Coke gulps Pepsi’s backwash in strategic reversal

February 25, 2010

Muhtar Kent failed the latest Pepsi Challenge. The Coca-Cola chief executive threw cold Dasani on his main soft-drink rival’s decision to acquire its bottling subsidiary last year. Now, surprise, Coke is copying the transaction with a takeover of Coca-Cola Enterprises’ North American bottling operations, valuing it at about $13 billion.
The about-face doesn’t mean the decision isn’t financially and strategically sound. The 1980s-era smoke-and-mirrors trick of spinning off asset-heavy businesses to focus exclusively on its secret-formula concentrate doesn’t work any more. Nonetheless, Kent looks like a charlatan for so recently dismissing the idea after Pepsi beat him to it.
The numbers seem to stack up for both Coke and its bottler. That’s a bit surprising given they also did when Coke spun it off in 1986. Coke cleverly avoids paying cash for the assets it’s acquiring. Instead, it will cancel its 34 percent stake in Enterprises, worth $3.4 billion; assume $8.9 billion of debt on which it can take a tax shield; and absorb about $600 million of unfunded pension liabilities.
In return, Coke gets control of a bottling system that needs to adapt. The separation of the bottler from the concentrate was applauded by Wall Street at the time, when fizzy drinks were fashionable and the Wal-Marts of the world didn’t have such huge market share.
But consumer behavior has changed. U.S. customers want a wide variety of non-carbonated beverages, which the bottlers don’t look after. And shoppers buy drinks at superstores, which are more efficiently served by fewer large trucks from warehouses rather than the 55,000 smaller ones Enterprises dispatches from bottling plants. While this will require a retooling, Coke still says it can squeeze $350 million of synergies from the deal.
So why all the glum faces from Coca-Cola shareholders? They sliced $4 billion off its market cap. True, Enterprises engineered a sweet deal. But there was only one plausible buyer for the assets, so it’s hard to argue Coke was swindled by its subsidiary. And Coke is paying about 8.5 times EBITDA — around what Pepsi paid for Pepsi Bottling.
More likely, Coke investors simply resent being surprised. While the company’s reversal of a decades-long strategy looks sensible, it came out of left field. Kent, and his predecessor Neville Isdell, pooh-poohed Pepsi’s deal. A CEO who changes his mind shows either great intellectual flexibility — or a tendency to waffle.

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