Coke vs. Pepsi, 2001

Background of the Noncarbonated-beverage Market

► The noncarbonated drinks segment had grown 62 percent in volume over the last five years while the soft-drink volume growth had been sluggish because its share in the industry fell from 71.3 percent in 1990 to 60.5 percent in 2000.

► PepsiCo, Inc. acquired Quaker Oats in a stock-for-stock deal at around $14 billion.

► Through this merger, PepsiCo, Inc. consolidated its lead in the noncarbonated-beverages segment because it gained access to Gatorade to control 83.6 percent of the sports drink market. At present, this company already possessed extremely strong brands in the same segment such as Aquafina, Tropicana and Lipton.

► Historically, Coca-Cola had trounced PepsiCo in terms of Economic Value-Added (EVA)

EVA

(1,500)

(1,000)

(500)

0

500

1,000

1,500

2,000

1994 1995 1996 1997 1998 1999 2000

Coca-Cola

PepsiCo

► The important brands in this market segment are the following:o Orange Juice: In 1998, PepsiCo’s Tropicana, market leader, held

more than 40 percent of the total chilled orange juice market and 70 percent of the not-from-cocentrate orange juice segment while Coke’s Minute Maid had less than 20 percent of the market.

o Bottled Water: PepsiCo test-marketed Aquafina as early as 1994 while Coke’s Dasani entered the market only on 1999. Aquafina was the number one ranked bottled-water brand in the US market in 2000.

o Iced Tea: PepsiCo’s Lipton boasted a 16-point share lead over Coca-Cola’s Nestea.

o Sports Drinks: PepsiCo’s Gatorade held 83 percent of the US sports-drink market while Coca-Cola’s Powerade was a distant second at 11 percent.

o Specialty Drinks; PepsiCo, in alliance with Starbucks, introduced the highly popular Starbucks Frappuccino in 1996. It took Coca-Cola until 2000 to announce that it was going to test-market a frozen coffee beverage. In October 2000, PepsiCo beat Coca-Cola in acquiring South Beach Beverage Company, maker of the SoBe brand of teas and fruit juices.

Background of the Soft-drink Market

► In the fall of 1999, PepsiCo, for the first time in history, occupied two of the three places for US soft-drink brands on store shelves as its Mountain Dew dislodged Diet Coke from third place.

► Over the last five years, Pepsi launched aggressive and exciting marketing campaigns that helped boost volume and visibility (e.g. Generation Next, Joy of Pepsi and Power of One).

► In the summer of 2000 Coca-Cola veered away from traditional feel-good ads and launched trendier ones. Unfortunately, these were highly unpopular and

elicited negative reactions from customers and bottlers. Coca-Cola replaced these and made sure that the ads were traditional “feel-good” themes and trendy (e.g. Life Tastes Good).

Background of Coca-Cola (KO)

► Annual Sales (2010): $20.5 billionMarket Value (2010): $110.1 billion

► The largest manufacturer, distributor, and marketer of soft-drink concentrates and syrups in the world.

► Marketed and distributed a variety of non-carbonated-beverage products: Minute Maid orange juice, Fruitopia, Dasani bottled water and Nestea.

► 1st or 2nd spot in Fortune’s annual ranking of top wealth creators from 1993 to 1998. (Reason: Spinning off its bottling operations to avoid consolidation on its balance sheet)

► Challenges faced:o Asian Financial Crisiso South America’s difficultieso Russian Ruble’s devaluationo Mistake/s of Doug Ivester (Previous CEO): a 41 percent decline in

net income due to a 7.7 percent price hike on syrup that led to an increase in bottler prices.

► Douglas Daft (New CEO): “KO needed to be a dominant player in the noncarbonated-beverages market” (solution to the challenges faced)

Background of PepsiCo, Inc. (PEP)

► A $20 billion company involved in the snack food, soft drink and noncarbonated beverage businesses.

► Snack foods accounted for roughly two-thirds of sales and operating income while beverages accounted for the remainder.

► Contributions of Roger Enrico (CEO):o Sold off the fast-food chains KFC, Taco Bell and Pizza Hut,

ridding the company of a business that had long been a drag on returns.

o Spun off Pepsi’s capital-intensive bottling operations into an independent public company that led to higher-margin business of selling concentrate to bottlers. Independent PepsiCo bottlers would be able to raise capital on their own, freeing up cash flow within the parent company for other uses.

o Brokered the acquisitions of Tropicana, the market leader in orange juice, and Quaker Oats, whose Gatorade brand dominated the energy-drink market.

o Return on equity almost doubled from 17 percent in 1996 to 30 percent in 2000.

Financial Analysis

From 1994 to 2000, Coca-Cola Company initially had operational efficiency with intensified capital investments. Unfortunately, the NOPAT, invested capital and WACC apparently declined starting 1998 (see Exhibit 1). There was also a steep decrease in its return on equity from 57 percent in 1997 to roughly 23 percent in 1999 (see Exhibit 2). These only reflect the difficulties faced by the company then and indicate the change in leadership of the company as Doug Ivester became its CEO in 1997. He was incriminated with several business mistakes in Coca-Cola with the biggest one when a 41 percent decline in net income occurred due to a 7.7 percent price hike on syrup that led to an increase in bottler prices.

In financial ratios, Coca-Cola Company was not able to maintain profitable operations within the period from 1997 to 2000 (see Exhibit 4). The decreases in working capital turnover and cash from operations ratio have shown its unhealthy production stance in the industry. Reductions approximating to 50%

in net profit margin, return on asset, and return on equity proved that the company is not in a profitable position. Despite the fact that debt-equity ratio averaged at 0.60, its coverage to debt has significantly decreased. As a whole, Coca-Cola Company is not a promising avenue for growth as provided by the dramatic plummet of sales, book assets, net income and operating income by astonishingly more than 100 percent.

PepsiCo, Inc, on the other hand, exhibited improvements on the WACC return on invested capital, and EVA from 1997 to 2000 (see Exhibit 1). The return on equity also improved from 5 percent in 1997 to about 13 percent in 1999 (see Exhibit 2). Acquisitions of market leader brands (i.e. Tropicana, Gatorade and Frappuccino) posit positive results on the company as shown by the statistics. In addition, these reflect the efficacious leadership of its CEO, Roger Enrico, from 1996 to 2000. During his term, he sold off the fast-food chains KFC, Taco Bell and Pizza Hut, ridding the company of a business that had long been a drag on returns and spun off Pepsi’s capital-intensive bottling operations into an independent public company that led to higher-margin business of selling concentrate to bottlers. Thus, Wall Street analysts were also upbeat about these prospects.

The financials of PepsiCo, Inc. has demonstrated an optimistic trend, most notably, from 1999 to 2000 (see Exhibit 5). In spite of a 0.05 cash ratio in 1998, its operations are still maintained profitably as postulated by the increases in cash from operations ratio, net profit margin, return on equity and return on asset. Its financial position has been more than enough to cover for the debts which are proven by the times interest earned and cash from operations-debt ratio. The company caters for potential growth because of significant increases in net income and operating income. Most importantly, the growth ratios of PepsiCo, Inc. are apparently better than those of Coca-Cola Company.

In the forecasted economic value added analysis for the period covering 2001 to 2003 (see Exhibit 9), both companies created value from its cash operating profits against its capital charge. However, Coca-Cola Company has better figures as compared with its rival. This could be explained by its change in management and use of ads that were traditional “feel-good” themes but still maintaining the trendy perspective (e.g. Life Tastes Good). Coca-Cola’s endeavor to creatively package and market itself in the industry gave it the chance to bounce back from past challenges. Hence, there is a promise of glory days for this company.

However, even though Coca-Cola Company had better projected economic value added figures from 2001 to 2003, it still remains mismatched with its rival. In fact, PepsiCo, Inc. had stock prices at par with the market value within the period covering 2003 to 2012 (see Exhibit 10). This only shows that economic value added is of limited dependability to gauge the marketability of a company. At this point, economic value added would not guarantee a superior stock price or a value at par with the market. At any rate, economic value added still remains a viable measure of operational profitability as it estimates efficiency against capital charges.

Exhibit 9

Forecasted Economic Value Added (EVA) and Return Comparison (in million dollara)

PepsiCo, Inc. Coca-Cola Company2001 2002 2003 2001 2002 2003

Net Operating Profit After Tax (NOPAT)  

3,479 3,935 4,160   3,956 4,470 4,797

Operating Profit 4,385 4,885 5,369 5,399 6,132 6,633

Goodwill Amortization 236 295 295 295 295 295

Cash Taxes 1,142 1,245 1,504 1,738 1,957 2,131

Invested Capital   15,439 18,036 17,224   16,554 16,868 17,016

Loans and Notes Payable 0 0 0 3,600 3,500 3,400

Current Portion of Long-term Debt 281 444 64 154 153 2

Long-term Debt 2,106 1,825 1,381 681 528 526

Deferred Income Taxes 1,625 1,974 2,252 302 239 170

Equity 9,282 11,648 11,382 11,267 11,898 12,368

Accumulated Losses 1,394 1,394 1,394 2,722 2,722 2,722

Accumulated Goodwill Amortization 751 751 751 192 192 192

Marketable Securities 0 0 0 2,364 2,364 2,364

Return on Invested Capital (in %)   0.225 0.218 0.242   0.239 0.265 0.282

Weighted Average Cost of Capital (WACC)  

0.065 0.065 0.066   0.065 0.065 0.065

Cost of Debt 0.074 0.074 0.074 0.072 0.072 0.072

Cost of Equity (CAPM) 0.066 0.066 0.066 0.065 0.065 0.065

Risk-free Rate 0.058 0.058 0.058 0.058 0.058 0.058

Volatility (Beta) 0.440 0.440 0.440 0.420 0.420 0.420

Market-risk Premium Rate 0.075 0.075 0.075 0.075 0.075 0.075

Effective Marginal Tax Rate 0.350 0.350 0.350 0.350 0.350 0.350

Total Debt 483 444 64 154 153 2

Short-term Borrowings 202 0 0 0 0 0

Current Portion of Short-term Debt 0 0 0 0 0 0

Current Portion of Long-term Debt 281 444 64 154 153 2

Total Equity 63,349 63,349 63,349 155,432 155,432 155,432

Share Prices (2000; in $) 43.81 43.81 43.81 62.75 62.75 62.75

Outstanding Shares (Basic) 1,446 1,446 1,446 2,477 2,477 2,477

ROIC-WACC Spread   0.160 0.153 0.176   0.174 0.200 0.217

EVA   2,468 2,754 3,031   2,876 3,370 3,687

Exhibit 10

Source: investing.money.msn.com