Monday, July 10, 2006

Are We in a Soda Bubble?

As far as sodas are concerned, the little guy is laughing all the way to the bank.

Non-traditional, boutique beverage purveyor Jones Soda (JSDA) -- which designs and distributes alternative beverages in five beverage brands, including WhoopAss, a citrus energy drink, and Jones Naturals, a non-carbonated juice and tea -- has seen its shares pop nearly 100% this year. JSDA's takeoff comes on the heels of another niche beverage player's success, that of Hansen (HANS). Hansen, which makes the Monster Energy drink, is the category leader, with privately-held Red Bull coming in second. We believe Hansen's success stems from its decision to offer twice the energy Red Bull offers (8 vs. 16 oz.), but at the same price point.

Now that Jones is offering its swigs at retail behemoths such as Barnes and Noble (BKS) and Target (TGT), things are getting interesting to say the least. JSDA's revenue rose 27% to $8.8 million in the latest quarter from $6.9 million in the year-ago period. Last week, JSDA did a private placement for $30 million. The surging demand for niche beverages leads us to believe that JSDA will either land bigger deals -- or better -- get acquired.

An acquisition wouldn't be a bad idea.

Jones Soda lacks scale and if it's smart, it'll capitalize on the uber-hip alternative drink category before more competitive entrants emerge (Pepsi and Coke have already crossed the 50 yard line). Furthermore, growing concern over the nutrition of these beverages could escalate and whack shares down; if you don't think concerned moms can crush a stock, think again. Lastly, the energy drink craze is just that -- a fad. It can end faster than NSync's career. We estimate that the energy drink segment has grown at a 80% clip over the last 7 years --- naturally, it will slow down from here on out, until it hits our terminal value of 5% growth. And guess what? 5% is for wimps.

So now is the time for Jones Soda to bust a move, in other words. Our channel checks revealed that 100% juices that offer vitamins and minerals have enjoyed very short shelf lives; demand remains robust and with the critical summer selling season well-underway, it is likely that more customers will test Jones Soda drinks. Similarly, this'll be the time the investment community at large "tests" Jones Soda. From what we can tell, only two analysts cover the stock. Management at JSDA swears its focused on domestic growth/expansion rather than volume per se. Any channel-enhancing deals, akin to the one just signed between Hansen and beer leviathan Anheuser-Busch (BUD) would certainly pique the interest of takeover-minded managers and analysts alike.

With consumers (Gen X'ers, mostly) currently having no qualms about plunking down between $2 and $4 USD for these New Age premium concoctions, now may be a good time for JSDA to link up with a distribution partner, even as "un-alternative" as that may seem. Could Hansen snap up Jones Soda? Possibly. Jones Soda could help Hansen beef up its natural soda product category, which Hansen had no choice but to downplay once its Monster brand took off like a Boeing jet; currently, energy drinks account for 77% of Hansen's sales. Hansen, meanwhile, could help Jones Soda target more than just the "skateboard/teahouse" crowd. Ultimately, we think a deal would enable the 2 firms to leverage their brand equity with customers while augmenting margins and expanding product reach. With nearly $100 million in the bank and barely any debt, Hansen's clearly in the financial position do whatever it please.

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