Bloomberg News

PepsiCo Poised for 49% Gain Imitating Kraft Breakup: Real M&A

September 21, 2011

Sept. 21 (Bloomberg) -- PepsiCo Inc. shareholders stand to reap a 49 percent gain if Chief Executive Officer Indra Nooyi splits the soft drinks business from snack foods, joining a wave of breakups from Kraft Foods Inc. to Tyco International Ltd.

PepsiCo, the world’s largest snack-foods maker and second- biggest soda producer, fell 9.7 percent to $60.39 in the past year through yesterday, wiping out almost $11 billion in market value. The shares trailed a 22 percent jump for Coca-Cola Co., the largest soft-drinks maker, and a 9.3 percent advance for Kraft, the No. 2 food company, according to data compiled by Bloomberg. Dividing Purchase, New York-based PepsiCo’s soda and Gatorade unit from Doritos and Lay’s chips may value the combined entity at $90 a share, Edward Jones & Co. said.

Breakups are accelerating as Kraft prepares the spinoff of its North American grocery unit to focus on snack foods, Tyco disclosed plans this week to split in three and McGraw-Hill Cos. said it will separate education from financial ratings. With U.S. soft drinks maker Dr Pepper Snapple Group Inc. soaring more than 52 percent since its 2008 spinoff, separating PepsiCo’s more profitable snacks from drinks that are losing market share in the U.S. may also lead to a higher valuation, according to Sanford C. Bernstein & Co.

“I’m sure Pepsi’s facing some pressure,” given Coca- Cola’s stock outperformance, said Jack Russo, an analyst for Edward Jones in St. Louis, in a telephone interview. “You go through these cycles where you build empires and you break them apart. We’re going through a cycle where the investment bankers are convincing companies smaller is better and the sum of the parts is worth more than the whole.”

New Snacks Initiative

PepsiCo’s shares climbed as much as 2.1 percent today and were up 1.8 percent to $61.49 at 10:04 a.m. in New York.

“The combination of our snack and beverage portfolios creates significant value for our shareholders through synergies driven by a common customer base and distribution platform, supplier leverage and shared infrastructure,” PepsiCo said in an e-mailed statement yesterday. “The value of this combined portfolio has been greatest in our international markets, which share many activities; and we are now well positioned to realize further benefits in North America following the successful integration of our bottling business.”

PepsiCo also said it created two new groups to market snacks and drinks together and guide snack innovation. The Power of One - Americas Council and the Global Snacks Group will both be run by John Compton, who will retain his role as PepsiCo Americas Foods CEO. The company also reiterated its full-year profit forecast from July.

Market Value

PepsiCo’s market value had dropped to $95.6 billion as of yesterday from $106.4 billion a year ago, while Atlanta-based Coca-Cola’s climbed $28.3 billion to $162.2 billion, data compiled by Bloomberg show. While PepsiCo shares have declined in the past year, beverage rivals Coca-Cola and Dr Pepper and food competitors including Kraft, General Mills Inc., Hershey Co., Kellogg Co., Danone and Unilever have all gained.

The Standard & Poor’s Consumer Staples Index increased 10 percent in the past year through yesterday.

PepsiCo, which reached a peak market capitalization of $128 billion in January 2008, has faced rising commodity costs for plastic packaging and ingredients, a declining share of the American soft drink market and difficulty pushing prices higher amid a slowing recovery in the wake of the U.S. recession.

The shares fell 7.5 percent through yesterday since Nooyi, now 55, became CEO in October 2006, beating a 10 percent drop in the S&P 500. Coca-Cola climbed 58 percent in the same period.

Commodity Prices

The company’s beverages and snacks would be worth more apart because commodity price swings and market share losses in one operation reduce the value of the entire company, Ali Dibadj, a New York-based analyst for Bernstein, said in a phone interview. The two units attract different types of shareholders, he said.

“There’s a large chunk of the company that’s just suffering, which is the North American beverage business, and that’s dragging down the rest of the company, which is doing OK,” Dibadj said. “The point of the split is that you’re not getting the benefit of being together.”

In 2008, Cadbury Schweppes Plc, then the world’s largest candy maker, spun off its American soft-drink business under pressure from billionaire investor Nelson Peltz. Since then, shares of Dr Pepper, the Plano, Texas-based maker of 7Up and Canada Dry, gained more than 52 percent through yesterday, giving it a market value of $8.3 billion.

McGraw-Hill, Tyco

McGraw-Hill, based in New York, disclosed Sept. 12 that it will divide its global markets, including Standard & Poor’s ratings and J.D. Power and Associates, from its textbook publishing. This week, Schaffhausen, Switzerland-based Tyco said it will split into three companies focused on making industrial valves, home security systems and commercial smoke detectors.

Kraft plans to separate its North American grocery unit to give the Northfield, Illinois-based company’s snack foods business, including Planters nuts and Oreo cookies, flexibility to expand in emerging markets. The Aug. 4 announcement prompted some equity analysts to explore the financial benefits of PepsiCo following suit.

“We believe Pepsi management is watching Kraft’s strategic moves to see how it unfolds,” Ann Gurkin, an analyst for Richmond, Virginia-based Davenport & Co., said in a phone interview. “A split would definitely unlock value for Pepsi shareholders. They’re very valuable franchises.”

Sum of Parts

In a breakup, PepsiCo’s snacks could be worth about $50 a share and the beverage business may be valued at $40 a share, based on a sum-of-the-parts model from Edward Jones’ Russo. At $90 a share, that’s 49 percent higher than the company’s closing price of $60.39 yesterday.

Bill Pecoriello, CEO of Stamford, Connecticut-based Consumer Edge Research LLC, estimates that PepsiCo’s beverages may command an enterprise value of as much as $55 billion and the snacks business may be worth $80 billion, assuming it takes on no debt. That means the pieces combined may be worth about $70 a share, he said.

The company is worth at least $72 a share, based on a sum- of-the-parts analysis by Bernstein’s Dibadj. That’s 19 percent higher than the closing price yesterday.

Still, PepsiCo may reach $74.73 a share on its own in the next 12 months if the company remains in its current structure, based on analysts’ stock price estimates compiled by Bloomberg.

‘Sluggish Period’

“Whenever you have a sluggish period in the market, there are more calls for getting quicker gratification and quicker returns,” Hank Smith, chief investment officer of Haverford Trust Co., which manages $6.5 billion in Radnor, Pennsylvania, said in a telephone interview. “The shareholder that has a three- to five-year outlook is probably better off with Pepsi and Frito-Lay together as opposed to apart.”

He helps oversee about 900,000 shares of PepsiCo, which his firm has invested in for 15 years, and more than 600,000 Coca- Cola shares, an investment dating back to 1979.

More than half of PepsiCo’s $58 billion in revenue last year came from the U.S., where soft drink sales are growing more slowly than in emerging markets, data compiled by Bloomberg show. Coca-Cola generated 32 percent of its $35 billion in sales from the U.S. and Canada.

“Coke is just so dominant outside the United States,” Don Yacktman, president of Austin, Texas-based Yacktman Asset Management Co., which counts PepsiCo as its second-largest holding, said in a phone interview. “Some places I like to say, ‘You can have a Coke or you can have a Coke.’”

Diet Coke

Coca-Cola, which doesn’t have a food unit, has performed better in the stock market recently because it generates revenue from more countries, said Haverford’s Smith.

Diet Coke surpassed Pepsi-Cola as the second-best-selling soft drink in the U.S. last year, according to data from trade newsletter Beverage Digest. Coca-Cola remained No. 1. Total revenue at Coca-Cola is projected to climb 33 percent this year, versus a 15 percent increase at PepsiCo, according to analysts’ estimates compiled by Bloomberg.

PepsiCo’s Frito-Lay business in North America, which sells Ruffles potato chips, Doritos tortilla chips and Rold Gold pretzels, brought in $13.4 billion in revenue last year, or 23 percent of the company’s total sales.

‘Sensible for Years’

“I’d say if it was a standalone company, Frito-Lay North America might well be the best consumer products company,” PepsiCo CEO Nooyi said on the company’s July 21 earnings conference call. On the other hand, the overall beverage business in North America “is not a business that as a category has been sensible for years,” she said.

A split would give the food division the capacity to pursue global acquisitions and boost market share, said Consumer Edge’s Pecoriello. PepsiCo will likely increase marketing spending to shore up both businesses before weighing such a move, he said.

A breakup is “likely a consideration down the road,” he said. “Investor concerns over the beverage business have weighed down the valuation of PepsiCo as a whole. The valuation of the two separate pieces is greater than the whole as it’s currently valued today.”

--With assistance from Mohammed Hadi in Hong Kong. Editors: Sarah Rabil, Daniel Hauck.

To contact the reporters on this story: Duane D. Stanford in Atlanta at dstanford2@bloomberg.net; Devin Banerjee in New York at dbanerjee2@bloomberg.net; Tara Lachapelle in New York at tlachapelle@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Robin Ajello at rajello@bloomberg.net.


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