Coca-Cola (KO) has recently become a savvy asset manager, and we think recent moves speak volumes about the company’s strategy to retain dominance in the non-alcoholic beverage space for decades to come.
Coca-Cola’s management is capitalizing on what we’d describe to be the ‘Hidden Advantage‘—something more commonly witnessed in activist dealings in which small initial stakes turn into large gains once news is made public. In February, for example, Coca-Cola scooped up 10% of Green Mountain at $74.98 per share (it subsequently increased its stake to 16%). With shares of Green Mountain (GMCR) now trading at ~$115 each, the deal for just a small portion of Green Mountain looks incredibly savvy—especially in the event Coca-Cola ends up buying Green Mountain outright. Much like an activist investor, Coca-Cola is sitting on a large profit in shares of Green Mountain thanks in part to optimism about a deal that it promulgated itself.
The Coca-Cola/Green Mountain transaction led us to ponder at the time whether all M&A should proceed this way (i.e. the suitor scoop up a portion of the target’s shares on the cheap before disclosing that merger talks have begun—much like an activist investor may establish a position in a company before disclosing a stake). We received our answer, at least as it relates to Coca-Cola’s views on the topic. On August 14, the non-alcoholic beverage giant struck again, purchasing a ~17% equity stake in Monster Beverage (MNST), giving it a meaningful influence on two of the fastest-growing and most innovative segments in the non-alcoholic beverage market: coffee brewing technology and differentiated energy drinks. Though Monster Beverage has given back some of its gains, shares of the company surged ~30% on the announcement.
We give high marks to Coca-Cola’s management in consummating both of these transactions, ensuring the company’s dominance in the non-alcoholic beverage space for decades to come (if not generations). Scooping up these valuable strategic assets also makes it increasingly more likely that rivals Dr. Pepper Snapple (DPS) or Pepsi (PEP) will be more proactive in identifying innovative assets, perhaps even taking a stab at home-soda maker SodaStream (SODA). Coffee giant Starbucks (SBUX) could even consider entering such a market. SodaStream will not remain independent for much longer, in our view, and with its shares trading at the low end of our estimate of their fair value range, a suitor is likely paying very close attention. Bloomberg, for example, recently reported that SodaStream is in talks with an unnamed investment firm to go private at $40 per share (shares are trading at ~$32 each). A take-out could be months away or even sooner.
Valuentum’s Take
Coca-Cola is doing a fantastic job securing its dominance in the non-alcoholic beverage market, and we applaud management’s moves. Shares of the firm aren’t cheap, however, and we think there will be a better entry point for new money.
It’s also hard not to like Pepsi’s fundamentals, particularly with the firm’s scale in North America and the company’s valuable snacks business. The firm has nearly twenty $1 billion global brands sold in the US. Shares of Pepsi aren’t cheap either, however, and we prefer Coca-Cola over Pepsi as a dividend growth idea on the basis of the latter’s debt-heavy balance sheet (which limits financial flexibility, as we’re currently witnessing given the deals Coca-Cola has been able to land).
Starbucks’ shares have also had quite a run, and we don’t think they make much sense for the bargain hunter at present levels. Even Dr. Pepper is trading above our estimate of its intrinsic value.
One of the rare bargains in the non-alcoholic beverage space rests in SodaStream. However, if the firm is not bought out by a larger suitor, the company will inevitably face significantly greater competition from a Coca-Cola/Green Mountain combination. In what is traditionally inherent to any risk-reward scenario, SodaStream’s shares hold the most risk and the most reward.
We’re not making changes to any position in the Best Ideas portfolio and Dividend Growth portfolio at this time.
KO-MNST deal notes: Pursuant to the terms of the transaction agreements, at the closing, The Coca-Cola Company will make a net cash payment of $2.15 billion and transfer its worldwide energy business to Monster. In exchange, Monster will issue to The Coca-Cola Company the shares of Monster common stock, transfer its non-energy business to The Coca-Cola Company, and enter into expanded distribution arrangements. The transaction, which is expected to close late in 2014 or early in 2015, is subject to customary closing conditions, including receipt of regulatory approvals.