Toeholds, Yogurt, and The One That Got Away: Lifeway $LWAY and Vita Coco $COCO

Watchlist and Wait

Special thanks to

Mexican Investor

for turning me on to Lifeway Foods (LWAY).

While I usually focus on value stocks, one of my PhD advisor’s areas of research was on mergers and acquisitions with a toehold.  A toehold is where a larger company has acquired a minority stake in a company while that company is still small.  For a quick summation of the research, acquisitions where the acquirer already has a toehold stake in the target tend to be much more successful on average than acquisitions without.  

Decades ago, when phones were still attached to walls, I was an occasional customer of the local arcade.  When someone was already playing Street Fighter II or SmashTV, the etiquette at that time was to put a quarter on the machine to let the other person know that you are next in line.  A toehold is a bit like that quarter, other potential acquirers know that someone is already in line to buy this company when the original founder feels that they have done all they want to do with it.  In the meanwhile, who knows how much free advice, research, distribution relationships, etc. that the target gets out of having a big brother to help them expand.  Both companies get to test the relationship in anticipation of the eventual acquisition.  

The larger acquirer has access to plentiful cheap debt, and typically a shortage of skilled executives capable of growing the market for their products organically.  Letting the founder stay in the arena trying things out is usually the best path forward, even at the much higher eventual acquisition price.

When I find a small cap stock with a large toehold, I have to pinch my nose, ignore the fact that the multiples are never really a bargain, and just buy a bit.  This strategy worked well for me with Vita Coco (COCO), about 30% owned by Keurig Dr. Pepper.  When I found COCO at around $9 a share a couple of years ago, my value mindset got the better of me, and I sold it when I thought it was expensive around $13 a share.  Today it sits at $24.35 and a price to earnings ratio of 26.  Even knowing what I know about the success rates of firms with a toehold, it was hard for me to buy a stock at a price to sales ratio of 1.5x, and I was itching to sell it at a price to sales ratio of 2x.  I was able to make a 45% return in a few months, but I missed out on an easy 2.5x as COCO went from a market capitalization of about $450 million to $1.3 billion. 

Lifeway Foods (LWAY), is a kefir drinkable yogurt company with a 24% ownership stake by Danone.  For reference, COCO had been growing sales at about an 11.74% annual rate between 2019 and 2023.  LWAY has grown sales at about an 11.46% annual rate between those same years, although growth was much slower in the decade prior.  

Trying to come up with a terminal value for LWAY, for previous acquisitions by Danone, it looks like they tend to pay an average of 3x revenue, give or take.  LWAY’s trailing 12 month revenue is $176 million, if they grow that at about 10% annually for the next five years, and Danone acquires them for 3x revenue, that would be a 22.4% return for investors who buy the stock at today’s price of $20.91.  Of course I have no way of knowing if Chairman, CEO, president, and daughter of the founder Julie Smolyansky will be done with her vision for LWAY in just five years, but the combination of organic growth and multiple expansion are a fantastic pair, no matter how many years from now the eventual acquisition will be.

On top of that, LWAY has been profitable for the last five years, and has been paying down debt, and retiring just a tiny sprinkling of shares.  Any return of capital to shareholders in the next five years would only add onto that 22.4% base return.  Again assuming Danone eventually acquires LWAY for 3x revenue, and revenues can grow at a 10% annual rate.

With the market at all time highs, there are a lot of stocks that give me the feeling that I am late to the party.  But on a positive note, the odds of a pullback in September and October are very high.  There is a good chance LWAY might go on sale in the next couple of months.  If a potential 22.4% return isn’t enough for you, by all means, wait for a better entry price.  I wouldn’t think it would be imprudent to start a tiny placeholder position here though,  but it was $12 a share just last month.

The odds of a dip to buy increase dramatically with a family feud between Julie Smolyansky, and her mother and brother, Ludmila and Edward.  Julie owns about 17% of the company, her mother and brother combined own about 29%, and of course Danone owns 24%.  An activist investor with a 4% stake, Kenan Wealth Management, sent a letter in 2023 urging for a sale of LWAY due to the prolonged underperformance, and alleging that Julie as CEO doesn’t come into the office every day.  Brother Edward, former COO,  was terminated with cause in early 2022, about the same time that he and Ludmila asked the board to fire Julie for mismanagement of the company.  Edward and Ludmila agreed not to fire Julie, as long as LWAY pursued their strategic options which they did not do.  Now they are back pushing for a strategic sale of LWAY again.

With so much drama surrounding the company, I am shocked that the share price isn’t in the toilet, and if there are any more chapters of drama to unfold, the share price could easily provide a buying opportunity again soon.  If I am really late to the party, then the sale of LWAY could happen at any time, although I have my suspicions as a member of the UN global entrepreneur’s council and WEF young global leader class of 2015, Julie does not want to give up power.  So the best prediction is a long and bloody struggle for control that provides many buying opportunities.

I wish I had learned about LWAY a few years ago, but there is still an opportunity here for people who are familiar with the Chinese proverb of the sandpiper and the clam.

”A clam swam to the bank and opened its shell in the sun. a snipe flew over and saw it. It dived to the ground and pecked at it. Before the snipe drew back its beak, it was gripped tightly inside because the clam suddenly felt the pain and closed its shell quickly. The snipe shook its head violently to cast off the clam, but it failed. The snipe said angrily, “listen, you clam, it’s not going to rain today, neither will it tomorrow. Then you’ll die from thirst. So quick! Let me off!” the clam was angry too. “You listen; I won’t let you off today, neither tomorrow. Then you will die of hunger. Do you still dare to eat me?” the snipe and clam were locked in a fight and quarreled, and neither of them liked to give up first. Just at that moment, an old fisherman came. He picked them up and took them home for dinner.”