Does Coke Have A Hard-Earned Thirst?

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This story features CUSCAL LIMITED.
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The company is included in ALL-ORDS and ALL-TECH

By Greg Peel

Macquarie has placed itself on restriction as far as offering advice on valuation for Coca-Cola Amatil ((CCL)) is concerned. This means the Macquarie beverage analysts cannot currently provide a recommendation or target for the stock. A restriction is required on the broking department of a firm whenever the structured finance or M&A department of the same firm is retained by a particular listed company to provide assistance. The implication is that inside knowledge could be obtained that would put the particular broking arm at an advantage over the market.

Macquarie analysts must be constantly frustrated given the investment bank seems to have its finger in just about every pie. The BHP/Rio analyst might as well have taken all off in 2008. But for the rest of the market, a sudden restriction from Macquarie indicates something must be afoot.

In this case the implication is not too difficult, as at Coke’s AGM last Friday CEO Terry Davis indicated it would make sense for the company to look into making another attempt at a takeover of rival soft drink peddler Cadbury Schweppes Australia. Coke Amatil tried to buy the Australian Schweppes operations some ten years ago, but the ACCC knocked it back. Davis believes times have changed, and this time the competition watchdog might be more receptive.

This was about the only real point of interest at what was an otherwise unsurprising AGM update. Coke’s year had been affected by a wet summer and by heavy competition in grocery lines, but we all knew that. As Deutsche Bank suggested, it was all in the price already. But Deutsche also believes Coke is understating its guidance for 2008, as cost control measures should help to offset a downturn in consumer spending. Coke appears to be in a better position than its rivals.

But one gets quickly bored just flogging the same old ubiquitous caffeine-laden sugar bomb, and as long ago as 2001 Coke thought perhaps it might be a good idea to get into beer as well. It all looked a bit too hard in a market dominated by the two incumbents Foster’s ((FGL)) and Lion Nathan ((LNN)), so Coke decided to go the other way and expanded into grocery items instead. Coke has since made a fortune selling water to Australians despite the fact it is as good as free from any tap.

But a year ago, Coke became bored with water as well. Still determined to get into beer, it decided to edge into the market by distributing a few fancy imported brews, including American stuff that Aussies enjoy referring to as “Love on a beach”. Analysts across the market were underwhelmed with this move, suggesting that while the Aussie beer market was one of the most profitable in the world (I do my bit) breaking the duopoly would be impossible. You can keep your Miller and Peroni, we drink Tooheys and VB thank you very much.

Well Coke went ahead anyway and – let’s face it – how many Peronis have you ordered lately outside of an Italian restaurant? If Coke really wants to get into beer, the best way to do it is simply to buy one of the big brewers. Once again, the market is suggesting perhaps Coke might have a go at Foster’s. The Schweppes thing may just be a diversion, although an offer for Schweppes makes sense at this point given Cadbury-Schweppes has now divested itself of the Schweppes part in every country of operation other than Australia. Cadbury may well be hoping an offer is forthcoming.

Would Coke need the skills of the Macquarie bankers to help it buy Schweppes Australia? Hmmm.

When Foster’s the beer merchant bought Southcorp the wine merchant in 2005, the result was one of the biggest beverage companies in the world. According to Merrill Lynch, the result was also one of the biggest disasters in the world. Merrills has never let up on its tirade of negativity towards Foster’s from the time the merger was touted. Last year the analysts smugly noted Foster’s shares had underperformed the market by 50% ever since. A look at a 5-year relative chart now shows that while the broad market has doubled over the period, Foster’s has managed to grow in value by only about 25%.

And Merrills is still at it. This morning the analysts noted that Foster’s US wine business is serially underperforming, and has been for four to five years. Foster’s has thrown over US$3bn at the US market in that time, and in FY08 looks like only posting about US$170m in earnings. Merrills has long suggested Southcorp would mean Foster’s downfall, and the sad reality is that it is not the US wine business in general that’s struggling – only Foster’s share of it.

On this basis Merrills suggest that perhaps some change of marketing tactic might turn the ship around, but the analysts aren’t confident. If you want my opinion, Australian wines had their time in the sun and now the Yanks have moved on to newer fads, such as wine from Chile perhaps, or more likely the plethora of new, lower-priced Californian offerings. With the Aussie pushing parity, it’s unlikely Foster’s can do much to increase market share now.

So Foster’s is, in theory, vulnerable. Could Coke swoop?

Well one problem is that Coca-Cola Amatil has a market cap of $6bn, while Foster’s has a much bigger $10bn. For Coke to take over Foster’s it would need to have a backing partner of some description, like – I don’t know – a large investment bank? As global credit markets slowly begin to ease and risk appetites slowly return to normal, perhaps the time is right. Buy Foster’s, flog off the wine business to Constellation or someone similar, and keep the beer. Coke would finally have the beer exposure it always wanted.

Stay tuned.

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