Fundamental Research - Laguna Blends Inc. (LAGBF)

Transcription

Siddharth Rajeev, B.Tech, MBA, CFA
Analyst
May 5, 2016
Laguna Blends Inc. (CSE: LAG / FWB: LB6A / OTC: LAGBF): Network Marketing Company with an
Initial Focus on Hemp - Initiating Coverage
Sector/Industry: Multi-Level Marketing
Market Data (as of May 5, 2016)
Current Price
C$0.12
Fair Value
C$0.45
Rating*
BUY
Risk*
4 (Speculative)
52 Week Range
N/A
Shares O/S
20.36 mm
Market Cap
C$2.44 mm
Current Yield
N/A
P/E (forward)
N/A
P/B
N/A
YoY Return
N/A
YoY TSXV
-6.2%
*See back of report for rating and risk definitions
www.lagunablendsinc.com
Investment Highlights
Laguna Blends Inc. (“Laguna, “company”) is a brand new network marketing
(multi-level marketing / MLM) company with an initial focus on functional
beverage products containing hemp and other efficacious ingredients.
Hemp is a good source of protein, omega 3, 6 and 9 fatty acids, magnesium,
zinc, iron, dietary fibre, etc., and therefore, has been receiving increasing focus
on its potential use in health foods and functional foods.
The company, formed in 2014, went public through the reverse takeover
(“RTO”) of a Canadian Stock Exchange (“CSE”) listed company in September
2015. CEO, Stuart Gray, and his spouse, own 18.5% of the outstanding shares.
The company has launched two products to date - the first one is a hemp
protein coffee called Caffé, and the second one is a hemp protein functional
beverage called Pro369. Laguna does not manufacture its own products, but
partners with researchers, manufacturers and suppliers to produce white label
products under the brand name Laguna Blends.
Laguna launched sales on March 7, 2016, with 135 direct independent sellers
(affiliates) in the U.S. and Canada. As of April 4, 2016, the count increased to
over 700.
We are initiating coverage on Laguna with a BUY rating and a fair value
estimate of $0.45 per share.
Risks
Laguna is a startup and has yet to report revenues.
The company’s ability to attract affiliates is vital for its long-term success.
Although hemp focused beverages are relatively new, the functional food and
beverage industry is dominated by large players.
As with any direct selling company, the company is also susceptible to
negative changes to regulatory laws.
Critical technologies are currently licensed from third-parties.
Although MLM is a large market and there are thousands of companies
operating in the space, MLM companies are viewed with scepticism by a
certain segment of the market.
Key Financial Data
(in C$); YE - M ar 31
Revenues
EBITDA
Net Income
EPS (basic)
Total Assets
 2016 Fundamental Research Corp.
2015 (9M)
(1,878,903)
(8,007,694)
(0.73)
304,412
2015E
(2,231,738)
(8,360,529)
(0.41)
270,616
2016E
747,983
(903,888)
(903,888)
(0.04)
547,048
“10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront”
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PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Page 2
Multi-Level
Marketing
Direct selling is the act of marketing and selling a product directly to consumers instead of
through retail outlets. Direct selling is broadly classified into single-level marketing and
multi-level marketing (“MLM”). In the case of single-level marketing, a seller (also
referred to as an independent sales representative, consultant, distributor, etc.) makes
money by purchasing products at the wholesale price from the parent company and selling
them directly to customers at retail prices. As for multi-level marketing (also referred to
as network marketing), sellers are compensated not only from the sale of products to
customers, but also from the sales made by other sellers (also referred to as a seller’s
downline) whom they recruit / sponsor.
According to the World Federation of Direct Selling Associations (“WFDSA”), there were
approximately 99.7 million direct sellers in the world in 2014 (up from 84.6 million in
2011), and they generated retail sales of US$182.8 billion (up from US$151.3 billion in
2011). From 2011 to 2014, global direct sales grew at a compounded annual growth
rate (“CAGR”) of 6.5%.
The U.S. is the largest market and accounted for 19% of global sales, followed by China
(17%) and Japan (9%) in 2014.
Global Direct Sales by Region (2014)
Source: WFSDA
In the U.S., direct selling accounted for US$34.5 billion in sales from 18.2 million
sellers (across 1,400 companies) in 2014. Canada accounted for US$1.83 billion from
779,688 direct sellers in the same year. The following chart shows the growth in sales and
the number of direct sellers since 2006 in the U.S.
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Source: DSA
The following table shows the average annual sales per direct seller. The average sales in
the U.S. were $1,894 in 2014, in line with the global average of $1,834.
2014
Canada
U.S.
Global Average
$1,825,000,000
$34,470,000,000
$182,800,000,000
Direct Sellers
779,688
18,200,000
99,700,000
Average Annual Sales
$2,341
$1,894
$1,834
Average Monthly Sales
$195
$158
$153
Total Sales
Source: DSA and other sources
Direct sellers are typically able to purchase products at a 30% discount to the retail price.
Therefore, based on average annual sales of approximately $2,000, a typical direct
seller typically makes 30% of the sales, or $600 per year. However, industry sources
state that a very small percentage of the direct sellers generate US$100,000+ in income.
Their income comes not only from product sales but by also through commissions from
sales generated by their downline.
Most people choose to get involved in direct selling due to its potential to provide
additional income with flexible work schedules. Another key reason is that they can buy
exclusive products and services at a discount from the parent company. Direct selling is
also a very low risk business as it does not involve any significant capital investment.
According to the DSA, approximately 14.9% of the households in the U.S. had
someone involved in direct selling in 2014 (versus 13.8% in 2013).
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Approximately 94% of the direct sellers have full-time jobs and work part-time (typically
10 hours a week) as direct sellers.
Direct Sellers by Time Worked
Source: DSA
The industry is dominated by women, but that dynamic is changing as the percentage of
men has been increased from 12.1% in 2007, to 25.6% by 2014.
Direct Sellers by Gender in the U.S.
Source: DSA
The mean age of direct sellers was 46.3 years in 2014, with 48% of the total in the 35 to 54
year age group.
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Direct Sellers by Age
Source: DSA
Negative sentiment towards direct selling: MLM companies have historically been
subject to criticisms and lawsuits primarily because consumers confuse them with illegal
pyramid and ponzi schemes. In a pyramid scheme, new recruits are required to make a
significant upfront payment in return for a share of money received from every new
member they recruit. On the other hand, legitimate MLM companies offer real
products / services to consumers and members make most of their income from
product sales rather than hiring new members. Also, legitimate MLM companies
typically charge a nominal fee upfront for a starter kit ($50 - $100), which includes items
such as samples, catalogs, order forms and other tools that help the seller to sell. The
following table shows a list of the major players in the space. The largest MLM company
is Amway, which generated US$9.5 billion in revenues and had approximately 3 million
direct sellers in 2015, in more than 100 countries.
2015 (US$,
billions)
Salespeople
Average
Annual Sales
per Salesperson
Amway
$9.50
3,000,000
$3,167
Avon Products (NYSE: AVP)
$6.16
6,000,000+
$1,027
Herbalife (NYSE: HLF)
$4.46
4,000,000
$1,115
Vorwerk
$4.00
592,000
$6,757
Infinitus
$3.88
Mary Kay
$3.70
3,500,000
$1,057
Natura (BOVESPA: NATU3)
$2.41
1,700,000
$1,418
Tupperware (NYSE: TUP)
$2.28
2,600,000
$878
Nu Skin Enterprises (NYSE: NUS)
$2.25
1,208,000
$1,860
Company Name
Most of these players sell a wide array of products including cosmetics, personal care,
food and beverage, kitchenware and appliances, home care, wellness, electronics, etc. The
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following chart shows the key segments in the U.S. – the number one segment is
“wellness”, which are basically products (such as weight-loss products and dietary
supplements) that promote good physical and mental health. Laguna`s initial focus is on
this segment. With increasing concerns for health and appearance, this segment has
enjoyed significant growth in the past decade.
Source: DSA
In Canada, the mix is slightly different, with personal care products being the largest
segment, followed by home and family care products and wellness products.
Although direct sales only account for less than 1% of the total retail sales in the U.S. (see
chart below), they account for 30.1% in wellness product sales, clearly indicating
Laguna’s reason to enter the market through this segment. Unique and niche products
tend to do well with direct sales, as they require person-to person product education
and higher levels of customer service.
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Total Direct Sales as a Percentage of Total Retail Sales
Source: DSA
Direct Selling vs Industry Retail Sales
Source: DSA
According to IBISWorld, the industry’s EBIT (earning before interest and taxes) margin is
estimated to have been approximately 5.3% in 2015. These margins are similar to
companies operating in the retail sector because their lower rent and utilities costs are
offset by higher wage costs.
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Costs as a percentage of Revenues
The following chart shows the margins of the key players in the space. As shown, net
margins ranged between 4% and 8% for most companies in 2015.
Company Name
Gross
Margin
Debt /
Capital
EV /
Revenues
EV /
EBITDA
P/E
Avon Products (NYSE: AVP)
60.50%
7.20%
-18.60%
191.20%
0.60
8.40
N/A
Herbalife (NYSE: HLF)
52.80%
15.30%
7.60%
103.40%
1.40
9.20
15.00
Natura (BOVESPA: NATU3)
69.40%
17.70%
6.50%
83.70%
2.00
11.20
25.10
Tupperware (NYSE: TUP)
67.40%
16.60%
8.10%
82.70%
1.60
9.90
16.40
Nu Skin Enterprises (NYSE: NUS)
78.20%
14.10%
5.90%
23.20%
1.00
6.80
17.40
Immunotec Inc. (TSXV:IMM)
25.70%
6.80%
4.80%
16.10%
0.20
3.80
7.20
59.00%
12.95%
2.38%
83.38%
1.13
8.22
16.22
Average
EBITDA Net Income
Margin
Margin
The following table shows a summary of Immunotec Inc.’s (TSXV: IMM) performance.
The table serves two purposes – 1) shows the growth potential of companies in the space,
and 2) gives an understanding on the various operating costs of the business. Immunotec,
headquartered in Quebec, Canada, primarily offers nutritional products through its
network of independent consultants. Mexico is their largest market with approximately
49% of the total revenues in the quarter ended January 31, 2016. The U.S. and Canada
accounted for 48%.
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Immunotec Inc. (TSXV:IMM) - C$
2013
2014
2015
Revenues
$54,771,074
$80,790,470
$84,758,161
Cost of Sales
$13,499,239
$18,694,307
$20,350,042
Field Incentives
$25,785,581
$42,074,019
$42,595,855
Selling, general and administrative
$12,614,723
$15,003,825
$15,733,134
$1,377,274
-$2,692,559
$4,042,216
2013
2014
2015
Cost of Sales
24.65%
23.14%
24.01%
Field Incentives
47.08%
52.08%
50.26%
Selling, general and administrative
23.03%
18.57%
18.56%
2.5%
-3.3%
4.8%
Net Profit
% of Reve nue s
Net Profit
Immunotec generated C$85 million in revenues in 2015, up from $54.77 million in 2013,
reflecting a CAGR of 24%. Their cost of sales averaged 24% of the revenues, field
incentives (bonus / commissions paid to sellers) averaged 50% of the revenues, and
selling, general and administrative expenses averaged 20% of the revenues. Note that field
incentives are paid to a very small percentage of the total number of direct sellers –
explained by the highly skewed income distribution of direct sellers.
MLM companies compete with department stores, mass merchandisers and e-commerce
retailers. The emergence of e-commerce, providing convenience and competitive prices to
consumers, has resulted in a significant drop in industry wide margins. MLM companies
also face stiff competition from other companies in the space primarily because of the
industry’s low barriers to entry and low start-up costs or licensing requirements for new
members. As with retail sales, the demand for direct sellers’ products are also dependent
on macroeconomic factors such as the gross domestic product (“GDP”) growth,
unemployment rate, disposable income, consumer confidence, etc. The following chart
shows the strong correlation between direct sales and U.S. GDP growth.
Source: DSA
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The industry has a high turnover rate among direct sellers; therefore, businesses
have to consistently attract and recruit new members to grow sales. According to the
DSA, the dropout rate was 33.5% in the U.S. in 2014, but the industry attracted 40.7%
new recruits in the same year. They key to retain members for a long duration is for
businesses to not only offer high-quality and unique products, but also attractive earning
opportunities (known as “field incentives”) to its members.
Overview of
Laguna
Blends
Laguna Blends was founded by Stuart Gray, who has a strong background in the network
marketing business. The company was originally incorporated in Nevada, U.S., in June
2014, under the name Bonzy Marketing Corp. Subsequently, in September 2014, the name
was changed to Laguna Blends Inc. The company went public through the reverse
takeover (“RTO”) of Canadian Stock Exchange (“CSE”) listed Grenadier Resource
Corp. in September 2015. In January 2016, the company completed a 2.5:1 share
consolidation and reduced the number of outstanding shares from 45.65 million to 18.53
million.
Management believes that traditional network companies have not kept up-to-date with
technology, and therefore, decided to build the business backed by innovative and new
technologies. The backbone of Laguna’s infrastructure is a virtual 3D technology
platform (called Laguna World - http://www.lagunaworld.com/) that allows its
members (affiliates) to recruit, train, and generate sales. The primary objective of the
platform is to enable affiliates to build their business from their own home, or while
travelling, replacing the need for physical meetings. The platform also allows affiliates to
record and tracks their sales, and the company to track the performance of all of its
independent consultants, and the various incentives earned. According to Laguna, they are
the only network company that utilizes such a technology, and believes this technology is
a game changer in the industry. We were provided a virtual tour of Laguna World and
witnessed the platform’s features, which we found to be very impressive. Images of
Laguna World are shown below:
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Source: Company
The company currently licenses the cloud technology from an unrelated private
company.
Laguna charges a start-up fee of $39.97 to its new members, which includes a Laguna
online business kit, replicated website (personalized page) and back end office and access
to Laguna World. The company also charges a nominal annual renewal fee of $25.
As mentioned earlier, the primary difference between MLM companies and illegal
pyramid schemes is the affiliates’ compensation structure. Therefore, Laguna decided to
replicate the compensation structure of proven and established MLM companies in order
to avoid any potential scrutiny from consumers, investors or regulatory agencies. The
various types of compensation plans offered by Laguna to its affiliates are listed below.
The list is presented only for illustrative purposes, and the definitions are beyond the scope
of this report.
Retail Profit
Builder/Retailing Pack Bonus
Fast Start Bonus
Binary Bonus – 1/3 – 2/3 Cycling
Four Level Matching Bonus
Lifestyle Bonus
Rank Achievement Bonus
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Binary Re-Entry Opportunity
Laguna does not manufacture its own products, instead partners with researchers,
manufacturers and suppliers to produce white label products under the brand name Laguna
Blends. Management decided to enter the business with functional beverage products
containing hemp and other efficacious ingredients. The company has so far launched two
products. The first one is a hemp protein coffee called Caffe, and the second one is single
serving hemp protein pouches, called Pro369. The company has partnered with different
companies for the first two products. Details of each product and their partners are
discussed later in the report.
Hemp is a variety of the Cannabis plant. It is a high growing plant typically cultivated for
industrial and commercial (non-drug) use. Hemp is refined into a wide range of products,
including hemp seed foods, oil, resin, wax, cloth, rope, pulp, paper, etc. Hemp is not to be
confused with the recreational drug, cannabis / marijuana, which is also a variety of the
cannabis plant, but does not have the same active ingredients.
A 60-year ban on hemp production was lifted in Canada in 1998. In the case of U.S., the
ban was lifted in 28 states in 2015, but products made with hemp can be sold legally in the
entire country.
Hemp
Industry
Hemp is a good source of protein, omega 3, 6 and 9 fatty acids, magnesium, zinc,
iron, dietary fibre, etc., and therefore, has been receiving increasing focus on its
potential use in health foods and functional foods.
According to a report by the Congressional Research Service, the global market for hemp
consists of over 25,000 products. The Hemp Industries Association estimates that the total
retail sales of hemp food, supplements, and body care products in the U.S. is
approximately US$200 million. The total value of all hemp related products is estimated at
US$620 million a year. Canadian sales are estimated to be approximately US$20 - US$40
million.
Large retailers such as Costco (Nasdaq: COST), Superstore (TSX: L), Walmart (NYSE:
WMT), etc. now carry a variety of hemp products, including hemp hearts (raw shelled
hemp seeds), hemp seed oil, hemp beverages, hemp granola and cereal. The majority of
these products are manufactured and sold by privately held Canadian companies such as
Nature’s Path Foods and Manitoba Harvest Hemp Foods.
Hemp protein is becoming an increasingly popular substitute in the functional beverage
market. Numerous health and nutrition companies such as Vega (acquired by WhiteWave
Foods Company, [NYSE: WWAV], in 2015 for US$550 million) are producing hemp
protein products targeting health conscious consumers. While most hemp proteins contain
fewer grams of protein relative to generic whey protein, the abundance of omega 3, 6 and
9 fatty acids, fiber, vitamins and minerals make it an appealing product. Canadian
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companies account for the majority of producers in the hemp protein market.
Laguna believes that network marketing is the most effective way to distribute hempbased products because it allows person-to-person product education and higher
levels of customer service, which are not as readily available through other
distribution channels.
Growing health concerns, consumer awareness, and general convenience are expected to
drive demand for functional food and beverages. Functional food and beverages are
basically products that have potentially positive effects on health beyond basic nutrition.
The industry has been experiencing rapid growth over the last decade.
According to Leatherhead Research, a food research company, the global market for
functional foods is expected to grow from US$43.21 billion in 2013, to US$54 billion by
2017, 25% growth from 2013 levels. The industry was at US$34.2 billion in 2009.
Functional
Food and
Beverage
Industry
The market for functional drinks in the U.S. grew from $19 billion in 2009, to $27 billion
by 2013, reflecting a CAGR of 8.7%. The market is forecasted to rise to US$38.5 billion
by 2017.
Market for Functional Drinks
Source: Trifecta Research 2015
While protein drinks only accounted for a 1.4% share of the functional category last year,
the segment is experiencing the strongest growth of any sub-segment.
Euromonitor International states that the U.S. market for sports nutrition plus
energy/nutrition bars and sports drink is set to hit US$20 billion by 2020, up from the
current US$16 billion, which includes sport nutrition (US$6.7 billion, of which sports
protein powders make up US$4.7billion), US$6.9 billion sports drink, and US$2.5 billion
in energy and nutrition bars.
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Source: Euromonitor International
Laguna’s focus is on daily consumable products and their strategy is to develop
modified versions of such products by adding unique features and selling points. The
following section presents details of Laguna’s first two products:
Caffé – launched in March 2016, this is an instant coffee beverage that is infused with
whey protein, hemp protein, and natural flavors. Each box consists of 30 sachets. Each
6.4g sachet contains 2g of protein.
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Although several companies produce coffee flavored protein and coffee drinks with added
protein, management believes that Caffé is the only product that combines coffee, hemp
and whey protein. Starbucks (Nasdaq: SBUX) offers protein coffee, but they are ready to
serve cold protein coffee in a can. Several companies, including (Kellogg’s / NYSE: K),
offer coffee flavored protein beverages. Caffé is unique and differs from these products as
it is an instant black coffee with the addition of hemp and whey protein. While most coffee
flavored protein beverages target athletes or avid gym-goers, Caffé is marketed towards
coffee-drinkers looking for the nutritional benefit of hemp and whey protein.
A box consisting of 30 sachets is offered by Laguna to its affiliates at a wholesale price of
US$44.95 (C$54.97). Laguna suggests that affiliates market their products at a 15+%
premium to end-consumers. This implies a single serving price of US$1.50 (C$1.83) for
affiliates, and US$1.72 (C$2.10) for end-consumers. Being distinct due to its hemp and
whey content, Caffé is marketed as a premium product and commands a higher price when
compared with most instant coffee (US$0.10 – US$0.20 per serving). According to US
News, the average American pays US$2.70 for a standard cup of coffee.
Product development: In September 2014, Laguna entered into a research and
development and supply agreement wherein Laguna appointed Walking Tree as a
researcher, developer and supplier of products for an initial term of two years. As per the
agreement, Laguna retains all of the intellectual property and rights on the products
developed by Walking Tree. Laguna spent approximately $100k for a year of expenses in
connection with research and development of the Caffé.
Manufacturing: Contract manufacturer of nutraceutical and pharmaceutical products,
PNP Pharmaceuticals Inc. (“PNP”) of Burnaby, B.C. manufactures Caffé. Commercial
production commenced in January 2016, and 500,000 sachets have been produced to date.
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According to Laguna, PNP was an ideal choice as the contract manufacturer because PNP
manufactures pharmaceuticals, in addition to nutritional products, so they are required to
meet quality standards that other manufacturers do not. Founded in 1999, PNP operates a
75,000 square foot manufacturing facility in Burnaby, BC.
Packaged products are shipped from Expeditors’ (Nasdaq: EXPD – a global logistics and
freight forwarding company) distribution centre in Richmond, B.C. Expeditors arranges
the delivery of the product to consumers on behalf of Laguna.
Laguna’s
Products
Pro369 – launched in April 2016, this is a single serving 30g “on the go” hemp protein
drink. Consumers can directly mix the product in water, milk, shakes, smoothies, almond
milk, sprinkle it over cereal, etc. It currently comes in four flavours:
Vanilla caramel
Tropical fruit
Mixed berry
Chocolate banana
Pro369’s main ingredients are hemp, ginseng, and stevia. Each packet of Pro369 includes
13g of protein, 2.9g of omega 3, 6 and 9, and 50mg of ginseng. Typical protein shakes
offer 25g of protein; however, the addition of omegas and ginseng make Pro369 a
convenient “all-in-one” nutritional source. Pro369’s omega content is comparable with
most omega 3-6-9 supplements and provides the daily adequate intake. The product has
been approved by Health Canada as a Natural Product, with the following approved health
claims:
A source of protein that helps build and repair body tissues.
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Source of amino acids involved in muscle protein synthesis.
Assists in the building of lean muscle.
An adaptogen to help maintain a healthy immune system.
Supportive therapy for the promotion of healthy glucose levels.
Our research indicates that very few protein supplements in the market have Health
Canada approval.
Laguna offers Pro369 to its affiliates at a wholesale price of US$44.95 (C$54.97) per box
(12 servings). Affiliates market the product at a 15+% premium to consumers. The single
serving price is US$3.75 (C$4.58) for affiliates, implying a consumer price of US$4.31
(C$5.27). While the price of whey protein products varies, we find that the average cost
per serving is between US$0.50 and US$1 (C$0.64 – C$1.29). Laguna markets Pro369 as
a premium protein due its unique features mentioned above and the five approved health
claims from Health Canada.
We were provided samples of both products and we found both of them to be
convenient and of good taste.
Product development: In April 2015, Laguna entered into an agreement with Naturally
Splendid Enterprises Ltd. (“NSE”) (TSX-V: NSP) to jointly develop and market products,
primarily focused on hemp protein formulations developed by NSP. As per the agreement,
NSP will contribute to the research and development, and Laguna will be responsible for
marketing and sales.
Naturally Splendid, headquartered in Vancouver, BC, is a biotechnology company that is
focused on the development, commercialization, and licensing of plant based products
with a special focus on hemp and hemp derivatives. The following chart summarizes its
various divisions and operations.
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As per the agreement, NSP will grant to Laguna:
•
•
a worldwide exclusive and a non-transferrable and royalty-free license to market, sell
and distribute the developed products under the Laguna brand name as a white label
product, dependent on Laguna achieving the following sales targets: $1.60 million in
the first year of the agreement, and $4.50 million in the second year.
if Laguna does not achieve the sales targets, the license will turn into a non-exclusive
license.
All of the research and development was completed at NSE’s expense.
NSP is currently contracting out the production of Pro369 to a third-party manufacturer.
The manufactured products are delivered to Expeditors’ facility in Richmond, BC and Los
Angeles, CA for distribution to affiliates in the U.S. and Canada.
Relevant
Comparables
We identified two companies that provide a benchmark for Laguna’s operations:
Organo Gold: Established in 2008 in Richmond, BC, Canada, Organo Gold has been
successful so far as a MLM company. Organo Gold currently operates in 35 countries and
offers a variety of coffees, teas, health & wellness products, and bath & beauty products.
Organo Gold is a private company and details pertaining to its financial performance are
unknown. However, sources indicate that they generated $270+ million in revenues, and
had 600,000+ members in 2012.
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Rocky Mountain High Brands, Inc. (OTCPK: RMHB): Dallas-based Rocky Mountain
Brands was established in July 2014. Specializing in the development, manufacturing, and
distribution of hemp-infused food and beverage products, RMHB began producing its first
line of products in February 2015. They currently have five hemp-infused beverages,
hemp-infused edibles (protein bar, energy bar and chia crisp bar), hemp-infused 2 oz.
energy shots and 2.5 oz. coffee shots. The company uses a network of brokers and
distributors to market its products. In the six months ended December 31, 2015, the
company generated US$0.59 million in revenues, US$0.27 million in gross profit, and an
operating loss of US$0.81 million.
Laguna intends to expand its product line to include other hemp-based nutritional
products.
Future
Products
In April 2016, the company announced that it entered into an agreement with Robert
Lamberton Consulting for the development of a “Limitless, Healthy Brain and Memory
Coffee” product. As per the agreement, Robert Lamberton Consulting will bear all the
costs associated with the development of the product, while Laguna will own the
intellectual property and world wide marketing rights for the product. Robert Lamberton is
a Clinical Nutritionist, Functional Medicine Consultant. He provides consulting services to
help companies develop and market nutritional products.
Laguna will pay Mr. Lamberton a royalty of 3% on sales for the first eight years, which
will drop to 2% thereafter.
As mentioned earlier, larger MLM companies offer a wide range of products through their
affiliates. Currently, Laguna is considering future product offerings in the functional
beverage category, such as hemp teas and additional coffee products. They are also
considering adding new product categories.
Building a
Network of
Affiliates
The company launched sales on March 7, 2016, with 135 affiliates in the U.S. and Canada.
As of April 4, 2016, the count increased to over 700, of which, approximately 70% are in
the U.S. and 30% in Canada. Management indicated to us that approximately 150 – 175
affiliates are currently active. The company has yet to disclose any sales data, but
announced that they intend to post financial sales data in early May of 2016. We believe it
is a very promising sign that the company has been able to expand its network of affiliates
at a rapid pace in a short time period.
Management
Management has extensive experience in the network marketing business. CEO, Stuart
Gray, and his spouse, own 18.5% of the outstanding shares. The high equity interest is
very encouraging for investors as it shows management’s positive outlook on the
company, and aligns management and investors’ interests.
The company has four directors – Rhys Williams, Stuart Gray, Negar Adam and Martin
Carleton, of which, two are independent. Brief biographies of the management team and
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Page 20
board members, as provided by the company, follows:
Stuart Gray – CEO and Director
Mr. Gray’s responsibilities with Laguna consist of managing the day to day operations of
Laguna, being responsible for business development, management and financial reporting,
and such other responsibilities typically ascribed to a CEO and CFO. Mr. Gray was
introduced to business and sales through network marketing at 19 years of age. He
achieved early MLM success achieving the second highest level in the Company’s pay
plan in 18 months. Stuart built a team of leaders in several countries and had one of the
largest volume groups in the company for the Silver Executive level. Mr. Gray went on to
educate himself in business and marketing. Mr. Gray first attended the Okanagan College
for business and marketing and then trained at the Vancouver Film School where he
graduated as a Producer/Director in 1995. He founded NewTrends Film and Video
Productions (“NewTrends”) in 1996 and served as President of NewTrends from 1996 to
2006. During his tenure, NewTrends was recognized for profitability, innovation and
technology and won several awards in these categories. Mr. Gray has in excess of 18 years
of experience in business and marketing. As a Producer and Director by background,
Stuart has founded several media- and promotional- related companies and has provided
consulting to over 120 public and private companies in the U.S. and Canada. Mr. Gray has
assisted in taking several companies public through reverse takeovers and assisting in
fundraising.
Stuart Kei Kawasaki – President Laguna Blends USA
Mr. Kawasaki has been involved in the multilevel marketing industry since 1988, with
extensive hands-on experience in all aspects of corporate and business development, event
management, product and field development as well as overall financial and operational
responsibility. His corporate experience has ranged from ground-up startups to billion
dollar companies and has initiated and grown operations in 19 countries around the world.
Currently the principal at BeeCubed, a business and management consultancy that assists
companies in all phases of starting up, building, reorganization and crisis management.
Industry niches include direct sales/network marketing, retail/wholesale and servicesoriented companies. Mr. Kawasaki earned a Bachelor of Science degree from Santa Clara
University. Selected achievements: successful ground-up launch of internationally based
MLM company in the North American/global market, implemented and/or reorganized
operations to be compliant in international markets for client companies, established and
launched operations in China, Indonesia, Singapore, Malaysia, Thailand, Philippines,
Australia, Israel, the United States and Canada; oversaw operations with full profit and
loss responsibility for up to 20 staff and 15,000 independent distributors.
Ray W. Grimm, Jr. – President Laguna Blends Inc.
Mr. Grimm is a veteran entrepreneur with more than a quarter century of experience
building some of the top nutritional and weight loss companies in direct sales history. Mr.
Grimm has what many consider to be the Midas touch in building multimillion dollar
companies, three of which exceeded $50 million in sales within their first five years. In
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Page 21
2011, Mr. Grimm also created and co-founded one of the fastest growing weight loss
brands ever developed producing $10 million in sales in its first year. His vision,
leadership and expertise in nutrition, weight loss and direct sales are unmatched and so is
his unique formula for success all of which have benefited the physical and financial
health of thousands. Ray has extensive experience in managing operations, sales, training
and marketing of fast growing companies. He is a proud member of the DSA (Direct
Selling Association) and founding member and current member of the MLMIA
(Multilevel Marketing International Association).
Dennis Compo - Executive Director of Marketing
Dennis Compo has consulted in the Music, Entertainment, Sales and Marketing Industries
for 35 years. He has held the following positions:
GanoLife Canada Inc, Vice President - June 2013 – July 31, 2014
Legends Of Rock-N-Roll , Vice President - August 2005 – Present (9 years)
Gano Excel Canada, Vice-President and General Manager - July 2008 – October 2012
Martin Carleton - Head Technical Development
Mr. Carleton’s responsibilities with Laguna consist of acting as member of the board of
directors of Laguna and participating in the governance of the company. Mr. Carleton has
8 years of experience in the Internet Technology sector where he has worked both as a
web developer and project manager. Most notably, Martin has led a team of developers in
creating a prize winning metering system for Skype that garnered the “Skype API
Developer Award” in 2005 and in 2006 as part of his San Francisco based internet startup. Since then Martin has undertaken numerous projects developing commercial websites
as a developer and more recently overseeing the construction of an internet/TV fiber optic
network intended to serve an 800-room temporary logging facility in the Oil fields of
North Dakota. Originally from Ottawa, Canada, Martin obtained his B. Eng in
Communications Engineering from Carleton University.
Rhys Williams - Director
Mr. Williams has been involved in the business of manufacturing since 1993, when he
served as a Final Quality Inspector for Western Star Trucks. In 2002, while attending
University College of the Fraser Valley, Mr. Williams co-founded BC Northern Lights
Ltd., a private indoor greenhouse appliance company that has received recognition and
rewards for its innovative product line. Mr. Williams was also involved in the early
development of the Urban Cultivator product which was featured on CBC’s Dragons’ Den
in 2011. The Urban Cultivator is an award winning kitchen appliance that grows fresh
herbs and is distributed worldwide.
Negar Adam - Director
Ms. Adam earned a Bachelor of Commerce from the University of British Columbia and
has a corporate finance background. Mrs. Adam has been a director and officer of
numerous Canadian public companies over the last 15 years. Ms. Adam has been the
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Page 22
President and Secretary of Makena Resources Inc. since June 19, 2007 and serves as its
Chief Executive Officer. In addition to previously sitting on the board of several
companies listed on the TSX Venture Exchange, Ms. Adam is self-employed as a
consultant who offers consulting services to public companies since 1999.
Charles Carleton – Head of Laguna Tech
Mr. Charles Carleton has 20 years’ experience in Technology and Entrepreneurship. He
has worked both for large corporations and small start-ups and is at ease in both worlds. A
solid technical and analytical background coupled with good overall business acumen has
enabled him to effectively work across all departments which compose a successful
business. Originally from Ottawa, Canada, Mr. Charles Carleton obtained his BSC cum
lade in Experimental Physics from York University in Toronto. He headed west and spent
the next 15 years in the tech industry out in California between Silicon Valley, San
Francisco and San Diego as an employee for Microsoft, Allied Signal and Honeywell. He
also started some of his own software companies during that time. One of which was
partnered with Skype in their very early existence (when they were only seven guys
working out of an office over a bar in Estonia) and contributed in designing and building
their original Platform and API.
Financials
The following chart shows a summary of the company’s operating performance.
STATEMENTS OF OPERATIONS
(in C$) - YE Mar 31st
Revenues
2015 (9M)
COGS
Gross Profit
-
EXPENSES
General and administrative
855,841
Stock based compensation
158,506
Buiness development
EBITDA
864,556
(1,878,903)
Amortization
EBIT
(1,878,903)
Other income
Interest expense
EBT
Unusual items
(1,878,903)
(6,128,791)
Taxes
Net Profit (Loss)
EPS
(8,007,694)
-0.73
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Page 23
In the nine month period ended December 31, 2015, the company reported $1.88 million
in operating losses. General and administrative (“G&A”) expenses were $0.42 million,
and consulting / business development expenses were $1.30 million (of which
approximately $0.78 million were related fees paid in shares). Management expects
G&A and business development expenses to be approximately $0.75 million in 2016.
The company reported public company listing and acquisition fees of $6.07 million in the
nine month period. This was a non-cash event.
Our revenue forecasts for FY2016, and FY2017, are $0.75 million, and $3.08 million,
respectively. Our net loss forecast for 2016 is $0.90 million (EPS: -$0.04) and for
FY2017 is $0.37 million (EPS: -$0.02).
Cash Flows
The following table shows a summary of the company’s cash flows:
Summary of Cash Flows
($, mm)
2015 (9M)
Operating
-$0.88
Investing
-$0.16
Financing
$1.04
Effects of Exchange Rate
$0.00
Net
Free Cash Flows to Firm (FCF)
$0.00
-$1.04
Free cash flows (“FCF”) were -$1.04 million in the nine month period ended December
31, 2015.
Balance
Sheet
The company had $0.08 million in cash, with a working capital of -$0.70 million at the
end of December 31, 2015. The following table shows the company’s cash and liquidity
position.
Liquidity & Capital Structure
Cash
Working Capital
Q3-2015
76,005
(702,878)
Current Ratio
0.3
LT Debt
-
Total Debt
689,231
LT Debt / Capital
0.0%
Laguna currently has $0.81 million in debt, of which, $0.70 million is held by the CEO’s
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Page 24
spouse. Terms and conditions of the debt are shown in the table below.
Amount
Interest (p.a.)
Maturity
Lender
$250,000
$150,000
$100,000
$200,000
10%
10%
10%
10%
16-Jul-16
12-Nov-16
11-Dec-16
20-Jan-17
Spouse of the CEO
Spouse of the CEO
Spouse of the CEO
Spouse of the CEO
$50,000
$25,000
$20,000
$10,000
$805,000
10%
10%
10%
10%
10%
31-Jul-16
12-Nov-16
20-Jan-17
28-Jan-17
Unrelated party
Unrelated party
Unrelated party
Unrelated party
Equity financing – In March 2016, the company announced its plans to pursue a $0.21
million private placement by issuing 1.86 million units at a unit price of $0.11. Each unit
consist of a common share and share purchase warrant (exercise price - $0.15 per share
for one year).
Stock Options
and Warrants
The company currently has 40,000 options (weighted average exercise price – $0.70), and
2.30 million warrants (weighted average exercise price - $0.85) outstanding. All the
options and warrants are currently out of the money.
Valuation
and Rating
The following table shows the revenue forecasts based on the company achieving 24,000
active affiliates by the end of 2020. Note that our forecasts are based on the assumption
that Laguna will continue to introduce new products to its portfolio. Future revenues will
primarily depend on Laguna’s ability to attract affiliates.
2016E
2017E
2018E
2019E
2020E
# of Active Affiliates (year-end) - company est.
2,000
5,750
# of Active Affiliates (year-end)
1,000
3,000
6,000
12,000
24,000
Average Sales per Year / Affiliate
2,000
2,000
2,000
2,000
2,000
1,150,000
4,000,000
9,000,000
18,000,000
36,000,000
22,983
79,940
179,865
359,730
719,460
Cost of Sales (20% of Sales)
230,000
800,000
1,800,000
3,600,000
7,200,000
Compensation plan (50% of Sales)
575,000
2,000,000
4,500,000
9,000,000
18,000,000
Total Sales
Annual Affiliate Fee ($39.97 per year)
Our base-case forecasts are shown below:
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Page 25
Revenues
2016E
2017E
2018E
2019E
2020E
747,983
3,079,940
7,679,865
15,359,730
30,719,460
COGS
543,750
2,250,000
5,625,000
11,250,000
22,500,000
204,233
829,940
2,054,865
4,109,730
8,219,460
3,839,933
Gross Profit
EXPENSES
625,645
688,209
959,983
1,919,966
232,475
255,723
281,295
309,425
340,367
Consulting & Buiness development
250,000
246,395
307,195
614,389
1,228,778
(903,888)
(360,387)
506,392
1,265,950
2,810,382
5,000
9,750
14,263
18,549
EBIT
(903,888)
(365,387)
496,642
1,251,687
2,791,832
Interest expense
EBT
(903,888)
(365,387)
496,642
1,251,687
2,791,832
EBITDA
Amortization
Unusual items
Taxes
Net Profit (Loss)
EPS
-
-
173,825
438,091
977,141
(903,888)
(365,387)
322,817
813,597
1,814,691
-0.04
-0.02
0.02
0.04
0.09
We estimate the average expected return on equity for companies in the Vitamins and
Nutritional Supplements industry, Household and Personal Products industries is
approximately 10.2%. Adding a micro-cap premium and a premium to account for the
early stage nature of Laguna’s operations, we used a discount rate of 13.5% for our
Discounted Cash Flow (“DCF”) model. As shown below, our DCF valuation on Laguna’s
shares is currently at $0.40 per share.
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Page 26
DCF Valuation (C$)
2016E
2017E
2018E
2019E
2020E
Funds Flow from Operations
-$671,412
-$104,664
$613,863
$1,137,284
$2,173,608
-increase in w/c
-$287,998
-$261,657
-$276,373
-$461,544
-$923,087
Cash Flows from Operations
-$959,410
-$366,322
$337,489
$675,740
$1,250,520
-capex
-$100,000
-$100,000
-$100,000
-$100,000
-$100,000
Free Cash Flows
-$1,059,410
-$466,322
$237,489
$575,740
$1,150,520
Present Value
-$933,401
-$361,988
$162,426
$346,931
$610,822
Discount Rate
13.5%
Terminal Growth
3%
Present Value
$10,616,587
Cash - Debt
-$613,226
Fair Value
$10,003,361
*
Shares O/S (treasury stock method)
Value per share (C$)
24,904,681
$0.40
*Assuming a $0.50M equity financing this year
The following chart shows the sensitivity of our fair value estimate to the expected
number of active affiliates by the end of 2020. As shown in the chart, the valuation
increases to $1.06 per share if our models assume 100,000 active members by the end of
2020. The valuation drops to $0.30 per share if our models assume only 12,000 members
by the end of 2020.
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Page 27
The following table shows the valuation based on our expected EBITDA estimate in 2020
and the average EV / EBITDA multiple of 8.2x of selected MLM companies (presented
earlier in the report). The estimated value was discounted back to the present using a
13.5% discount rate.
Comparables Valuation
2020 Forecast (EBITDA)
Average EV/ EBITDA
Expected EV ($)
Value per Share ($)
2,810,382
8.22
$23,091,970
$0.48
Based on our valuation models, we are initiating coverage on Laguna with a BUY
rating and a fair value estimate of $0.45 per share. The company is expected to start
reporting sales figures shortly. We believe the value proposition and market
absorption of the initial set of products will play a key role in the company’s ability to
attract affiliates.
Risks
The following risks may cause our estimates to differ from actual results (not exhaustive):
Laguna is a start-up and has yet to report revenues.
The networking marketing industry is highly competitive.
The company’s ability to attract affiliates is vital for its long-term success.
Although hemp focused beverages are relatively new, the functional food and
beverage industry is dominated by large players.
The demand for the company’s products is dependent on macroeconomic factors,
such as GDP growth, unemployment rate, disposable income, consumer confidence,
etc.
As with any direct selling company, the company is also susceptible to negative
changes to regulatory laws.
Critical technologies are currently licensed from third-parties.
Although MLM is a large market and there are thousands of companies operating in
the space, MLM companies are viewed with scepticism by a certain segment of the
market.
As a manufacturer of nutritional beverages, Laguna may be exposed to product
liability claims, regulatory action and litigation.
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Page 28
Appendix
2015E
2016E
2017E
-
747,983
3,079,940
COGS
-
543,750
2,250,000
Gross Profit
-
204,233
829,940
568,768
625,645
688,209
Revenues
EXPENSES
Consulting & Buiness development
EBITDA
211,341
232,475
255,723
1,451,629
250,000
246,395
(2,231,738)
(903,888)
(360,387)
Amortization
5,000
EBIT
(2,231,738)
(903,888)
(365,387)
Interest expense
EBT
(2,231,738)
(903,888)
(365,387)
-
-
(8,360,529)
(903,888)
(365,387)
-0.41
-0.04
-0.02
Unusual items
(6,128,791)
Taxes
Net Profit (Loss)
EPS
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Page 29
BALANCE SHEETS
2015E
2016E
2017E
Cash and cash equiv.
30,788
221,378
5,057
A/R
37,955
36,784
151,466
164,597
173,926
359,846
37,275
14,960
61,599
ASSETS
CURRENT
Inventory
Prepaid
Total Current Assets
270,616
Fixed assets
Total Assets
447,048
100,000
270,616
547,048
577,967
195,000
772,967
LIABILITIES
CURRENT
A/P
604,312
302,156
387,740
Loans payable
825,000
1,575,000
1,575,000
Due to related party
114,231
Total Current Liabilities
1,543,543
114,231
1,991,387
114,231
2,076,971
SHAREHOLDERS EQUITY
Share capital
Reserves
Deficit
Total shareholders’ equity (deficiency)
Total Liabilities and Shareholders Equity
7,607,988
8,107,988
8,357,988
609,806
842,281
1,098,004
-9,490,721
-10,394,609
-10,759,996
(1,272,927)
(1,444,339)
(1,304,004)
270,616
547,048
772,967
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Page 30
STATEMENTS OF CASH FLOWS
2015E
2016E
2017E
-8,360,529
-903,888
-365,387
OPERATING ACTIVITIES
Net profit for the year
Adjusted for items not involving cash:
Depreciation
5,000
Stock compensation / option expense
Unusual items
779,506
232,475
255,723
-1,450,707
-671,412
-104,664
-32,026
1,171
-114,681
-164,597
-9,329
-185,920
20,644
22,315
-46,639
508,226
-302,156
85,584
-1,118,461
-959,410
-366,322
-156,759
-100,000
-100,000
-156,759
-100,000
-100,000
251,448
500,000
250,000
1,040,000
750,000
1,291,448
1,250,000
250,000
16,228
190,590
-216,322
14,560
30,788
221,378
30,788
221,378
5,057
6,130,316
Funds From Operations
Change in working capital
A/R
Inventory
Prepaid
A/P
NET CASH USED IN OPERATING ACTIVITIES
INVESTING ACTIVITIES
PP&E
NET CASH USED IN INVESTING ACTIVITIES
FINANCING ACTIVITIES
Equity
Debt
NET CASH FROM FINANCING ACTIVITIES
Foreign Exchange / Others
INCREASE IN CASH FOR THE YEAR
CASH, BEGINNING OF THE YEAR
CASH, END OF THE YEAR
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Page 31
Fundamental Research Corp. Equity Rating Scale:
Buy – Annual expected rate of return exceeds 12% or the expected return is commensurate with risk
Hold – Annual expected rate of return is between 5% and 12%
Sell – Annual expected rate of return is below 5% or the expected return is not commensurate with risk
Suspended or Rating N/A— Coverage and ratings suspended until more information can be obtained from the company regarding recent events.
Fundamental Research Corp. Risk Rating Scale:
1 (Low Risk) - The company operates in an industry where it has a strong position (for example a monopoly, high market share etc.) or operates in a regulated
industry. The future outlook is stable or positive for the industry. The company generates positive free cash flow and has a history of profitability. The capital
structure is conservative with little or no debt.
2 (Below Average Risk) - The company operates in an industry where the fundamentals and outlook are positive. The industry and company are relatively less
sensitive to systematic risk than companies with a Risk Rating of 3. The company has a history of profitability and has demonstrated its ability to generate positive
free cash flows (though current free cash flow may be negative due to capital investment). The company’s capital structure is conservative with little to modest use of
debt.
3 (Average Risk) - The company operates in an industry that has average sensitivity to systematic risk. The industry may be cyclical. Profits and cash flow are
sensitive to economic factors although the company has demonstrated its ability to generate positive earnings and cash flow. Debt use is in line with industry
averages, and coverage ratios are sufficient.
4 (Speculative) - The company has little or no history of generating earnings or cash flow. Debt use is higher. These companies may be in start-up mode or in a
turnaround situation. These companies should be considered speculative.
5 (Highly Speculative) - The company has no history of generating earnings or cash flow. They may operate in a new industry with new, and unproven products.
Products may be at the development stage, testing, or seeking regulatory approval. These companies may run into liquidity issues, and may rely on external funding.
These stocks are considered highly speculative.
Disclaimers and Disclosure
The opinions expressed in this report are the true opinions of the analyst about this company and industry. Any “forward looking statements” are our best estimates
and opinions based upon information that is publicly available and that we believe to be correct, but we have not independently verified with respect to truth or
correctness. There is no guarantee that our forecasts will materialize. Actual results will likely vary. The analyst and Fundamental Research Corp. “FRC” does not
own any shares of the subject company, does not make a market or offer shares for sale of the subject company, and does not have any investment banking business
with the subject company. Fees were paid by Laguna to FRC. The purpose of the fee is to subsidize the high costs of research and monitoring. FRC takes steps to
ensure independence including setting fees in advance and utilizing analysts who must abide by CFA Institute Code of Ethics and Standards of Professional Conduct.
Additionally, analysts may not trade in any security under coverage. Our full editorial control of all research, timing of release of the reports, and release of liability
for negative reports are protected contractually. To further ensure independence, Laguna has agreed to a minimum coverage term including four updates. Coverage
can not be unilaterally terminated. Distribution procedure: our reports are distributed first to our web-based subscribers on the date shown on this report then made
available to delayed access users through various other channels for a limited time. The performance of FRC’s research is ranked by Investars. Full rankings and are
available at www.investars.com.
The distribution of FRC’s ratings are as follows: BUY (69%), HOLD (8%), SELL (5%), SUSPEND (19%).
To subscribe for real-time access to research, visit http://www.researchfrc.com/subscription.htm for subscription options.
This report contains "forward looking" statements. Forward-looking statements regarding the Company and/or stock’s performance inherently involve risks and
uncertainties that could cause actual results to differ from such forward-looking statements. Factors that would cause or contribute to such differences include, but are
not limited to, continued acceptance of the Company's products/services in the marketplace; acceptance in the marketplace of the Company's new product
lines/services; competitive factors; new product/service introductions by others; technological changes; dependence on suppliers; systematic market risks and other
risks discussed in the Company's periodic report filings, including interim reports, annual reports, and annual information forms filed with the various securities
regulators. By making these forward looking statements, Fundamental Research Corp. and the analyst/author of this report undertakes no obligation to update these
statements for revisions or changes after the date of this report. A report initiating coverage will most often be updated quarterly while a report issuing a rating may
have no further or less frequent updates because the subject company is likely to be in earlier stages where nothing material may occur quarter to quarter.
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INFORMATION AND MAKES NO EXPRESS OR IMPLIED WARRANTIES OR FITNESS FOR A PARTICULAR USE. ANYONE USING THIS REPORT
ASSUMES FULL RESPONSIBILITY FOR WHATEVER RESULTS THEY OBTAIN FROM WHATEVER USE THE INFORMATION WAS PUT TO.
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not intended as being a complete description of the company, industry, securities or developments referred to in the material. Any forecasts contained in this report
were independently prepared unless otherwise stated, and HAVE NOT BEEN endorsed by the Management of the company which is the subject of this report.
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Fundamental Research - Laguna Blends Inc. (LAGBF)

Transcription

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