Schweppes Goes Better With Coke

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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

Last week there was a bit of a buzz around beer and wine specialist Foster’s Group ((FGL)) based on speculation that soft drink specialist Coca-Cola Amatil ((CCL)) might be considering a takeover bid (see “Does Coke Have A Hard-Earned Thirst”; Australia; 20/05/08). The catalyst for the speculation, apart from the fact Coke has made various attempts to become a player in the Australian beer market in the past, was a sudden Macquarie research restriction on Coke.

For Coke to take over the much bigger Foster’s, it would likely need the help of a large investment bank. And if it was only making a smaller acquisition, did it need to call in Australia’s largest? The assumption was that Coke could put together a deal with Macquarie to buy Foster’s, and then sell off the serially underperforming wine business Foster’s acquired by buying Southcorp, leaving it as a dominant beer and soft drink producer.

But another possibility, and one that was not overruled at the recent Coke update, is that Coke was looking to buy Schweppes Australia from Cadbury-Schweppes Australia. Citi analysts have ignored a possible takeover of Foster’s and considered this deal as a distinct possibility. While Cadbury has always suggested it was not interested in selling Schweppes locally, across the globe the parent has done just that in every other centre. And locally the group has begun re-separating the operations of the confectionary and soft drink businesses – a pretty decent clue if ever there was one.

Citi believes there are three obvious parties who might be interested in Schweppes – Coca-Cola Amatil in combination with American parent The Coca-Cola Company (let’s just say “Coke”), Foster’s, and Foster’s local beer rival Lion Nathan ((LNN)). For the former, it would mean taking out a major soft drink rival. For the latter two, it would mean adding a successful soft drink business to the beverage pool. In Foster’s case it would be nice to have a solid business to offset the current disaster that is wine.

Citi has pretty quickly ruled out Lion Nathan. Lion owned the Pepsi licence last century but couldn’t make a go of it and thus sold it to Cadbury-Schweppes in 2000.

In the case of Foster’s, the Citi analysts believes there would be strategic benefits and synergies available to Foster’s, which would prefer to hang on to the Pepsi licence therein. It would also deliver a counter blow to Coke by moving onto Coke’s soft drink domain to offset Coke’s foray into boutique beer. However, would the market go for it? The Foster’s share price has serially underperformed the index ever since Foster’s bought Southcorp in 2005, and the outlook for the wine business is only getting worse, not better. One might expect a big groan from the market and a lot of selling if the embattled grog merchant decided it was going to pay up for soft drink as well.

Which brings us back to Coke.

The Citi analysts believe an acquisition of Schweppes would be a dream deal for Coke. For starters, the first thing it would do is cut rival cola pretender Pepsi adrift in Australia, thus delivering the competition a severe blow. But in the carbonated soft drink market in general, Coke would remove its major rival in the form of Schweppes. The synergies of such a deal would be immense, as every aspect of the business from the head office to bottling, distribution and sales force could be integrated at significant cost savings to achieve significant market share gains. The analysts see a price tag on Schweppes (including the Pepsi licence) of anywhere between $650m and $850m.

But of all potential suitors, Coke could afford to pay the most based on the synergies it could generate.

However, there is, of course, a small matter of the ACCC.

Coke has already once tried to buy the Cadbury-Schweppes brands in Australia – back in 1999. The deal involved Coke retaining only the international brands of Schweppes, Dr Pepper and Canada Dry while divesting of everything else. The ACCC said no. Coke then revised the deal, suggesting it would get rid of its own local Coca-Cola Company brands such as Kirks, Halls, Gest, Shelleys, Ecks and Marchants (which reads as a who’s-who of every soft drink label we grew up with as kids in various regional areas) as well as its water label Deep Spring. But still the ACCC said no.

The ACCC could not get past the fact Coke would control the “leading carbonated drinks in almost every category”. So the question is: What’s any different now?

Citi believes the ACCC’s view in 1999 was based on a “relatively narrow market definition” which considered the carbonated soft drink market in isolation. The analysts suggest Coke would argue that the wider soft drink industry should be considered – a market in which water, fruit juice, sports drinks and energy drinks now form a greater part. Hence there is plenty of competition outside of Schweppes from the likes of Danone, Red Bull and National Foods/Berri.

Citi notes that in 1999 Coke controlled 65% of the carbonated soft drink market. It still controls 63% today. But in a wide market perspective, Coke controls 45% today where it controlled 50% in 1999. So a positive ACCC decision will no doubt come down to whether the commission can see beyond simple fizzy drink or not.

Citi is not offering its opinion on what the ACCC would decide. The analysts are, however, happy to suggest a takeover of Schweppes would be a real positive for Coca-Cola Amatil.

CCL currently boasts a 6/3/1 B/H/S rating in the FNArena database, with an average price target of $9.58.

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