The market has doused beverage stocks after Keurig’s acquisition of Dr Pepper Snapple Group sent gyrations through the space.
Shares of Dr Pepper Snapple have surged 24% since the trading session before the acquisition announcement. Meanwhile, share prices have dipped 7% for Coca-Cola, 6% for Monster and 5% for Pepsico. But analysts and experts alike have questioned the advantages of an $21 billion Keurig-Dr Pepper pairing, which may be short-lived. And, as the new, formidable competitor puts Coca-Cola (KO, Financial), Monster Beverage (MNST, Financial) and Pepsico (PEP, Financial) on their toes, the new dynamic could pose bigger problems for the industry as a whole.
Keurig (GMCR, Financial)’s owner, Luxembourg-based JAB Holding Co., bid for Dr Pepper Snapple on Jan. 29. Under the terms of the deal, Keurig paid Dr Pepper Snapple shareholders a special dividend of $103.75 per share, for a cash payment of $18.7 billion. Shareholders would also receive 13% of the combined company, named Keurig Dr Pepper.
“While we broadly view the deal as positive for DPS shareholders, we continue to struggle to see significant strategic rationale for the deal,” Bonnie Herzog, managing director of equity research at Wells Fargo who has a “market perform” rating on the stock, said in a research note. “For JAB (who is to own 87% of KDP), we continue to view the deal as less a strategic business combination, and more the creation of a platform company to pursue additional M&A down the road.”
Mergers and acquisitions in the industry have been occurring at a rapid clip in recent years. In the third quarter of 2017, food and beverage companies completed 70 transaction – a 10% decline year-over-year, according to Stout Advisory. In the first nine months of the year, however, 229 transactions closed, up 4% from the same period the previous year.
JAB has also been busy building its empire. It acquired Krispy Kreme Doughnuts in 2016 and Panera in July 2017. It couldn’t resist adding Au Bon Pain to its shopping basket in November.
Allen Adamson, co-founder managing partner of Metaforce and author of “Shift Ahead: How the Best Companies Stay Relevant in a Fast Changing World,” views this trend skeptically.
“Merging solves a short-term problem, it drives some short-term profitability but for all the companies in the category – Pepsi, Coke, Keurig – the growth rate for food and beverage is not what it used to be and there’s no easy fix,” he said.
Companies are facing the longer-term problem of making their core individual brands grow to achieve more scale and make more money. Mergers and acquisitions allow them to gain profitability through other means, such as reducing headcount, increasing distribution and having one finance group control more dollars.
“The bigger you are, the more in theory in the food and beverage industry business you can drop to the bottom line – in theory,” Adamson said.
Keurig Dr Pepper will experience some benefits to its bottom line after the deal. For example, it will achieve roughly $600 million in cost synergies in addition to cost savings programs at both companies, Herzog wrote in her note. For distribution, it plans to move some Keurig warehousing to the Dr Pepper Snapple system. She also projects that the beverage giant will gain procurement benefits, such as from direct purchases where it could have two to three times scale, in addition to eliminating overlapping jobs.
Where does that leave Coke and Pepsi? They will have to focus on diversifying their brands and contending with the increasing public antipathy for sugary drinks.
“Bigger is no longer better and Coke and Pepsi are big brands,” Adamson said. “Keurig Dr Pepper is a collection of small brands, so you’re better off with a portfolio of smaller brands that you are with two big brands today.”
Coca-Cola and Pepsico dominate the market and reap much of their revenue from a few brands. As of 2015, the Coke maker had 48.6% of market share and Pepsico grasped 20.5%, according to Statista. Coca-Cola, the world’s largest beverage maker, derives roughly 73% of its volumes from powerhouse carbonated soft drink brands Coke, Diet Coke, Fanta, Sprite and low-sugar versions of its largest. It has made a herculean effort to broaden its portfolio, however, launching 500 new products in 2016 alone.
Soda composes around 25% of Pepsico’s U.S. sales and according to its annual report, it is ramping up its non-carbonated beverage offerings and alternatives.
All of the biggest companies are having to act fast to combat both the giant forged by Keurig-Dr Pepper and Americans’ increasingly tepid demand for products once thought safely ensconced. Beyond expanding their portfolios and making acquisitions, there seem to be few answers for the industry.Â
In the fourth quarter of 2017, Coca Cola eked out a 1% gain in sales of its carbonated soft drinks such as Coke, Sprite and Fanta in North America, while global volume sales dipped 1%.
Pepsi saw carbonated soft drinks volume sink 1% in 2016, while non-carbonated beverage volume rose 7%. Overall volumes increased 1%.
Sales of all soft drinks decreased 1.2% in the U.S. in 2016, their 12th consecutive year of decline, according to Beverage Digest.
“While there might be some short-term benefits and some short-term pain for Coke and Pepsi [due to the merger], the entire category is going to have solve the problem of how to grow the category,” Adamson said.
