The US equities market is down today on concerns over new jobs data and the financial crisis in Greece. Coca-Cola (NYSE:KO) is down 3.9% to 53.01, with the S&P5 500 down .8%. The sharp price decrease was caused by Coke's “purchase” of Coca-Cola Enterprises’ (CCE) North American operations as well as overall market pressure. The business was originally spun off of the company more than 20 years ago. In this asset swap deal, Coke agrees to absorb $8.88 billion worth of debt held by the bottler and give up its 34% ownership in CCE, worth $3.4 billion. The details were published in a Reuters article this morning,
"The Coca-Cola Company announced that in a substantially cashless transaction, will acquire Coca-Cola Enterprises Inc.’s (CCE) entire North American business, which consists of approximately 75% of U.S. bottler-delivered volume and almost 100% of Canadian bottler-delivered volume. At the close of the transaction, The Coca-Cola Company will have direct control over approximately 90% of the total North America volume, including its current direct businesses."
Pepsi (NYSE:PEP) is making a similar deal, taking over its own bottler, Pepsi Bottling Group (PBG). Both beverage companies have chose to once again own their bottling operations to gain greater control over the selection of drinks they distribute.
Benefits for Coke will manifest immediately. Increased control and economies of scope generated from this transaction are necessary, as this gives Coke increased control in production across all of its brands. Coke’s bottom-line will likely receive a boost from diminishing commodity costs in the near future. Raw materials including high fructose corn syrup, sucrose, citric acid, orange juice concentrate, packaging materials for bottles, and aluminum for cans all vary in cost according to external market conditions. Acquisitions and new water and juice products will contribute to top-line growth in emerging markets. Coke’s North American sales segment constituted 26% of 2008 revenue, while bottling made up an additional 27%. Increased efficiencies of production will allow Coke to maintain margins in an increasingly flooded North American market. Coke expects to achieve $350 million in savings from this deal. Coca-Cola Enterprises (CCE) shareholders were rewarded with a 35% price increase today.
In the short term, Coca-Cola price depreciation was fueled by the additional debt assumed by this deal, which will incur its own interest costs.
The five year average return on investment of 21.7% towers above the industry average of 5.54%. When Coke originally spun off its bottling business, it proved to be a wise choice. Current market conditions make the reincorporation of Coca Cola Enterprises an equally wise choice. The investors will be the beneficiaries of the long-term orientation of this strategy.
Disclosure: Long KO