- Coca-Cola's balance sheet hides $9+ billion of value in its equity holdings.
- This equity cannot be unlocked until sold or a debt issue is raised against the holdings.
- Coke is in a much better liquidity position than is widely believed due to this equity value.
Much is made of Coca-Cola's (NYSE:KO) rising debt in the context of core business declines, a switch by consumers to healthier beverage options and a myriad of other concerns. In this kind of environment debt can be toxic if taken on too quickly or at onerous rates. Coke has done neither of those things but the fact is Coke's long-term debt has roughly quadrupled (!) in the past five years as the company has taken advantage of historically low rates. While I don't think debt has hit an inflection point yet, in perusing the company's most recent 10-K, investors may fail to realize there is actually some hidden value on Coke's balance sheet that could help the company out of jam, should the need arise, or to simply be opportunistic with acquisitions.
If investors carefully read the notes to the financial statements, Coke points out that its equity investments in Coke bottlers around the world are carried on the balance sheet at their cost. This carrying value, if all goes well, becomes obsolete as time passes and the value of the holdings rises. However, accounting rules prevent a company from marking up the value of such holdings on the balance sheet and thus, the only way to unlock the value is to convert the holdings to cash by selling the holdings. As a result Coke breaks this out for us so we can understand its actual position in these companies instead of the holding value, which has virtually no meaning for shareholders.
This table from the 10-K depicts Coke's equity holdings in several Coke-related businesses around the world, seven in all, and also shows the difference between the carrying value and their respective fair values as of the end of 2013. The difference is staggering as the seven positions are held at a value of $5.76 billion but are actually worth $14.91 billion based upon quoted prices, or a difference of $9.16 billion. This is a tremendous amount of hidden value that Coke could unleash if needed at some point.
This is terrific but what does it mean for shareholders? First, it means that Coke picked some great investments. Not only are these investments much higher in value than when they were purchased but they also produce a significant amount of net income each year, more than $600 million in 2013. Thus, these investments are great in two ways for shareholders. But in the context of the debt discussion, these investments provide Coke with a means to pay off debt, raise additional cash or borrow against these holdings' fair values in the event it sees the need.
An additional $9 billion on the balance sheet allows Coke tremendous flexibility it wouldn't otherwise have as that is roughly half the amount of cash and equivalents Coke had at the end of last year and the same can be said for long-term debt. If Coke wanted to finance a share repurchase, a larger dividend or an acquisition, it could use the value of these holdings in order to make it happen without taking on undue risk.
I don't think Coke is interested in selling these holdings outright because, as I said, they collectively produce an enormous amount of income each year. Giving up $600+ million in annual income is not desirable so this would only be a last resort, a situation Coke is far from at this point. However, Coke could very well borrow against the value of these holdings as a cheap way to take on additional leverage for whatever purpose it chooses. With the value of these holdings to be verifiable via public exchanges and the fact that they produce reliable income, a debt issue linked to these holdings would be very well received and likely oversubscribed. These holdings aren't some murky, level 3 estimation of fair value; they are real businesses with confirmable prices.
The point of this discussion is to unmask the enormous amount of value on Coke's balance sheet that may be hidden from view for some investors. Not only is there enormous value but the fact is that Coke could very cheaply borrow against these holdings in the future if an opportunity arises to make an acquisition or another partnership, such as the Green Mountain (NASDAQ:GMCR) deal. With these investments producing significant income it is unlikely they'll be sold but the prospect of very cheap, collateralized debt against these investments would be enticing for debt investors and Coke shareholders alike, allowing Coke to earn attractive returns with the debt. The situation now doesn't afford Coke the opportunity to unlock this hidden value but a debt issue against these holdings would allow Coke to use its equity gains without having to sell out of its positions.