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Coca-Cola Follows PepsiCo's Lead and Buys Its Largest Bottler

By , Associate Editor, Money Morning •

The soda rivalry continues as Coca-Cola takes a page out of PepsiCo's playbook.

The Coca-Cola Co. (NYSE: KO) plans to buy the North American operations of its largest bottler Coca-Cola Enterprises Inc. (NYSE: CCE) in a $12.3 billion deal. This move comes 24 years after Coca-Cola separated from bottling giant CCE, and six months after PepsiCo's similar purchase of its two largest bottlers.

Coke's initial strategy of separating market and beverage development from product and distribution was initially used to free up the segments' respective balance sheets, while using regional bottlers as a gateway to local retail markets. However, changes in consumer tastes have led to a decline in soda sales, meaning business must change, too.

Coca-Cola Chief Executive Officer Muhtar Kent asserts the deal is not a strategy reversal, but instead a strengthening tactic to remain competitive.

"It is not a reversal at all, it is actually fully in-line, we have said all along that CCE continues to be a very important, key partner for us in one of the most key markets, which is Europe and that's why this makes so much sense for us," said Kent, in an interview on CNBC.

CCE will get Coke's bottling operations in Norway and Sweden, worth $822 million, and will also have the rights to buy Coke's German bottling and distribution business. CCE will give shareholders $10 per share cash and one share in a new Europe-focused CCE to operate under the same name.

Coke will give up its 34% stake in CCE, valued at $3.4 billion, and assume CCE's $8.9 billion in debt.

According to the press release on Coca-Cola's website, the deal will generate $350 million in Coke's "operational synergies" over four years, and add to earnings by 2012. 

PepsiCo Inc. (NYSE: PEP) spun off its bottling operations in 1999 - 13 years after CCE went public - and created Pepsi Bottling Group Inc. (NYSE: PBG). But PepsiCo was ahead of Coke in August 2009 when it bought Pepsi Bottling Group and PepsiAmericas Inc. (NYSE: PAS).

PepsiCo's move reflects a carbonated-beverage market that is losing popularity. Soft-drink sales have struggled, declining yearly since 2005. CCE reported a 10% sales volume decline in North America last year.

Combining operations in-house will allow Coke and PepsiCo to regain control over distribution decisions to retail customers, increase flexibility when catering to evolving consumer trends, simplify sales procedures and reduce costs after manufacturing reorganization.

"They're going to be able to ship these directly to warehouses instead of going through the bottlers, which then has to go straight to the retailers," David Silver, equity research analyst at Wall Street Strategies, told CNBC. "So that's where they're going to be able to save not only the fuel cost, but distribution cost."
Coke is also eliminating the often-strained relationships between beverage companies and bottlers; they argue over product pricing, sales sharing and marketing costs.

"Our new North American structure will create an unparalleled combination of businesses, which will serve as our passport to winning in the world's largest nonalcoholic ready-to-drink profit pool," said Kent. "With this transaction, we are converting passive capital into active capital, giving us direct control over our investment in North America to accelerate growth and drive long-term profitability."

Whether or not it's a reversal or a restructuring, many investors and analysts have greeted the decisions with skepticism. Bottling and distribution operations come with steep capital requirements, and these deals are pricey.

"This decision will make less cash available in the immediate future for stock buybacks and dividend increases and represents a big gamble," said Money Morning Contributing Editor Horacio R. Marquez. "My bias is against the added complexity and capital requirements involved with the Pepsi deal. But we can never count out Pepsi's innovation and resiliency, and so we will give them the benefit of the doubt."

Morningstar Analyst Philip Gorham communicated similar hesitancy in supporting Coke's deal.

"Our initial reaction is that this move makes strategic sense for Coca-Cola, and we had expected the firm to follow Pepsi's lead, he said. "With Pepsi having already made a similar move, we think Coke was forced into this acquisition by fear of allowing Pepsi to win a competitive advantage through flexibility in its route to market. However, Coke appears to have paid a very rich price, in our opinion, so we are placing [Coke and CCE] under review until we have fully examined the implications of the proposal."

Shares of CCE were up 33% after the acquisition announcement Thursday. Coke shares fell 3.5%.

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