An energy drink with a Monster of a stock

Fueled by its caffeine drink, Hansen Natural's stock has been on a rocket ride. Now Hansen faces growing pains and an SEC probe. Is it overdue for a crash?

By Matthew Boyle, Fortune writer

(Fortune Magazine) -- The YouTube video starts with a bunch of teens horsing around. A chunky kid with glasses cracks open a Monster-brand energy drink and quickly chugs it, then doubles over clutching his stomach as he downs a second.

Undeterred, he tears into a third 16-ounce Monster. Each delivers 160 milligrams of caffeine, more than three times the amount in a similar serving of Coke Classic. Midway through the third, he spews into a plastic bag. In just under a minute he's finished all three, and he looks anything but energized.

rodney_sacks.03.jpg
Hansen CEO Rodney Sacks kept the company name (and crunchy-granola image) far away from Monster to help appeal to an audience of edgy young males.
monstertruck_220.jpg
Brand president Mark Hall has built Monster's image with extreme-sports sponsorships.
Better living through chemistry?
When you get beyond the sugar and caffeine, the ingredients in most energy drinks sound pretty arcane. Here's the skinny on some of the most popular and what they supposedly do for you.
Guaraná
A plant with high concentrations of caffeine. Contributes to the distinctive - and like it or hate it, it is distinctive - flavor of energy drinks.
Taurine
Derived from the amino acid cysteine, but unlike amino acids, taurine is not a protein building block, so its health benefits are questionable.
Maltodextrin
A carbohydrate like sugar, but made from starch, so it's less sweet. Allows drinkmakers to add more fuel without upping the sweetness factor.
L-Carnitine
An amino acid that helps transport fuel to the body's cells.
Glucuronalactone
A chemical compound produced when glucose is metabolized in the liver. Purported to fight fatigue.
D-Ribose
A sugar that aids metabolism and is a component of ATP, an energy source for cells.

The creators of Monster, a once-sleepy Southern California beverage company called Hansen Natural, wouldn't condone such behavior. But they haven't petitioned YouTube to pull the video either - or any of the other homemade homages to their sizzling flagship brand.

Four-and-a-half years after its launch Monster accounts for about 80 percent of the $600 million in sales that analysts project for 2006 and more than 80 percent of Hansen's profits. It's also entirely responsible for the stratospheric rise of Hansen's stock, which is up 6,000 percent since Monster's debut.

This year Hansen (Charts) rose to No. 2 on Fortune's Fastest-Growing Companies list, so far defying short-sellers who've insisted that energy drinks are a fad. Hansen's recent $2.8 billion market value is higher than that of nearly a fifth of the Fortune 500, and big players like Fidelity Investments and Barclays Global Investors own huge chunks of its shares.

Like the kid in the video, though, Hansen, once chugging along nicely, has recently encountered some distress of its own. The $5.7 billion energy-drink category, in which Monster holds the No. 2 position behind industry leader Red Bull, has slowed down as copycat brands jostle for shelf space - and the attention of teen consumers - alongside entrants from Coca-Cola (Charts) and PepsiCo (Charts).

To expand its national reach, Hansen has teamed with beer giant Anheuser-Busch (Charts). But the transition to Anheuser's system has slowed operations and contributed to lower-than-expected sales growth in October, which sent Hansen's volatile stock plummeting 14 percent in one day.

Sales could take another hit if the Food and Drug Administration takes aim at Monster and its ilk. There's also the matter of a Securities and Exchange Commission investigation into the timing of stock-option grants.

How Hansen responds to those issues will go a long way toward determining whether it remains a steady-growing firm or becomes the next Krispy Kreme (Charts), another Wall Street darling that grew too big, too fast.

Young and edgy

Seated outside the Sugar Shack, a popular breakfast spot in Huntington Beach, Calif., Billy Hopkins orders an Arnold Palmer - iced tea and lemonade. "It's too early for an energy drink," he explains, almost apologetically, as the late-November sun creeps over the surf shops that line Main Street.

Hopkins, 15, is a rising star on the surfing scene and as such represents the energy-drink sector's bread and butter. Before a big test at school, he'll often chug two Red Bulls, his drink of choice. (Told of the YouTube Monster guzzler, he responds as only a surfer could: "That's gnarly.")

He's heard that energy drinks aren't good for him but doesn't care, noting, "Soda is worse." The statement shows how far iconic soda brands like Coke have fallen in the public's estimation over the past few years, creating an opportunity for companies like Hansen and its CEO, Rodney Sacks.

A quick-witted South African lawyer, Sacks came to the U.S. in 1989. Along with countryman Hilton Schlosberg, now Hansen's president and CFO, Sacks gathered some investors and went looking for a business to buy. Eventually a Los Angeles investment banker told them about a little beverage company called Hansen.

Founded in 1935, the company made juices and natural sodas but was virtually unknown outside California. When Sacks and his group paid $14.6 million for Hansen in 1992, it had sales of just $17 million and a dozen employees. At first Sacks was content to chase whatever beverage trend was in vogue, but he knew Hansen's me-too products had little chance of standing out. "We needed to create something different," he recalls.

Aware of the success Red Bull was enjoying in Britain, Sacks in 1996 introduced an "energy smoothie" with ginseng, a popular stimulant partly responsible for the unique - some would say uniquely awful - taste of most energy drinks.

It sold well enough for Hansen to launch a stand-alone energy drink in 1997 (the same year Red Bull hit the U.S.), but the good-for-you Hansen name was a turnoff for young, edgy energy-drink consumers. Sacks needed a new brand.

Enter Mark Hall. The lanky salesman joined Hansen in early 1997 and soon settled on the name "Monster" after polling teenage boys and Hansen employees. Hall also decided to give consumers 16 ounces of buzz for roughly the same price as Red Bull's 8.3-ounce can. In doing so, he took a page out of beverage history. In 1934, Pepsi began selling 12-ounce bottles of cola for 5 cents, the same price charged by Coke for 6.5 ounces. A jingle reinforced the pitch: "Twice as much for a nickel too - Pepsi-Cola is the drink for you."

Guerrilla marketing

Eschewing traditional marketing avenues like TV, Hall built Monster on the backs of up-and-coming athletes in obscure sports, like freestyle motocross stud Mike Metzger, whom Hall originally paid just $600 a month. While Red Bull now sponsors NASCAR and professional soccer, Monster remains true to the fringe. "They stayed loyal to us," says action-sports agent Steve Astephen of the Wasserman Media Group, "so this industry's consumers stay loyal to them."

Hall, whose business card reads monster man, also mustered a squad of young men who cruise around in black Ford E350 vans and jockey for the best shelf space at stores nationwide. Such guerrilla tactics have helped Monster take the top spot from Red Bull in lucrative markets like Phoenix, Dallas, Chicago, Detroit and Southern California.

Red Bull's intransigence helped. When Monster and other brands launched 16-ounce cans, Red Bull stood pat. It was costly: Over the past five years Red Bull's market share in dollar terms has gone from 91 percent to well under 50 percent, according to Goldman Sachs, and much of that loss has been Monster's gain.

Only recently has Red Bull, privately held and based in Austria, responded with larger cans. Too little, too late, say analysts, and Hall predicts Monster will become the nation's top energy brand in 18 months. His boss Sacks, though, is not enthused with such forecasts and won't make any of his own.

To supplant Red Bull while fending off challengers like Coca-Cola's Full Throttle and RockStar (privately held but distributed by Coke's top bottler), Hansen inked a distribution deal with Anheuser-Busch in May. (Hansen will continue to use other distributors as well.) Both companies got something they wanted - Hansen plugged into Anheuser's extensive sales network, and Bud wholesalers, looking at sluggish beer sales, gained access to a hot brand.

But the deal poses some problems. For one, the Bud system has not proved adept at selling anything but beer. (Ever hear of Anheuser's energy brand, 180? Neither have we.) Nonalcoholic drinks are sold on credit, unlike alcohol, which is cash on delivery, so Anheuser's wholesalers will have to upgrade their financial systems to carry Monster.

In regions like Florida where Hansen has switched to Anheuser, lame-duck bottlers gave Monster and its sister energy brands no support, which contributed to that sales shortfall in October. And the companies still haven't agreed on whether Anheuser will put its full weight behind Monster in bars and clubs, where Red Bull has a commanding presence.

"It's going to take a long time to prove whether [this] was a good decision," says industry analyst John Craven. Hansen thinks the pain is worth the benefits, but the energy market's long-term health is by no means assured. Market research firm Euromonitor predicts that the category will grow at only a 7 percent annual rate from 2006 to 2010, which pales in comparison to the 61 percent clip of the past five years. Growth rates in convenience stores, where most energy drinks are sold, have already started to dip, as teens have gravitated to brands like Glacéau's Vitaminwater and teas like Honest Tea and Arizona.

Roadblocks

A public backlash against energy drinks could dampen sales further. Regulators in Norway and France have so far kept Red Bull off store shelves, and it is sold with a lengthy warning label in Canada. The FDA held a public hearing Dec. 5 to discuss vague health claims like "brain boosting" made by "functional food" companies, a rubric that includes energy drinks.

Spend time on Web sites devoted to Monster, and it's not hard to imagine an enterprising plaintiffs lawyer going after an energy-drink company if a teen ends up in the hospital after a monstrous drinking binge. "id rather go out drinking a monster than any other way & at least i would b happy," writes one deluded member of a Monster-themed Myspace.com group. Yikes.

CEO Sacks, who employs a pharmacologist, says one would have to drink at least 80 Monsters to reach dangerous levels of caffeine. (The Web site energyfiend.com calculates how many energy drinks it would take to kill yourself.)

But a new study of Illinois residents by Northwestern University researchers found an alarming number of poison-control-center calls and hospital visits from young people who had abused caffeine supplements including energy drinks.

Of more immediate concern for Hansen these days is an SEC probe into stock-option grants that has prompted an internal investigation and also delayed the full filing of Hansen's third-quarter financials. Hansen declines comment except to say it is cooperating with the SEC.

An analysis by shareholder advisory firm Glass Lewis found several instances in which Hansen delayed filing SEC Form 4's, which detail option grants. In each case, Glass Lewis says, Hansen's stock price increased "significantly" between the grant date and the filing date. Analysts don't seem that concerned, and none of the grants in question involve Sacks or Schlosberg, who together control about 20 percent of the company's stock.

Hansen's stock is currently at about $31, where it carries a valuation - 20 times forward earnings - that Canaccord Adams analyst Stephen Colbert deems "cheap," given its earnings projections, and on par with behemoths like Coca-Cola. (Hansen has traded as high as $52 this year.)

"This is still a great growth story," he says. The passionate day traders who follow Hansen's every move would agree. "Put your silly charts away and buy some stock before you miss the boat," wrote one fan whose authoritative handle is "sniffmydigits."

Short-sellers predictably beg to differ. A stock that has soared so high seems custom-made for a precipitous fall. But Hansen has burned skeptics before - MarketWatch columnist Herb Greenberg told his readers to bail on Hansen throughout 2005, only to issue a big mea culpa later on.

At its current price, Hansen is also a viable acquisition candidate, and Sacks is willing to entertain offers. Some say PepsiCo would make an ideal suitor, as its energy drinks have underperformed, while others mention Britain's Cadbury Schweppes, which distributes Monster in the U.S. and Mexico.

Whatever happens, Hansen should take this opportunity to get its own house in order. The company's headquarters, in Corona, Calif., just east of Anaheim, are in a state of chaos - Sacks' desk, for example, is buried under reams of paper and product samples, and his harried executive assistant could use two assistants of her own. "I work all day and all night," says Sacks. Such is life when you've created a monster.

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.