June 4, 2008: 12:09 AM EDT
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Food's next billion-dollar brand?

Industry veteran Steve Hughes is out to turn Smart Balance into a household name.

By Matthew Boyle, writer

Smart Balance wants to expand its brand beyond margarine and peanut butter.

(Fortune) -- Success has followed Steve Hughes wherever he has roamed in the food industry the past two decades.

In 1988, Hughes spearheaded the launch of ConAgra's (CAG, Fortune 500) Healthy Choice line of low-calorie frozen and prepared foods, which became a billion-dollar brand in just four years. He then moved to Tropicana, where he turned around the orange juice maker's struggling U.S. business over a similarly short period. Since then, Hughes has also worked his marketing magic on brands like Celestial Seasonings tea and Silk soy milk - once niche products that have now gone mainstream.

Today, Hughes is betting that he can take another small, fast-growing, good-for-you product and turn it into a billion-dollar brand with a wide assortment of items found all across the grocery store. But it won't be easy - he'll have to battle entrenched, deep-pocketed competitors, sky-high commodity prices and increasingly pinched consumers to do so.

The brand is Smart Balance (SMBL), which you've probably seen in the margarine shelf next to products like Shedd's Spread and I Can't Believe It's Not Butter, both made by Anglo-Dutch consumer products giant Unilever (UN). With 13.5% market share, Smart Balance sits behind those two Unilever brands as the No. 3 player in margarine, a $1.2 billion retail category.

While it's not the biggest brand in margarine, Smart Balance has an edge on its rivals in that it's made with a patented blend of vegetable and fruit oils that has been shown to raise levels of HDL, or "good" cholesterol, which can help improve consumers' cholesterol levels. The blending process was discovered by food scientists at Brandeis University over a decade ago, and is licensed exclusively to Smart Balance.

According to the American Heart Association, roughly 100 million Americans have elevated levels of cholesterol. And it's likely that many of them have chosen to stock Smart Balance in their refrigerators, as its sales have skyrocketed since its launch in 1997 while sales for the margarine category overall have stagnated.

Last year margarine accounted for roughly 70% of the company's $175 million in sales, with the remainder coming largely from peanut butter and cooking oils, which are natural brand extensions for an oil-based product. (Smart Balance also makes a line of popcorn.)

But Hughes - who took control of Smart Balance when Boulder Specialty Brands, his special purpose acquisition vehicle, acquired GFA Holdings last May - believes that Smart Balance can expand to categories such as milk, cream cheese, yogurt, sour cream and even oatmeal. He also wants to push the brand into restaurants, college cafeterias and other food service accounts.

"In a world where everyone is looking at functional products," he says, "we are positioning this as a brand that could grow to a billion dollars, a true mega-brand."

As Hughes well knows, that's easier said than done. "The success of these [new] products is not a foregone conclusion," says Citigroup analyst Gregory Badishkanian, one of the few analysts who cover Smart Balance. Analysts so far have been pleased with Hughes' basic strategy of increasing the number of Smart Balance products carried by outlets like Wal-Mart, Kroger and Safeway from 12 to 18.

But many of those new items are simply brand extensions, like Omega-3 enhanced versions of its tub margarine. Breaking into entirely new categories, like milk, is a different proposition altogether. At $11 billion, milk is by far the largest category that Smart Balance is trying to enter and a good example of the challenges it faces. Hughes says that he's figured out a way to make a fat-free milk that has the taste and texture of 2% milk. A test of the product in Florida supermarkets has gone well so far, he claims.

Yet surging commodity prices have delayed plans for a national milk launch, which was supposed to happen this year. According to the latest USDA product pricing report, dairy prices continue to rise, which has cramped profits at companies like Dean and Kraft. Hughes says soybean oil prices have more than doubled, from 30 cents a pound this time last year to 62 cents today.

Unlike margarine or peanut butter, which is dominated by nationally advertised brands, two-thirds of milk sales come from private label products, whose presence makes it tough to convince penny-pinching consumers to pay more for a premium product. That said, success as a branded player in milk is possible - just look at Horizon Organic from Dean Foods.

Another pitfall Hughes must navigate is the risk of diluting the brand by entering too many new categories too quickly, says Martin Bishop, director of brand strategy at consultancy Landor Associates in San Francisco. "They don't want to spread their promise too thin," he quips. Hughes says he's trying to avoid that: "We're taking this step by step, building the foundation."

Still, it remains to be seen whether Smart Balance's heart-healthy message (and higher prices) will resonate with mainstream consumers. "For the portion of the population that cares, it's solid," says Nick Hahn, managing director at Vivaldi Partners, a marketing and brand consultancy in New York. "I don't think you will convince Joe Six-Pack though."

Thus far at least, Wall Street doesn't seem convinced either. The stock sits at $8.08, well off its 52-week high of $14.10, and the solid first-quarter earnings the company announced in early May have done little to sway investors.

Hughes, who has brought together a well-seasoned management team with veterans of Unilever, Tropicana, and ConAgra, remains undaunted. "We're approaching the end of the beginning now," he says. "We're in second gear now, and shifting to third."

Even if it finds that higher gear, the odds are against Smart Balance becoming the food industry's next billion-dollar brand. But Hughes' track record alone means it's worth keeping an eye on. Says Bishop: "If anyone can do it, they can." To top of page

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