Pepsi's About-Face

Includes: CCE, KO, PAS, PBG, PEP
by: Ockham Research

“$6 billion dollar deals, right, Pepsi could be buying two separate firms…if it happens. Bottling operations, sort of an about face I heard an analyst call it. What happened there, PepsiCo about ten years ago, spun off these capital intensive bottling operations. If you don’t know the bottlers actually buy the concentrate from Pepsi, along with the syrup and then add the water and other ingredients to make what we know as Pepsi and the other soft drinks that they produce. Well, these are capital intensive operation’s they spun them off, but now they want control back of those.

The whole market out there is changing, soft drink sales are down and non-carbonated sales are what happened here, so Pepsi cola will buy the two biggest bottlers for $6 billion in cash and stocks and $29.50 for Pepsi Bottling Group $23.27 a share for PepsiAmericas, both are 17% premiums to where those bottlers stock prices closed in Friday’s trading session. The deal basically would give about 80% control to PepsiCo of its North American operations, it’s biggest operations in the world and would really reshape its business model in a changing environment out there.” Fox Business Network 4/20/2009Ockham historical valuation PAS

That was part of a longer discussion related to one of the big stories of Monday morning; Pepsi (NYSE:PEP) made an unsolicited offer for its two largest bottlers Pepsi Bottling Group (PBG) and PepsiAmericas (PAS). This represents a major change in Pepsi’s strategy as they will once again control almost the entire process of bringing their products to market. There is a lot of speculation out there about how Coke (NYSE:KO) will respond. Obviously, Coke will need to determine for themselves whether buying their biggest bottler, Coca-Cola Enterprisies (NYSE:CCE), is in the best interest of the the company. There may be more information tomorrow via Coke’s quarterly earnings report. CCE is benefiting from the speculation and activity in the sector as shares are up nearly 2%, while the rest of the market flounders. Ockham historical valuation PBG

Interestingly, both PBG and PAS are trading higher than the offering price as the market thinks that perhaps the bottlers will ask for a little richer valuation than the first bid. By our valuation methodology, PBG was Fairly Valued prior to the offering but PAS was actually Undervalued. Based on what the market has historically been willing to pay for PAS price-to-sales and price-to-cash flow, we think they could actual be worth as much as $27.50 per share based on the current fundamentals.