By Marin Lovin (UCL) 25/09/2018 |
Overview of the deal
Acquirer: Coca-Cola Company
Target: Costa Limited
Estimated value: $5.1bn
Announcement date: 21/08/2018
Acquirer Advisors: Rothschild & Co
Target Advisors: Goldman Sachs, Morgan Stanley, Deutsche Bank
Whitbread’s divestiture of the Costa Coffee chain stems from mounting pressure from hedge funds holding shares in the company. Though this divestiture idea has been previously suggested by London analysts and pushed for by U.S. hedge fund Sachem Head, it is Elliott Management, an activist U.S. hedge fund and the largest investor in the FTSE 100 company, that has been driving the decision. Believing that breaking up Whitbread could create $3bn of value, Elliott Management has built up a 6% stake in Costa’s parent company and utilised it aggressively by taking an activist investor approach in favor of the divestiture.
Coca-Cola’s $5.1bn bid came at a time when Whitbread had been actively working on the divestment, resulting in a quick deal code-named ‘Project Del Sol’. Though surprising to the public, the deal’s swiftness could signify the confidence of all parties in the transfer of the coffee chain - Whitbread through focusing on its low-cost hotel chain Premier Inn and UK restaurant chains, Coca-Cola by diversifying its notoriously unhealthy soda business to reflect a growing customer trend towards healthier beverages, and Costa by leveraging on Coca-Cola’s large global distribution network to open new expansion prospects.
The Costa deal, which will help broaden Coca-Cola’s portfolio, plays to Asia’s evolving consumer demand. The region’s buyers — who tend to have a “broad-based” palate for beverages — will seek more diverse products as middle classes grow, urbanisation accelerates and technology keeps evolving, said Mr Murphy. -John Murphy, Asia Pacific president at Coca-Cola
Company details (Coca-Cola Company)
The Coca-Cola Company is a global U.S. manufacturer and distributor of non-alcoholic beverages, with a portfolio of over 500 brands including Coca-Cola, Sprite and Fanta. Whilst being known mainly as a soft drinks producer, the company also produces bottled water, sports drinks and soy-based beverages.
- Founded in 1892, headquartered in Atlanta, Georgia, U.S.
- President and CEO: James Quincey
- Number of employees: 61,800
- Market Cap: $194.6bn - EV: $223.8bn
- LTM Revenue: $33.1bn - LTM EBITDA: $11.0bn
- LTM EV/Revenue: 6.8x - LTM EV/EBITDA: 20.4x
Company details (SodaStream International Ltd.)
Costa Limited, a wholly-owned subsidiary of the UK multinational hospitality group Whitbread, is the UK’s largest coffee outlet. As of 2018, Costa operates 3,821 stores in 31 markets worldwide. Whitbread acquired Costa in 1995.
- Founded in 1971, headquartered in Dunstable, UK
- Costa Coffee CEO and Managing Director: Christopher Rogers
- Whitbread CEO: Alison Brittain
- Number of employees: 18,421
- FY2018 Revenues: $1.70bn - FY2018 EBITDA: $312.0m
*Currently privately held, hence lack of financial information
Projections and assumptions
At a $5.1bn pricetag, the general consensus is that Costa has prospered under Whitbread more than it could have independently. Coca Cola does not wish to change guidance for Costa over 2018, as the expected closure date is in the first half of 2019, nor does it plan to change the company’s long-term targets as of yet.
The acquisition will award Coca-Cola the title of retailer in the food services market. It will immediately add to its business a growing coffee platform, including cafés, vending machines scattered across smaller stores, and the coffee pod business which Coca-Cola currently lacks. Though Coca-Cola has an existing coffee business in Japan and South Korea, Costa brings with it an established supply chain and expertise in coffee processing, from sourcing to grinding.
However, this acquisition is more nuanced beyond the retail aspect. Coca-Cola has given a nod to the fact that its current brand portfolio “does not satisfy every beverage occasion” and that it needs to strengthen its core offerings by listening to the consumer. Therefore, a more clever aspect of the deal is that, through diversifying away from fizzy drinks, Coca-Cola is not primarily targeting Costa’s coffee-drinking customer base, rather it is elegantly responding to the changing wants of its own soda consumers. For example, as fast-food restaurants are keen to diversify their range of drinks on offer, Coca-Cola will now boast the ability to provide its fast-food clients with a choice of coffee drinks alongside the traditional soda.
There are multiple ways to incorporate the deal in the context of the increasing global scrutiny for sugary soft drinks. The coffee branch of Coca-Cola can help it regain its footing among food and beverage competitors, which it had lost to rival PepsiCo, who recently acquired SodaStream and currently boasts a portfolio with 50% “good for you” offerings. Approximately three-quarters of Coca-Cola’s annual sales are composed of sodas, while UK sales of sugary drinks have declined 11% this year alone, thanks partly to the introduction of a sugar tax.
Coca-Cola’s extension into the coffee market, which is growing at 6% yearly, could be a better strategy than PepsiCo’s acquisition of SodaStream, the complementary healthier fizzy drink company. To see why this is so, it should be noted that both coffee and Coca-Cola sodas contain caffeine, so looking at the transaction simply, extending Coca-Cola’s product offering from a caffeine drink to a more concentrated one provides a route for operating synergies. Building on that, an interesting point can be made about future financial synergies of the acquisition: as currently 75% of Coca-Cola’s sales are composed of soft drinks, the acquisition is a prime opportunity to diversify cash flows which could lower the cost of capital of the acquirer and, by extension, of the target. Lower cost of capital could, in turn, make financing further expansion into Asia easier and cheaper for both parties. Obesity is a rising issue in East Asian countries, meaning customers are likely to become increasingly sensitive to sugary drinks. Costa has started this expansion last year by taking full ownership of its Chinese joint venture Yueda.
Risks and uncertainties
There should be few regulatory hurdles throughout the deal, which is expected to close in the first half of 2019, as the companies are not in direct competition and, due to their size difference, do not pose a threat to market competitiveness. Whitbread, Costa’s parent company, will seek shareholder approval by mid-October. This is expected to go smoothly given the divestiture of Costa was initiated by activist shareholders.
The deal price at 16.4x FY18 EBITDA is considered by some analysts as “somewhat rich”, especially in comparison to Starbucks’ 13.0x forward EBITDA. Credit Suisse, for example, has valued the company at around half its acquisition price, using a 10.0x 2019E EBITDA. The high premium, in part, can be explained by Coca-Cola’s strategy to fend off the circle of private equity firms, of the likes of Bain Capital and CVC Capital Partners, eyeing Costa and informally approaching Whitbread, though without putting forward formal bid offers. Mostly, however, the price accounts for the future revenue growth opportunities in China. Costa must expand quick, as its biggest rival in China, Starbucks, is already planning to double its 3,400 stores in the country by 2022.
Risks are magnified for Coca-Cola as it assimilates a retail component into its business. As a new strategy for the company, Coca-Cola’s management is under significant pressure to adapt quickly, effectively and seamlessly to the new customer service aspects of business they had no need to think about previously. Furthermore, Costa has lower operating margins than Coca-Cola’s beverage business, and has also been struggling keeping up profit growth recently. Effective synergy implementation is thus all the more crucial to actualise the potential gains of the deal.
“Hot beverages is one of the few [drinks] segments where Coca-Cola does not have a global brand,” James Quincey, Coca-Cola’s British-born chief executive, said. “Costa gives us access to this market with a strong coffee platform.”
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