Doubling Every Year since Launching
DPS started distributing BodyArmor in 2013 through its network in New Jersey and Northern California. The
beverage is now sold in about 25,000 stores and 40 states, but should be available nationally in twice that
many stores next year as Dr. Pepper Snapple ramps up distribution.
DPS’ investment valued the maker of BodyArmor at $171M, meaning the company warranted a valuation 5.7x
2014 sales and 1.7x expected 2015 sales. Dr. Pepper anticipates that the strategic distribution network will
continue driving growth for BodyArmor as demand rises with increased sponsorship from professional athletes.
Ramp In Store-Count, Market Share Increasingly Make WTER A Compelling Acquisition Target
In 2001, the enhanced water category, eg. VitaminWater, Propel, had sales of $67.5M. By 2012 sales were
$1.48B, a 32% annual growth rate.
Alkaline88 – WTER’s flagship brand - one of the fastest growing products in the value-added water space,
reported a 164% increase in sales year-over-year (YoY) to $1.5M for the quarter ended June 30, 2015. This
jump was due, in part, to expanded distribution of Alkaline88 across the US to an estimated 17,500 retail
locations. Distribution is expected to top 25,000 stores by March 31, 2016. Figure 5 (below) shows the
correlation between store expansion and sales growth for WTER.
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Figure 5: Rapid Store Count Expansion Buoying WTER Sales
Like Suja, Alkaline88 gained a foothold in Southern California and then began expanding eastward. WTER’s
flagship product is growing at the storefront at a rate of over 700 stores per month, according to the
Company.
Figure 6: Three Consecutive Years Of Triple-Digit Growth Suggest Growing Demand For Alkaline88
WTER recently completed a successful road show with Costco in Northern California. Logic follows that as the
top-selling alkaline water brand in Southern California, Costco took an interest in expanding the product’s
geographic reach. Our thinking goes that successful sell-through at a handful of Costco locations will translate
to this national retail chain (and others) eventually filling orders for all of their 483 U.S. stores. Certainly this
would indicate strong sell-through and a bright future for WTER’s Alkaline88.
If Coca-Cola Bought WTER, It Would Pay 5x Current Share Price
We previously wrote that if Coca-Cola acquired the Alkaline Water Company – WTER – it would pay at least
5x what shares are currently trading at. This is based on a laundry list of acquisitions in the beverage space
that have commanded valuations of 3.5x to 11.7x sales, as illustrated in Figure 7 (below). The Suja and
BodyArmor deals are evidence that even in 2015, 6x-7x sales is a reasonable price for The Big 3 to pay for
continued market dominance.
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Figure 7: Fast Growing Companies Have Been Taken Out at 6.7x Sales;
Same Multiple Values WTER 400% Higher Than Current Price
The lion’s share of the $1.48+ Billion enhanced water category is dominated by Coca-Cola’s VitaminWater and
Pepsi’s Propel and SoBe Lifewater brands. If BodyArmor serves as a baseline, WTER’s Alkaline88 would only
need to penetrate about 1.5% of this [$1.48B] market in order to get into the range that catches the attention
of either Coca-Cola, PepsiCo or Dr. Pepper. At current growth rates, the company is on track to hit $20+M in
sales (~1.5% of enhanced water category) by the end of calendar year 2016.
As WTER’s brand continues to grow in the storefront and gather market share, investors can capture upside
from the disconnect between the 1.4x forward sales multiple the market has assigned WTER and the 6.7x
sales multiple The Big 3 have continuously demonstrated to be willing to pay.
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Legal Disclaimer: This research note has been prepared by One Equity Research LLC on behalf of The Alkaline
Water Company (the "Company") as part of research coverage services. One Equity Research has received
1.5 million restricted shares of common stock from the Company and expects to receive an additional 1.5
Million restricted shares as consideration. In addition, One Equity Research has received twenty nine thousand
nine hundred fifty five dollars from LP Funding LLC, a shareholder and consultant to the Company, for coverage
of The Alkaline Water Company as of the date of this note and expects to receive fifteen thousand dollars per
month from the Company for ongoing coverage. As of 10/4/2015 LP Funding has sold 722,500 shares of WTER
and may continue to sell shares without notifying One Equity Research. This research note is not an offer or
solicitation to buy or sell the securities of The Alkaline Water Company. The note is for information purposes
only, and is not intended to (and is provided explicitly on the condition that it not) be used as the sole basis
to make any investment decision. Investors should make their own determinations whether an investment in
any particular security is consistent with their investment objectives, risk tolerance, and financial situation.
Please read our full disclaimer at http://www.oneequityresearch.com/terms/
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