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Proposing a Value-Enhancing Deal for PepsiCo

Wednesday - 7/3/2013, 2:51pm  ET

PepsiCo has outperformed most of its peers over the past 12 months. After trailing Coca-Cola for a long period of time, the company has caught up and now trades at a very small discount to Buffett's favorite company.
There are two explanations for such overperformance. First of all, last year PepsiCo presented a medium-term strategic plan, which was followed by good operating results. Secondly, the market is expecting a large-scale strategic change. Here I will focus on the much-awaited strategic change. Specifically, I will analyze the possibility of PepsiCo dividing itself into one food (snacks) company and another beverage company. I think that if this were to happen many other enterprises would be interested into merging with those separate entities.
Here, I will examine the pros and cons of a possible merger of PepsiCo's beverage business with Anheuser Busch InBev , which already distributes PepsiCo beverage products in various parts of Latin America, such as Brazil and Argentina. But first, I will review the pros and cons of a potential merger between PepsiCo's food business with Modelez International .
The absolute world-wide snacks powerhouse.

If PepsiCo's food business would merge with Modelez International, I see a number of significant pros.

- Global top-line of $68 billion would make this food company the world’s second largest.
- The combined advertising budget would be as large as $3 billion, which would be one of the largest in the food industry .
- Modelez would get a better exposure to emerging markets while both companies could cut costs in developed markets.
- The two companies could leverage their unique market position through combining their  procurement and R&D platforms. The combined R&D budget could go as high as $700 million (the second largest in the food industry).

Cons: There is essentially one--high break-up costs. According to Mondelez's filings, the total break up costs at the Kraft-Mondelez de-merger were as high as $2.7 billion. Taking into account that deal, Credit Suisse's analysts calculate that de-merging PepsiCo would come with one-time costs that could go as high as $2.1 billion (the calculation is made by adding up on-going synergies that do exists between PepsiCo's food and beverage units).

A marriage that could be extended from Latin America to the world.
As I mentioned before, Anheuser Busch-InBev already is (though its subsidiary Sao Paulo based subsidiary AmBev) PepsiCo's biggest bottler. Hence, the combination of these two companies would be a natural one. Besides, Anheuser Busch-InBev is an expert in slashing costs and streamlining operations, which is exactly what PepsiCo needs in the U.S.


- Scale in emerging markets particularly where both beverage companies have strong market share presence (Latin America, China,and Russia).
- Distribution synergies would be a big plus.
- Both companies have already a partnership where they jointly purchase goods and services (such as IT Hardware) in the United States. Besides, both have recently teamed up on joint promotions and retail marketing. A full merger could be a natural extension of the relationship that these two companies already have in place.
- Following what has been done in the beer industry, PepsiCo could move to a model where only distribution is outsourced. This means that, in the U.S., a lot of the manufacturing could be kept in-house and consolidated to much larger facilities.

Cons: Again, mainly break-up costs (estimated at $2.1 billion).
The bottom line
Assuming that PepsiCo "de-merges" and both the remaining separate entities (food and beverage) are acquired at average M&A multiples, PepsiCo's shareholders could benefit hugely. I estimate that if the food business is bought at 14 times EV/EBITDA and the beverage business is bought at 14.5 times EV/EBITDA, taking off $2.1 billion in break-up costs from the total, PepsiCo shares should be valued at $97 (a 17% upside from current market prices).
That said, if the current company breaks up without someone else picking up the pieces, a de-merger would be a disaster. The company would have to pay more than $2 billion in break-up costs and then would lose a lot of currently existing synergies between the two businesses (above all in the U.S.). If I was a shareholder, I would vote for a break-up only if buyers could be found right next to the exit door. 

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This article was originally published as Proposing a Value-Enhancing Deal for PepsiCoon

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