While PepsiCo CEO Indra Nooyi has said she doesn’t want to split Pepsi up (into snacks and beverages) and has criticized the idea of doing deals for the sake of doing deals (click HERE from 19:50 onwards), “she may be open to an acquisition of the entire company,” speculated Bernstein analysts in a June 12 note to investors.
They also noted that anti-trust concerns would be minimal given that only an estimated 1.5% of PepsiCo’s global sales overlapped with Kraft Heinz, which is owned by 3G Capital - a Brazilian private equity firm led by billionaire Jorge Paulo Lemann, and Warren Buffet’s investment vehicle Berkshire Hathaway.
“We believe an acquisition of PepsiCo would offer top-line stability, cost-cutting potential, asset-light opportunities, and a management willing to talk.”
Ruthless cost cutting, or an ‘ownership mentality’?
But why a deal now? 3G has been aggressively slashing costs at Kraft Heinz following the merger in 2015 such that there is little fat left to trim, while revenue growth has remained elusive, likely prompting 3G to explore new acquisitions to keep shareholders happy, noted the analysts.
If Unilever was not enthused by the prospect of getting into bed with Kraft Heinz, PepsiCo (along with General Mills, Mondelez, Campbell Soup, Kellogg and Mead Johnson) has been cited as an alternative target; although cynics might argue that breaking up Kraft Foods Group on the grounds that its grocery and snacks businesses would be better off run separately, and then buying back another snacks business - Frito-Lay - flies in the face of that logic.
And while 3G has a reputation for ruthless cost-cutting, acknowledged Bernstein, “It’s not just cost-cutting; it's about treating the company's money as if it were your own, having an ownership mentality,” they wrote.
“This certainly means underspending one's competitors in costs like corporate support functions, nonworking media, marketing investments with poor ROI, general overhead, and anything else that doesn't drive profitable sales. However, it also means outspending one's competitors in all costs that do – marketing investments with good ROI, consumer analytics, IT systems, and above all, great people."
Refranchising bottling and distribution?
So where are the opportunities to drive value from an acquisition?
“The first, and most obvious” move, claimed Bernstein, “would be a refranchising of PepsiCo’s North American Beverages segment's bottling and distribution business… Certainly we have been advocating for a number of years that Coca-Cola move more quickly with its own refranchising, recognizing the benefits of an asset-light structure in terms of higher margins, higher returns, and lower capital-intensity.”
Second, Frito Lay North America could retain its direct store delivery (DSD) model, but potentially outsource or sell the delivery business to third party logistics companies, while retaining control over the “street-level relationships between sales reps and store managers,” speculated Bernstein.
Frito-Lay snacks business ‘already pretty lean’
While the Frito-Lay business “is already fairly lean,” so may not have a ton of fat to trim, it’s the crown jewel in PepsiCo’s portfolio, “delivering strong and consistent organic sales growth, as well as margin expansion in seven out of the last eight years,” Bernstein noted.
“With a dominant market share position in many attractive categories (nearly 50% overall share, and over 70% share in several), strong brand equity (Lay's, Fritos, Cheetos, Doritos, Tostitos, etc.) and a well-established, ubiquitous distribution network, this is clearly an attractive business.”
Internationally, meanwhile, the snack business “has a long runway of growth, given per capita expenditures /consumption that are substantially below domestic levels,” added Bernstein.
As for beverages, while carbonated soft drinks (CSD) volumes have been steadily dropping in North America (Nielsen data from Wells Fargo shows CSD unit sales excl energy down 1.3% YoY in the year to May 20 with PepsiCo's unit sales down 3.8% over the same period) this has been offset somewhat through price increases, and a focus on smaller, higher-priced cans and 20-ounce PET bottles, over 2-liters and 12-pack cases.
“Thus we think that CSDs can continue to be a steady category with modest growth over time in North America," said Bernstein. "Non-carbonated/still beverages are expected to grow meaningfully faster than CSDs [Nielsen data from Wells Fargo shows unit sales of sparkling flavored water +16.6% YoY in the year to May 20, while bottled water was up 7.9%], which will be the key driver of the +3-4% revenue growth we model for PepsiCo’s North America Beverages segment over the next several years.”
Wrench in the works?
One potential wrench in the works is that the Kraft Heinz deal involved Warren Buffett, who has a 9% stake in Pepsi’s biggest rival, Coca-Cola, added the analysts.
“[However], we think there are enough strategic and financial merits to a potential transaction for investors to contemplate its possibility as one of the most likely.”