Overview of the deal
Acquirer: Keurig Green Mountain (JAB Holding)
Target: Dr Pepper Snapple
Estimated value: $18.7 bn
Announcement date: 29/01-18
KGM/JAB Advisors: Goldman Sachs
Dr Pepper Snapple Advisors: Credit Suisse
In the last six years, JAB Holding has spent close to $60 billion on acquisitions in order to build an empire in the coffee and soft drinks industry. The German conglomerate, owned by the Reimann family, had been searching for another U.S. mega-deal for months. The result was the largest soft drink deal ever: the $18.7 billion acquisition of Dr Pepper Snapple by JAB’s subsidy Keurig Green Mountain. The merger will create a beverage giant, which might put pressure on Coca-Cola and PepsiCo and even Starbucks and Dunkin’ Donuts.
The main rationale behind this deal is to enhance the core business performances by leveraging economies of scale and scope; JAB has been one of the leaders of that strategy. The combined entity will hold a portfolio of more than 125 brands – from Dr Pepper and 7Up to K-Cup and Peet’s Coffee. Furthermore, JAB will gain access to a massive beverage distribution network, giving the investment company even greater control over consumer preferences and trends.
“Being sure of what JAB plans for the future is tricky. It is managed by professionals, but decisions on what to buy are taken by the Reimann family.” -The Economist
Company details (JAB Holding)
Keurig Green Mountain is a speciality coffee maker company which sources, produces, and sells coffee and other beverages under various brands. The company is owned by JAB Holding, a German conglomerate with its main focus on investments in consumer goods and luxury fashion.
- Founded in 1981, headquartered in Waterbury, USA
- CEO: Robert Gamgort
- Number of employees: 6,600
- 2017 Revenue: $4.1 bn - 2017 Adjusted Op. Income: $1.1 bn
*Currently privately held, hence lack of financial information
Company details (Dr Pepper Snapple)
Dr Pepper Snapple is a leading producer of flavoured beverages in North America which consists of more than 50 brands including Dr Pepper, 7Up, Orangina, Snapple and Schweppes. It is the third largest producer of soft drinks in the U.S.
- Founded in 2008, headquartered in Texas, USA
- CEO: Larry Young
- Number of employees: 19,000
- Market Cap: $21.99 bn - EV: $26.48 bn
- LTM Revenue: $6.8 bn - LTM EBITDA: $1.5 bn
- LTM EV/Revenue: 3.9x - LTM EV/EBITDA: 17.2x
Projections and assumptions
On the announcement date, Dr Pepper Snapple’s shares increased by 22.4%. Simultaneously, the value of Coca-Cola, PepsiCo and Starbucks shares declined. Dr Pepper Snapple’s shareholders are to retain their shares, leaving them with roughly 13% ownership of the combined entity, but they will also enjoy a $103.75 per share cash dividend. Regarding the financing, JAB and its partners will pay $9 billion from cash reserves and the remainder will come from the issuance of debt.
From a value perspective, the post-announcement share price of $120 for Dr Pepper Snapple implies an EV/EBITDA multiple of 16.4x, which is lower than the industry average of 17.8x. According to the management team, the strong expected future cash flows support quick deleveraging, with a target Net Debt/EBITDA multiple of 3.0x within 2-3 years.
The combined entity will be renamed to Keurig Dr Pepper, which will remain publicly traded in order to have easier access to capital for potential future acquisitions. This deal is expected to result in combined revenue of $11 billion, however, the company is still small compared to PepsiCo and Coca-Cola, who had 2016 sales of $63 billion and $41 billion, respectively. Hence, further acquisitions by Keurig Dr Pepper are very likely to be made in order to keep up with its tough competition in the long-term.
JAB’s acquisition of Dr Pepper is announced during a time in which Americans have been guzzling fewer soft drinks for more than a decade. Sales hit a 31-year low in 2017, thus making market participants struggle to explain why JAB has agreed to acquire Dr Pepper Snapple.
However, one explanation for JAB’s investment is the long-term benefit accrued through Dr Pepper’s distribution network. By buying Dr Pepper, JAB inherits a bottling and sales network which can be used to distribute various kinds of beverages. Likewise, Dr Pepper can benefit due to JAB’s diverse-owned brands which facilitate expansion into the high-growth, ready-to-drink coffee segment.
While both companies share their value proposition in traditional grocery, mass and club channels, Dr Pepper adds strength to the network by its small, high margin outlets. KGM compliments that with its unique strength in e-commerce, office and hospitality. Combined, the renamed company Keurig Dr Pepper aims to significantly benefit with its distribution system, which enables delivery to nearly every point of sale.
Overall, JAB is targeting $600 million in synergies on an annualized basis by 2021 by achieving cost reductions including integrating warehousing, transportation scope and procurement savings in media, production and marketing.
Risks and uncertainties
Although JAB disclosed its aim of cost synergies of up to $600 million, this target appears stretched and is based more on cost-cutting than achieving synergistic savings through consolidation. In addition, uncertainty exists in combining both companies’ distribution channels. Distribution of single serve coffee is very different from canned or bottled beverages. There are scale benefits and in particular overlapping costs that can be eliminated, but investors such as Lindsell Train, JAB’s 9th largest shareholder have yet to be persuaded, as the combined business will have, at least initially, a huge overhang of debt.
Furthermore, it should be emphasised that Dr Pepper, as a public company, will be primarily controlled by a private entity. Hence, only two seats on a seven-person board will be independent, making shareholders’ interest only secondary. Even though the interests of Dr Pepper’s shareholders are mostly aligned with those of JAB’s, conflicts of interest may arise.
Furthermore, it is possible that JAB will get downgraded by one notch to Baa2 with a negative outlook once the transaction has closed, if the deal is structured as it has been announced. A downgrade would reflect Dr Pepper's higher pro forma leverage after the merger, as well as the execution risk of achieving relatively large working capital improvements, synergies and cost reductions over the next few years, which are needed if Dr Pepper is to reduce leverage quickly.
“It's a deal that makes a lot of strategic sense. Once it gets going and they can deliver on some of the bold things they are talking about here, this will be a really important benchmark that investors will use to compare Coke and Pepsi.” -Bloomberg
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