Sodastream Stock: Identifying Poor Investments Ahead of Time

I never caught the bug to write glowing reviews about Sodastream (SODA) stock when it became fashionable during the 2011-2013 stretch that saw the price of its stock rise from $23 to $79. At the time, it had quickly grown its annual profits from $13 million to $43 million by selling $80 beverage carbonation systems that turn tap water into a carbonated soft drink that gives you about a dozen choices to mimic the soda offerings of Coca-Cola, PepsiCo, and Dr. Pepper.

Just three years later, the price of the stock has come down $36 and the $43 million profits have come down to the $23 million range. What insight would have made it possible to determine, in advance, that Sodastream was a passing fad rather than a rising insurgent capable of challenging the tri-opoly of Big Soda?

For me, the ex ante insights are two-fold:

First, you should be wary of do-it-yourself products that attempt to displace a product that already sells at a cheap price. You can get a Dr. Pepper or a Cherry Coke for a buck or two. This is not a significant enough of an expense that merits an alternative. Maybe a family of five might contemplate splitting a two-liter of Coke at home rather than ordering soda at a restaurant, but other than that, soda is not the type of expense that most customers are going to mitigate in their lifestyles.

If someone chooses not to drink soda, it is going to be a health-driven decision more than a financial one. Soda volumes aren’t going down by 2% each year because people don’t have $1.49 to give; it is because they want to put up some resistance against obesity and diabetes. For that reason, Sodastream was offering a solution to something that the market didn’t identify as a problem. Instead of becoming a cheaper alternative to soda, it should have tried to become a healthier option (which, given that the soda companies spend almost a billion dollars per year on this very problem, any startup would have its work cut out for it.)

Secondly, it cost $80-$120 to set up sodastream as an alternative to soda. For $80, you could purchase 80 2-liters of soda for $1 at Wal-Mart. That’s about 42 gallons of name-brand soda for the same price as Sodastream.

And, here is where Sodastream ran into difficulty. Customers can buy two-liters in increments of $1 a piece. That’s a very low cost that lets you buy what you need, as you need it. An $80 investment seems extreme when presented as an alternative to a status quo that lets you make purchases in $1 increments.

An insurgent business looking to overtake entrenched competitions must do one of two things: (1) offer the product at a lower price, or (2) offer a superior service. With Sodastream, the service is a knock-off of the big players that have established themselves since the beginning of the 20th century. Therefore, any avenue for success had to be through a lower price. Sodastream’s vision for success on this was too attenuated. Even for someone with a daily soda habit, it could take close to a year for Sodastream to become cheaper than the path of purchasing two liter Coca-Cola sodas. Given that the status quo is inexpensive, and the money-saving route requires a high upfront cost that takes a while before the cost savings materialize, the business model was doomed from the start.

On the flip side, this is why I cover stocks like Colgate-Palmolive and Hershey frequently on the site. They have large economies of scale, making it hard to compete on price. They are already cheap, making the demand for an alternative product minimal. And it is very difficult to make a superior toothpaste or chocolate that can also be sold in the $1-$3 range. When you think through what it takes to displace the status quo, you can see why Sodastream struggled. It would have been a far more potent competitor to Coca-Cola if, say, Dr. Pepper had acquired Sodastream and gave away the machine “for free” in exchange for a one-year service contract to receive $10 shipments of Dr. Pepper syrup each month.