Coke Takes A Gamble Riding A Monster

| About: The Coca-Cola (KO)
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The Coca-Cola Company purchased 16.7% of energy drink behemoth Monster Beverage last week for approximately $2.15 billion.

The deal makes Coca-Cola a bigger player in the energy market, but did it overpay?

Is energy the answer for the struggling volumes?

The Coca-Cola Company (NYSE:KO) purchased 16.7% of energy drink behemoth Monster Beverage (NASDAQ:MNST) last week for approximately $2.15 billion. As part of the deal, Coca-Cola will transfer the ownership of its energy drink portfolio, including the brands NOS, Full Throttle, Burn, Mother, and Play to Monster, while Monster will shift Hansen's natural sodas and juices, Peace Tea, and Hubert's Lemonade to Coca-Cola. The deal includes the option for KO to expand its purchase to 25%, but only if both boards agree to the measure. The transaction is expected to close in late 2014 or early 2015 pending regulatory approval.

The majority of Monster's business is located in the United States, which accounts for approximately 80% of total sales, so the alignment with Coke will greatly increase its global footprint. Monster had a 35.1% share of the $9 billion U.S. energy drinks market in 2013, second only to Red Bull's 42.9% share, according to the data service Euromonitor. It had a 14% share of the $27.5 billion global energy drinks market. Coke's CEO Muhtar Kent said that Coke plans to expand Monster's distribution footprint "in a major and meaningful way." Coke already distributes Monster in about half the U.S., with distributors affiliated with brewer Anheuser-Busch InBev (NYSE:BUD) controlling most of the remainder. As a result of Monster being in new markets, I expect that 14% global market share to improve, but the industry as a whole has been decelerating.

Volumes for soda, Coke's main product, have been struggling, so management has been looking for other products to add to the product mix. The company purchased a 10% stake in Keurig Green Mountain (NASDAQ:GMCR) earlier this year, and recently increased its stake to 16%. The alliance with Keurig Green Mountain has the potential for Coke to see significant gains in a relatively short time; however, with the Monster purchase, I am reminded of the Vitaminwater purchase back in 2007. The company paid $4.2 billion in cash, and despite the strength in water, this still hasn't been worth the lofty price tag. Neville Isdell was CEO of Coke when Vitaminwater was purchased, but I have been less than enthused with the past few high-ticket acquisitions. Through the first six months of 2014 (compared to the first six months of 2013), Coke had $4.47 billion of net cash provided by operations, so it clearly has the cash to spend, and Monster saw a considerable jump in net income through the first six months of the year ($236.3 million, compared to $170.4 million through the first six months of 2013).

Monster and energy drinks in general are facing significant regulatory headwinds amid concerns about their potential health effects. The U.S. Food and Drug Administration is investigating more than a dozen deaths allegedly tied to energy drinks, including some made by Monster. New York State Attorney General, Eric Schneiderman launched a probe in 2012 into the marketing tactics of several energy drink makers, including Monster.

Does this deal make sense for Coke? Yes, it does; the volume gains will definitely Coke's cash flow. Is it a good deal for Coke? No, I do not think so; it overpaid for the 16.7% stake (and asset swap). Coke is transferring ownership of its own energy drink portfolio to Monster, while taking Peace Tea and Hansen's Natural Soda. According to the latest 10-Q released by Monster (dated August 8, 2014), non-carbonated revenues declined more than 4% during the second quarter compared to the same quarter of 2013. Through the first six months of this year, sales are down almost 5%. For the Hansen's soda line of the business, revenues were up approximately 6% to $15.5 million. To put that in perspective, the smallest segment from Coke is Eurasia and Africa, which had $732 million of revenue during the first three months ended June 30, 2014 (and $290 million of profits). Such a small drop in the bucket in terms of total sales, but the benefits will come from the distribution growth of Monster and its other products. This may turn out to be successful, but I feel that Coke overpaid for a market leader in an industry that has plenty of headwinds of its own.

I am a shareholder for Coke. I have held my shares for a while, and it is a cornerstone in my portfolio. However, I am not overly enthusiastic about the immediate near term for the share price. I am not putting any new money behind the investment, especially considering the stock is currently trading approximately 4% below its 52-week high. This move does nothing to help the stock break out of its current range.

Disclosure: The author is long KO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.