Pepsi's Deal for Wimm-Bill-Dann: A Rich Price for the Russian Company?

Includes: KO, PEP, WBD
by: Investment U

By Tony D'Altorio

Last month, I wrote about CEO Indra Nooyi’s changes at PepsiCo (NYSE:PEP).

The company is shifting its focus from carbonated beverages to juices, teas, sports drinks and healthy foods. By 2020, it plans to build a $30 billion global nutrition business.

Well, before it ever conceived that plan, Pepsi has also been looking into emerging markets. Now it looks set to pull off a $5.4 billion deal that gives it both.

Pepsi is paying $33 per ADR share for its initial stake of 66% of the Russian dairy and juice company, Wimm-Bill-Dann (NYSE:WBD). After regulatory approval, it will then make a public offer to the other stockholders.

In short, Pepsi is betting big on the Russian food and drinks market.

Pepsi’s Deal with Wimm-Bill-Dann

Pepsi’s deal with Wimm-Bill-Dann will mark the largest foreign acquisition of a Russian company. It would also vault Russia ahead of Mexico as Pepsi’s top international market, far above China and India.

If it goes through, Pepsi becomes Russia’s largest food and drink business. And it gains a bigger presence in Eastern Europe and Central Asia overall.

Wimm-Bill-Dann says Pepsi plans to market products from its existing plants. That includes fruit juice concentrates and some Russian-only products, such as chocolate-coated Russian cream cheese.

The move would see Pepsi leapfrog Coca-Cola (NYSE:KO) in Russia.

Research firm Sanford Bernstein estimates that the competitors now dominate Russia’s juice market. Pepsi will control over half of it, and Coke 35%.

Adding to its new nutritional business, Pepsi also gains entry into dairy, which makes up 70% of Wimm-Bill-Dann’s sales. Nooyi notes: “Dairy has a huge, untapped potential to bridge snacks and beverages. We see the emerging opportunity to ‘snackify’ beverages and ‘drinkify’ snacks as the next frontier in food and beverage convenience.”

Overall, the deal offers exposure to emerging markets and more nutritional products.

The Russian Market

Few business propositions satisfy everyone, however. So it’s no surprise that Pepsi’s bold expansion plans don’t sit well with all of its shareholders.

Some of them would have preferred the company target some other emerging market. They don’t care much that Russia looks good to the entire consumer goods industry.

According to Pepsi, the Russian dairy market alone expands by 22% annually. Dairy usage per person is half that of developed markets, leaving lots of room to grow.

However, Russia doesn’t stack up in other ways.

Stephen Powers, an analyst at Sanford Bernstein, says, “The Russian market is fundamentally less attractive than other BRIC markets. There are different demographic trends (more aging) that are arguably less promising, more economic volatility and, for a dollar-based company, more currency risk.”

Additionally, transparency issues make it difficult to navigate. Russia ranked 154 out of 178 on the 2010 Corruption Perceptions Index, which measures public sector corruption.

Still, per capita incomes in Russia far exceed those in China and India. And Pepsi’s existing operations there mean it’s building economies of scale, which makes it easier for it to extract synergies from WBD.

Pepsi expects total pretax annual synergies of about $100 million by 2014.

Did Pepsi Pay Too Much?

Still, some stockholders still worry that Pepsi paid too much for Wimm-Bill-Dann.

After all, the Russian food business is cyclical. Food sales even fell in 2009 due to the recession.

And operating margins for WBD have stayed in the single-digits for the past decade.

A valuation of $5.4 billion for the company is double what Danone sold its 18% stake for in August. Though that price was settled years ago.

Yet Coca-Cola paid a similar valuation for Russian drink company Nidan earlier this year. And Pepsi paid about the same for leading Russian juice maker Lebedyansky in 2008.

Still a valuation 16.3 times this year’s earnings forecast before interest, tax, depreciation and amortization is full for even an emerging market food business.

Pepsi, with its $103 billion market capitalization, probably sees it as a small purchase. But it’s still richly priced, especially considering Russia’s cyclical consumer food market.

Investors should hope Pepsi doesn’t make a habit of swallowing such rich acquisitions.

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