Long Island Iced Tea (LTEA) is an early-stage entrant in the American beverage industry. The company’s revenues for its last fiscal year were very modest as it is still in the process of scaling its product distribution to a more significant number of retail doors. Since the beverage industry is notoriously crowded with both very well-established brands and numerous new introductions every year, the company’s road to success is anything but certain. Its most significant product is focused on the RTD tea segment, which is mature and dominated by incumbent brands like Lipton, Brisk and Arizona. Finding an area of unmet demand in a category as crowded as RTD tea therefore seems like a tough thing to do. The brands that have in recent years found growth are overwhelmingly concentrated at the higher end of the category’s price range.
Gold Peak, Honest Tea and Fuze would be some examples of brands that have found a profitable niche in the marketplace, and have been acquired by beverage giant Coca-Cola (NYSE:KO) as a way to complement its soda-heavy beverage portfolio. Meanwhile, growth in the lower- to mid-level price ranges, which are dominated by Arizona Beverage and the Pepsi (NYSE:PEP)-Lipton joint venture (UN), has been more subdued. Coca-Cola has even decided to unwind its longstanding but not-so-successful partnership with Nestle (OTCPK:NSRGY) regarding Nestea, which was something of an also-ran in this segment. Despite this, the iced tea category has become a battleground for soda giants Coke and Pepsi, both of which have large financial resources and marketing strength. I expect this to intensify as soda beverages continue to experience declines in demand.
Long Island Iced Tea is positioned as a better-for-you alternative with a below-average price point, in effect trying to tap into the higher growth segments by offering a value price. This appears to be a somewhat conflicted brand message, premium but not priced as such, which in my opinion could create confusion among consumers. Despite the long odds Long Island is facing in the beverage marketplace, the market is valuing this company at close to $45 million (or about 9x trailing revenues). The question is why.
Long Island’s Marketing Shortcut
An important reason for Long Island’s optimistic valuation is that it appears to have found a smart way into the very crowded market for RTD teas through its successful registration of the name Long Island Iced Tea. Of course, Long Island Iced Tea is a famous term for a cocktail containing, among other things, a number of spirits including vodka and tequila, but no tea. Management’s assumption is that the company can forego significant advertising expenditures to establish consumer recognition for its brand, because the term Long Island Iced Tea is already well-recognized among consumers.
In my opinion, there are three significant problems with this assumption, which cast doubt on the sustainability of the company’s current valuation. The first problem is that Long Island Iced Tea is well-established as a hard drink, which may give rise to confusion when a product carrying this name is found in the supermarket soft drink aisle. The second issue is that name recognition in itself is not a guarantee for widespread adoption of a new product. The idea that consumers will adopt Long Island Iced Tea purely because it sounds familiar is at best doubtful.
Finally, the company’s registration of the Long Island Iced Tea trademark appears somewhat uncertain. For instance, the company has secured registration for the trademark under class 30, intended for non-alcoholic beverages, in this case beverages based on tea, but not for alcoholic beverages. And more importantly, the trademark has been added to the supplemental registry, not the principal registry, which among other things means it can still be contested in court by other parties. If the company were to succeed in the marketplace, I would expect competitors to raise objections over the company’s use of a generic term that has been in use since decades.
My suspicion is that the company is trying to establish a more credible claim to future use of the term, potentially for alcoholic beverages, by using its supplemental registration to bring products to market. Long Island’s management may believe they will have a stronger claim to exclusive use of the name Long Island Iced Tea in the future if they have had a product named Long Island Iced Tea in the marketplace for a considerable time.
A Competitive Category
The ready-to-drink tea segment is attractive both for its size and better-than-average growth rates, but it is also crowded and significantly fragmented. A short case study on recent attempts to penetrate the category might be useful to illustrate the longs odds Long Island is facing. Arguably one the most successful North American beverage companies of the past two decades has been Monster Beverage (MNST), which has managed to establish its Monster Energy brand as the most credible challenger to category creator Red Bull since launching in 2002. The man credited with the creation of the Monster Energy brand is Mark Hall, who prior to his move to then Hansen Natural worked for Arizona Beverages, which is mostly known for its Arizona Iced Tea brand.
One could make a credible case that Monster Energy is the most successful non-alcoholic beverage introduction in the American market of the past 15 years. Therefore Mark Hall has a significant amount of credibility as a marketing executive. Still, his involvement at Monster Beverage has not prevented the company on numerous occasions of failing to gain traction with other beverage launches. Over the years, Monster Beverage has launched such brands as Hansen Energy, Lost Energy, Hitman energy shots and a RTD tea brand called Peace Tea. And despite the fact that Peace Tea is still in existence as a brand owned by Coca-Cola, it has never had much of an impact on the RTD tea category.
Monster’s executives, mostly Rodney Sacks, have in the past reflected on some of the reasons why the Peace Tea brand did not work as well as they had expected. An important part of the explanation is related to the maturity of the RTD tea category, which in the case of Peace Tea’s launch in 2009, was at least several decades old. Upon category maturity a range of well-established brands have taken up a category’s allocated shelf space, which makes it much harder to gain distribution, especially in the smaller establishments prevalent in the convenience and gas channel. Within a price range, the retailer usually stocks the category leader, and perhaps a somewhat cheaper competitor. Convincing shop operators to reserve shelf space for an untested brand is usually very difficult, unless it offers something unique.
A higher price point for a more premium product can be a way to secure shelf placement, promising higher margins for the retailer in the process. Different product characteristics can be another way, for instance a product with different ingredients, flavors or packaging. In Long Island Iced Tea’s case none of those seem to apply, making it less likely that the brand will gain significant distribution. Another commonly employed way to gain distribution is to pay the retailers for shelf space, also known as slotting fees. This is a common way to gain premium shelf space, but usually requires substantial financial investment without certainty of a pay-off. Given Long Island’s modest financial means this method seems unlikely to serve as a successful tool for expanding distribution of its brand.
One could argue that Peace Tea was a fairly successful introduction by any normal standard, just not when compared to Monster Energy. It is true that Peace Tea grew into a brand of modest size, certainly at a level that Long Island Iced Tea should be more than happy to achieve. But there are more than a few differences between (then) Hansen Natural and Long Island Iced Tea, not in the least the amount of executive talent. Mark Hall had experience in running operations for one successful brand invented by others (Arizona) and experience in launching and running operations for one very successful brand whose creation he oversaw (Monster). On top of that, Hansen had the benefit of having substantial financial means by the time Peace Tea was launched, existing distribution agreements with several strong partners including Anheuser Busch (BUD), Dr Pepper (DPS) and several Coca-Cola (KO) bottlers and the credibility of already having established a very successful beverage brand. Peace Tea’s problem in my opinion was not that it was ill-conceived or poorly executed but that it came very late to the game. Perhaps the brand was also not different enough from existing brands like Arizona, which made it even harder to gain shelf space.
When we look at Long Island Iced Tea, it is obvious that the company does not have a high-selling brand to spearhead its sales, it does not have very substantial financial means and it does not have distribution agreements with powerful beverage distributors. This leaves the company’s fortunes depending on the assumed recognition of the term Long Island Iced Tea and the beverage industry experience of its management team, as widely touted in its financial documents. But when we take a closer look at those beverage credentials it appears they are mostly related to the beer and spirits businesses, which are entirely different product categories with a very different target consumer and product marketing.
This leaves CEO Philip Thomas and his CFO Richard Allen as the ones with the most experience in soft drinks. In Richard Allen’s case the experience has been primarily in sales and financial functions with Cadbury Schweppes and Snapple, and in Mr. Thomas’ case his beverage experience is limited to Magnum Vending, which is his family’s vending machine business. Vending machine companies like Magnum usually sell third party brands; they are essentially a distribution business tailored to provide beverage distribution to offices and small retail accounts. In other words, the two key executives with soft drink experience appear to have very little experience with beverage branding and marketing.
The iced tea category is an attractive and growing segment, but is also contested by a significant number of established players with very large resources. In order to succeed as a newcomer you will need a differentiated product, something that offers a better customer proposition from what is currently available. In my opinion, Long Island Iced Tea is not currently in possession of such an advantage. It is true that the company is in the process of bringing other products to market, like its Long Island Lemonade line and its ALO Juice aloe vera drink, but those may serve to diffuse management’s efforts to grow sales rather than enhance it. In their latest annual filing, the company also mentions its ambitions to enter the alcoholic beverage market at some point in the future. It is possible that the company’s intention is to try to extend its trademark registration at some point to alcoholic beverages. If they follow through on that ambition, it would put the company in an atypical spot, since most beverage companies are either focused on non-alcoholic or alcoholic beverages.
Although I expect the company to continue growing from its currently very modest base, I have some doubts regarding its potential to achieve profitability within a reasonable amount of time. The company has a habit of frequently releasing information about newly signed distribution agreements, but it is difficult to estimate the size of these accounts. Additionally, a substantial amount of these agreements appear to involve the company’s gallon container products which, as it has admitted, carry very low or even negative margins.
“Sales of our gallon containers have and continue to be sold below their cost in order to drive expanded distribution and brand visibility to consumers on retail store shelves.” (page 24 of the company’s latest 10-K).
It is hard to see a viable business model in selling a product at a negative gross margin. It would either imply that they expect to grow it into a profitable product line by expanding its scale and securing significant unit cost declines in the process or, alternatively, that they intend to use this product as a way of gaining distribution for their more profitable packages. A potential problem with the second possibility is that retailers may never choose to stock the more profitable products.
Finally, and perhaps most importantly, the uncertainty surrounding its claim to the exclusive use of the name Long Island Iced Tea casts doubt on the company’s ability to secure brand ownership rights to this term. Combined with the long odds any new beverage entrant faces in the marketplace, the overhang this uncertainty creates leads me to the conclusion that Long Island Iced Tea is not an attractive investment candidate. I fully expect it to secure new distribution agreements with local beverage distributors, as it has in the past, but the path to a sufficiently large beverage brand that can deliver actual profits will be long and hard. For me, the odds for Long Island Iced Tea are simply too long.
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