With more closings expected over the next several weeks for MusclePharm’s offering, I took things a step further and had conversations with company founder Brad Pyatt. It turns out Mr. Pyatt has recognized the exigencies of his situation and is acting proactively and taking a number of positive steps.
The current secondary offering by MusclePharm took some courage for Mr. Pyatt to stomach. It will ultimately increase outstanding common shares from just less than three million to likely six million fully-diluted shares outstanding. They are effectively trying to sell fifty percent of the company for approximately $12 million. Mr. Pyatt’s pro rata share of the company ownership will be reduced by half. It is a sagacious manager who can realize that it is better to own a smaller piece of something potentially very large versus a bigger part of a capital constrained smaller entity. And big this company may become. With revenue growth consistently in the double-or triple-digit range and 2013 sales likely to exceed $100 million, MusclePharm could quickly become a dominant player in the supplement market. The company’s distribution system to achieve these figures is already in place. Currently, MusclePharm products are sold in 120 countries and 10,000 U.S. retail outlets with a goal of reaching 20,000 in the next 16 to 24 month. Large national chains like GNC, Dick’s Sporting Goods, and Vitamin Shoppe as well as over 100 online stores such as Amazon.com, Bodybuilding.com, GNC.com, Vitacost.com, SupplementWarehouse.com, and LuckyVitamin.com to name but a few, all carry the a full line of the MusclePharm’s product line.
The most important take-away to come from my conversation with Mr. Pyatt was his plan to rapidly turn MSLP to a profitable enterprise. With sales that should exceed $100 million in 2013, Muscle Pharm has achieved enough scale to renegotiate supply deals with their manufacturers. In 2012, overall gross margins averaged 17%. More favorable terms in 2013 could easily raise this figure by over 50% adding millions to the company’s bottom line. Mr. Pyatt also has the opportunity to reduce executive salaries and otherwise begin the process of lowering costs to improve margins. Cutting salaries is a breath of fresh air that to me indicates management is aligning interests with shareholders. MSCP recently leased a 152,000 square foot distribution center in Tennessee located in proximity to their manufacturers, giving the company complete control over product fulfillment. Previously, the company was dependent on third party for deliveries which often led to bottlenecks resulting in inefficiencies. Ability to ship quicker, translates into faster sales cycles or more inventory turns resulting in lower costs and more product out the door.
The proceeds from this equity offering will restore MSLP to financial health. $7 million will be used to pay off all debt and accounts payable. The balance sheet, henceforth, will be in pristine condition. Other uses of funds will be for international expansion and to increase the US sales force. Any residual will be for working capital purposes. Other shareholder friendly measures have been completed. During 2012 99% of all outstanding warrants have been converted leaving less than $20,000 of these derivatives on the balance sheet. Fully diluted share count for year end 2012 should be about 3 million. Mr. Pyatt has made a commitment to avoid any future dilutive derivative transactions. Finally after an earlier reverse split, the company is eligible for and has applied to be listed on the NASDAQ exchange. The company believes, and I think rightly, that an apporved NASDAQ listing will give them more exposure to institutions both as potential buyers of MusclePharm stock and for research coverage.
So what could a company in a fragmented industry with few publicly traded companies available for comparison be worth? There has been one recent transaction that provides valuable data for reasonable assumptions. In November 2012, Schiff Nutrition International signed an agreement to be acquired by British based consumer-products maker Reckitt Benckiser Group for $1.4 billion, outbidding German drug and chemical maker Bayer AG. Latest twelve months revenues for Schiff were $285 million which equates to a purchase price of almost five times sales. This metric is probably not appropriate for Muscle Pharm at this time given its current lack of profitability. Schiff had five year average gross margins of just under 41%. Even more relevant they registered average five year pre-tax margins of 10.1% and net profit margins of 6.4%. If, and it means if, MSLP registers $120 million in 2013 and achieves a 6.4% after-tax margin that would translate to a profit of nearly $7.7 million. Pre-acquisition, for the trailing six years, Schiff Nutrition traded at an average P/E of 16 times. At that multiple MusclePharm would achieve a market cap of $123 million equating to a share price of $20.50 at a reasonable 1x sales. In the past week, it should be noted the stock rallied $$2.30 or over 57% to close at $6.30 on news of the success of the share raise and Dr. Frost expressing his optimism with his pocketbook.
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