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  • Writer's pictureJoe Nigro

Preparing Flow for the water market of tomorrow

Flow Beverage Corporation (TSE: FLOW) is a Canadian spring water bottling company with facilities, springs and distribution channels in the US and Canada. The company brands itself as a sustainable company because instead of using plastic bottles it uses TetraPak packaging.

Flow and most “sustainable” bottlers are losing money and market share because their environmental liabilities are showing up in their costs. However, they can reinvent their business model to make use of a highly efficient vending distribution system combined with water spring acquisitions and partnerships. The results will be profits for shareholders, access to quality water for consumers and less resource consumption. We provide this blog as a means to explain our position, our understanding of the disadvantages of the current business model, and a proposition for what we believe is a fantastic value creation partnership between us.

Unfortunately, Flow’s business model is the same as that of the plethora of shelf-stable bottlers in the market. With small differences in marketing segmentation, most of these bottlers are chronically unprofitable. The lucky ones that can turn a profit have thin decreasing margins. We believe that if Flow continues with this business model (or a minor variation of it), the company will eventually destroy most of its shareholders value. In fact for many early investors that possibility is a reality already. However, we also believe that Flow is very well positioned to promote a radically different business model with extraordinary long-term economics. We call this business model spring water vending.

In a nutshell, spring water vending consists of our patented modular vending units that can be located easily in key distribution areas. These stations are filled with spring water obtained from either controlled or partnered springs. Customers can easily refill truly reusable, truly environmentally neutral bottles with spring water while paying a fraction of the shelf price. Spring water vending is beneficial for all stakeholders in the long term and has amazing economics. For shareholders, gross margins are much higher than bottled water because a key cost component is completely eliminated (bottling). The model promotes incremental acquisition and control of an increasingly scarce resource: pure spring water from Mother Earth. For consumers, water of the greatest quality can be obtained at a fraction of the current price while reducing the environmental impact of consumption. For our partners, new avenues for revenues are opened in their already existing installations. For the planet, billions of unnecessary bottles of all kinds will never need to be produced, recycled or disposed of. For local governments, it will help ease the infrastructure gap that is being formed around water distribution.

We are reaching out to you in order to propose a partnership, and combine your brand with our patented business model, to unlock an incredible untapped potential.

Flow’s problems are the water bottling industry problems

It is not necessary to delve deeply on Flow’s less than stellar performance. The company has been increasing revenue but that has not resulted in better absolute or percentage wise profits nor better economics. This has generated a tremendous loss of value for initial shareholders and people that believed in the growth potential of the company. If the business model of Flow is not changed radically the prospects are even worse given that the company cannot continue financing itself through issuance of stocks as it did before, at least not without severely diluting current shareholders. To put it simply, we believe that Flow’s performance problems stem from two sources. First, it is operating in a highly competitive, relatively undifferentiated segment of the market that requires significant marketing expenses. Second, these expenses cannot be compensated through higher than average gross margins because the segment’s competitive landscape puts a cap on price increases, and most importantly, because the company’s cost structure cannot be made efficient. Regarding the first source, market positioning, we believe our business model is based on a much less competitive segment of the market. Regarding the cost structure, our understanding is that the three main alternatives to Flow’s current business model will not solve the issue.

Outsourcing bottling

One alternative for Flow is to reduce its operating leverage and fixed costs by disposing or carving out its bottling facilities and outsource those capabilities to third parties. Although Flow may benefit from increased efficiencies of its managements’ time and reduced cash requirements, we believe the cost of bottling will be charged by third parties anyways. Fortunately, there is an available example of a public company that operates mostly in the same way as Flow but that has outsourced its bottling operations. That company is the Alkaline Water Company (NASDAQ:WTER). As can be appreciated from the table below, WTER’s gross margins are not much better than those of Flow, because bottlers still have to charge the operations’ costs to the company. Not only this, but WTER has also significantly increased revenue while not being able to generate sufficient gross profits to cover the marketing and general expenses the model requires to operate in such a competitive market.

Replacing the packaging

We believe that using TetraPak packaging does not provide customers with significant value while exposing Flow to a semi monopolistic provider that has significant pricing power. However, WTER also provides a counterexample to the benefits of such a replacement. As has been shown, although WTER has to pay a much lower price for its packaging materials, its margins are not very distant from those of Flow.

The problem (for companies and the planet) is bottling itself

The common denominator behind the failure of WTER and Nestlé’s water division, and also behind Flow’s failure, is the cost generated by selling water in small packages, irrespective of their materials, namely plastic, glass or composite based. Costs across every operating section of the company is increased by having to deal with enormous amounts of disposable packages. This has effects on bottling operations, sourcing, inventory management and channeling decisions. We also believe that the economics behind using disposable small size packages are going to deteriorate in the future, with the main components of these packages becoming ever more scarce and expensive. The recent increase in commodity prices, and its eventual translation into package prices will probably be the harbinger of massive failures across the industry, with companies incapable of translating package costs into retail prices. In addition, the environmental cost of disposable small packages for something as massively consumed as water is enormous. Leaving marketing and greenwashing aside, the materials composing the package make little difference in the total environmental cost of the operation. Glass, plastic or composite, all packages require enormous resources for production, transportation, filling, distribution and disposal. Flow will not be exempt from increasing customer awareness that consuming water in such small non-reusable packages, independently of their material, is extremely detrimental for the environment and the economy as a whole. We understand that Flow’s management is aware of this trend, as it is listed as one of the main operational risks in the company’s annual information report.

Flow is underutilizing its most valuable resource, the springs

Flow’s true differentiator and truly scarce economic resource are the water springs it controls. Not only customers are willing to pay more for better quality water, but also Flow benefits from controlling an increasingly scarce resource, instead of being damaged by its non-control of another scarce resource (packaging). However, Flow is completely underutilizing this resource. As the latest annual information report mentions, Flow is currently utilizing less than 7% of the capacity provided by the two springs it owns. We believe that a very simple, easy and fast way to improve Flow’s cash flows and profitability is to start commercializing the spring water directly from the spring to other bottlers and users. With almost negligible incremental costs, the company can open a source of revenue. Most importantly, we understand that Flow’s business model has to have water spring ownership as its core. This requires not only making the best use of the currently available spring water, but also generating opportunities and cash flows sufficient to acquire other springs in the region while competition for them is relatively low.

The spring water vending model

Both requirements, the need to abandon non reusable packages and the need to utilize and acquire water springs, have led us to the spring water vending model.

The model is simple: install our modular vending units in convenient spots across cities, like gas stations and supermarkets. Customers refill their reusable one, two and a half and five gallon bottles in the stations and connect them to simple dispensers in their houses. The company refills the storage tanks with pure spring water from either acquired or partnered sources. Some of the benefits of our business model:

  • Cheaper for consumers: customers can get spring water at only $1.3 per gallon, much cheaper than the same volume sold in single use packages

  • Gigantic margins: we calculate an average in-the-station cost per gallon of $0.13, depending on location, which translates into 70% to 80% gross margins.

  • Low capital requirements: our patented storage stations can a minimum of 3,000 gallons of spring water with a footprint of 160 square feet. No facilities are needed, as tankers can drop directly from the sources.

  • Cut the middlemen: all the benefits shared by customers and shareholders are obtained from eliminating all the middlemen that provide little value. The model does not suffer from powerful suppliers or distributors across the chain.

  • Standard atomized sourcing partners: the same standardized contract can be used across the country with different spring owners.

  • Standard atomized distribution partners: the distribution kiosks can be located in gas stations, supermarkets, parking lots, etc. Focusing on mom and pop partners we can avoid the negotiation power of the big retail outlets, and let them look for us when it is their necessity, not ours.

  • Unlock accretive acquisition of springs: currently springs owners tie the value of their springs to the value that can be obtained from the water, which is constrained by single use packages.

  • Own the scarcest resource on earth: the model provides for sufficient cash flow to incrementally lease, partner or acquire springs, and springs are poised to increase in value as a semi renewable resource with ever expanding demand.

  • Easy on the environment: there is probably no simpler, leaner way to obtain water from the source directly without any non value creating activities. Customers will understand that the costs saved on the environment are translated to them, in the form of cheaper higher quality water. Taking care of the environment should not be the more expensive, but rather the cheaper alternative.

  • Spectacular for local governments: the model solves the infrastructure problem faced by governments with horizontally expanding cities. Instead of spending millions in pipelines that contaminate the water and have bad scale economics, why not finance the installment of kiosks that have the same cost independent of location or population density?

Our proposal, partner with Maslow Capital

We own the modular vending system intellectual property and manufacturing of these units while you own the springs and brand. Our proposal, which was already discussed with your team months back, is to license the vending system, giving you the exclusive rights in the region adjacent to both your springs where refilling is economically profitable. You will be able to utilize your brand at the kiosks, increasing awareness of your company’s pursuit for a more sustainable future. The capital expenses required to build and install the kiosks are not significant and can be easily covered by making a more intensive use of your springs. Additionally, these modular vending units are mobile which allows you to access different markets with a flip of a switch if needed. Once the kiosks are dropped and plugged in, its economics will provide you with much better margins than any bottler can achieve. You will also be the first movers in your region for this market segment while providing the highest quality of water at a fraction of the cost from any competitor. We also believe that your entrance into this new market segment will benefit you in the search for additional capital that you may need for your existing businesses. We understand that your latest share issues were done at much higher prices than what the stock is trading at today. The announcement of a new complementary strategy will be important to renew investor confidence in the company and provide you with better terms for a capital infusion, protecting existing shareholders from undeserved dilution. From our perspective, partnering with you has three important benefits. First, your brand is an important player in the bottled spring water segment, providing increased awareness among other spring owners and bottlers across the country. Second, your company is public, therefore the improvements in margins and the advantages of our business model will be clear for all market participants to see. Finally, the quality of your water is excellent, which for us is the most important requirement when considering partners, as we believe that the true potential of our business model can be better used offering the highest quality of water for a fraction of its current cost.

As investors and entrepreneurs in the future of water, we hope you hear us out with this innovative business model and take action with us. Our goal is to transform the overall water industry by generating better margins, lowering consumer prices for high quality water and protecting against contaminative effects of single-use packaging for the environment.

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