Muscle Pharm Corporation (MSLPQ)

[The Rainmaker]

Why MusclePharm Could Go From $4 To $20

http://seekingalpha.com/article/1072661-why-musclepharm-could-go-from-4-to-20

Disclosure: I am long MSLPD.OB. (More...)

MusclePharm (MSLPD.OB) develops, manufactures and sells high-tech sports nutrition products. Judging by the popularity of MusclePharm's products, this company could become a leader in the $25 billion sports nutrition market.

In 2011 MusclePharm grew revenue 437%. I estimate revenue growth for 2012 to be over 500%. MusclePharm is getting near profitability, and I expect the company to earn at least $1 per share in 2013, primarily due to reducing costs and increasing margins.

I believe the share price will double once Wall Street becomes aware of MusclePharm's fundamentals. If the company's Q1 2013 EPS numbers are anywhere near my $.10 estimate, investors should realize a 3X gain from today's shareprice. I have been aggressively accumulating shares.

Customers rave about MusclePharm's products

When I began researching MusclePharm, the first thing I wanted to know was whether or not the company's products actually worked. I began by googling MusclePharm's most popular product, Assault, an effective and entirely safe pre-workout formula.

According to the company's research team, Assault can promote increases in strength, muscular endurance, energy, choice reaction, and agility while decreasing fatigue in healthy men. That's quite a claim, but when I read the reviews, most customers confirmed that the product worked. On the bodybuilding.com website there are over 3000 Assault reviews, and the average rating is 8.6 out of 10.

Here is what customers say about Assault.

I noticed an increase in strength, also increased stamina for sprinting exercises. I was faster and more focused. There's no question about whether the product worked for me. For me it was an effective product for an increase in energy, focus, stamina, speed, and strength.

After trying about half a dozen pre workout powders and energy drinks I found that Assault works the best for me hands down. The energy is long lasting and clean, no harsh crashes at all which was a welcome change after using some of the more hardcore products like 1mr and jack3d. Focus on Assault was awesome...I found that after 6 weeks of training on it I was not losing any muscle mass but dropping weight, and my lifts were actually INCREASING. Great all round product. I will definitely be getting this on my next order and probably trying some other MP products like Shred Matrix.

I have tried almost every pre-workout supplement on the market....Jack3d, N.O. Xplode, 1MR, SuperPump, Black Powder, Amino Energy, & NaNo Vaper just to name a few, and none compare to the combination of energy, focus and pump that Assault provides.

In my research I discovered that quite a few professional athletes are using MusclePharm's products. These guys depend on strength, agility, and endurance for their livelihood, and for me, their endorsements provide strong confirmation about the effectiveness of the product.

Baseball player, Bobby Parnell from the Mets started using MusclePharm supplements when he noticed that other players were during spring training. "It's a nutritional supplement that a lot of guys are taking now," Parnell said earlier this season. "A lot of guys are talking about it right now. It's the new thing."

Other pro-athletes using MusclePharm's products include Nick Swisher from the New York Yankees, Bryce Harper from the Washington Nationals, 49ers All-Pro Patrick Willis, and NBA star Roy Hibbert.

Last year, MusclePharm announced that it will serve as the official nutritional supplement supplier of the UFC® (Ultimate Fighting Championship) in the U.S. and Canada. This relatively new sport has surged in popularity, and in terms of viewers worldwide, rivals many major league sports events. This provides a good opportunity for MusclePharm to gain significant product exposure.

MusclePharm has six full-time scientists and one full-time medical doctor who do all the clinicals. From my investigation, it appears the company has developed safe, science-based products that do actually work. But if you think about it, MusclePharm would not be growing revenue at 400% annually unless customers really liked the products. The next thing I wanted to know was whether or not the company could make any money.

Impressive revenue growth

MusclePharm has been growing revenue at over 400% annually, but for my estimates, I am going to assume a more conservative future growth rate of around 50%. Here are past revenue numbers, and future estimates.

2010 revenue: $4 million

2011 revenue: $17 million

2012 revenue: $75 million (estimate)

2013 revenue: $110 million (estimate)

Right now MusclePharm only has about .3% of the $25 billion sports nutrition market. This is a wide-open field which the company has barely begun to penetrate. Ultimately, MusclePharm products could be sold worldwide into many new venues including the following:

Wal-Mart
Cosco
Convenience stores including 7-Eleven
Amazon
Health clubs
Sporting good stores
You get the picture. My point is that MusclePharm's strong growth should continue for the next few years given these many untapped opportunities.

Profitability should begin next quarter

In my opinion, the combination of strong revenue growth and increased margins as a result of cost-cutting will make profitability inevitable. I expect MusclePharm to generate at least $.10 per share next quarter, and over $1 per share for 2013.

2013 margins should increase by at least 10%.

Management appears to be intensely focused on near-term profitability and has been taking aggressive steps towards reducing costs, improving margins, and cleaning up the balance sheet. Here are the reasons I believe margins will increase significantly in 2013:

Number one: MusclePharm recently hired two executive heavyweights, CFO Gary Davis, and COO John Bluher (Prudential Securities, Janus, Neuberger Berman). One of the first initiatives was to cut management's salaries and bonuses from 12% of revenue down to 6% of revenue. It's unusual for management to reduce its own compensation, and this action demonstrates a commitment to profitability. Perhaps the most important aspect of this move is that management is now even more focused on share price appreciation, since net worth is now primarily tied to the share price, rather than salary.

Number two: Now that the company's revenue is reaching $75 million annually, MusclePharm will be able to negotiate significantly lower priced volume-based manufacturing deals.

Number three: If the company eliminates all debt as a result of a financing (explained below), interest payments will go to zero.

I expect at least 8% net profit for 2013

With MusclePharm's rapidly growing revenue stream and a 10% improvement in margin, the company should achieve a minimum of an 8% net profit for 2013. MusclePharm has reached the point where rapid growth and margin improvements should translate directly into earnings-per-share.

Solid EPS should begin next quarter

Once we start calculating EPS numbers, the story gets really good. With an expected 6 million shares outstanding, 8% net profit, and a P/E of 15, 2013 numbers look like this:

2013 revenue: $75 million
2013 net profit: $8.8 million
EPS: $1.46
Shareprice: $21.90
A near-term financing would benefit shareholders

In general I'm not a big fan of financings, but in this case I think a 100% equity-based financing would benefit MusclePharm and its shareholders for the following reasons:

Number one: The increase in shareholder equity should allow for a NASDAQ listing.

Number two: The company could wipe out all remaining debt, which would eliminate interest payments, thus increasing margins.

Number three: If the company announces a financing, there could be an SEC filing in which the company gives guidance for 2013 profitability. This would provide a positive near-term catalyst for the share price.

Although I don't know whether or not the company will take this step, I am basing my numbers on the assumption of a financing that increases the share count from today's 2.7 million shares to 6 million shares. I would expect this to happen within the next two or three weeks because I see no benefit in delaying an action like this. As a shareholder, I hope management takes this step.

Sports nutrition is big business

In 2010, retail sales of sports nutrition products reached almost $19 billion. In 2011, sales rose 14%, to $21.4 billion. 2012 sales are expected to top $25 billion. Now that it's considered hip to be fit, this growth trend should continue and could accelerate.

How big could MusclePharm get?

If Muscle Pharm can continue to grow revenue at a rate of 50% annually, within five years, Muscle Pharm will have captured about 2% of the $25 billion market, or $500 million. That would give the company a net profit of $40 million, an EPS of $6.66 per share, and a shareprice of $100.

Can that happen? It all depends on whether or not management continues to execute as they have. This is a strong sector that will turn in impressive double-digit growth figures for the next decade, and MusclePharm could definitely become one of the leaders.

Sports nutrition company buyouts on the rise

Over the past couple of years, there have been a dozen or so buyouts of sports nutrition companies, for an average of 2.3 times sales. But this is a low figure compared to England-based Reckitt's recent offer to buy Schiff at about 4.5 times sales, or 28 times EBITDA.

What is MusclePharm worth today in a buyout scenario?

If we take 2012's estimated $75 million revenue, and multiply it by 2.3, we get a buyout figure of $172 million, or $28 a share. If we base it on 2013's $110 million revenue estimate, we get a valuation of $253 million, or a shareprice of $42.

Given its rapid growth rate and anticipated margin expansion, I personally hope the company can hold on and develop its business for at least two more years, potentially putting buyout offers above $50 a share.

Who could buy MusclePharm?

I would like to buy this company. But since I can't afford the whole company, I am buying shares on the open market. Here are the most logical contenders who could benefit from owning MusclePharm:

From the pharmaceutical side, I see Unilever (UN), Novartis (NVS), Glaxo SmithKline (GSK), Johnson & Johnson (JNJ), Abbott labs (ABT) and Pfizer (PFE) as definite potential acquirers. Any of these companies could benefit from MusclePharm's strong brand name and the company's robust revenue growth. I believe the major pharmaceutical companies are well aware of the explosive growth of sports nutrition products, and this would be an ideal time to enter that market.

On the other hand, Pepsi (PEP) and Coke (KO) could get into a bidding war given their respective competitive positions with Gatorade and Powerade. Pepsi obviously has the lead with Gatorade, but Coke has been trying to gain a foothold with its product, Powerade. In 2011 Coke took another direction and made a play for Monster Beverage Corporation (MNST), but was unable to solidify a deal.

Right now both companies are looking for an edge. I can see Coke making an offer and then Pepsi making a counter bid. Since MusclePharm appears to be producing higher-quality and more science-based products than Gatorade or Powerade (just my opinion), I believe either Coke or Pepsi would gain significant market advantage by acquiring MusclePharm.

And of course with Monster Beverage Corporation sitting on over $500 million in cash and no debt, it could also make a play for MusclePharm. This is all based on my theory that MusclePharm will be coming out with a product that competes directly with Gatorade, Powerade, and Monster's products. Why wouldn't they? A move like this would definitely increase the likelihood of buyout offers.

And then we have Herbalife (HLF) which launched its new sports nutrition lineup about 18 months ago. By my calculations, Herbalife's sports nutrition products will be bringing in over $200 million next year. That's pretty impressive for a startup division. Herbalife only has 7 products now, and I imagine the company would love to own MusclePharm's 20 products. Also, as MusclePharm grows, it will continue to take more of Herbalife's market share, giving Herbalife even more incentive to acquire MusclePharm.

Risks for investors

The big risk is that I am wrong about management's ability to achieve near-term profitability. If the company continues to grow revenue without showing a profit in the first half of 2013, the share price could languish in the $4 to $6 range. Or perhaps the company will not do another financing (big mistake), and won't obtain a NASDAQ listing. This wouldn't be a deal killer, but it would put pressure on the share price.

Another risk comes as a result of MusclePharm's extremely high growth rate. The company's manufacturers could have trouble getting enough raw materials to meet MusclePharm's needs. Delayed shipments could mean delayed profits, which could negatively impact shareholders.

Conclusion

It's rare to find a company that presents such strong upside potential within such a short time frame. If I am correct in my assumptions, and the company provides 2013 profitability guidance, investors will be rewarded. This could happen in a couple of weeks, or in Q1 of 2013. A NASDAQ listing could occur in early February, which would also provide a positive catalyst for the share price.

Right now, the downside is limited, because the shares are so undervalued in relation to revenue growth and probable near-term profitability. This is a $13 million company, with sales of $75 million a year. That's crazy. I see MusclePharm as an ideal asymmetrical trade; low risk with huge upside potential.