Activist investor Nelson Peltz laid down the gauntlet when his investment vehicle, Trian Fund Management, issued a call for PepsiCo to merge with Mondelez International and then split its drinks and snacks businesses. While a number of hurdles stand in the way – not least apparent opposition from management – it is clear the pressure to perform has been turned up a notch or two as PepsiCo prepares to issue its half-year results tomorrow (24 July). Katy Askew reports.
Nelson Peltz is a man with a plan. Two plans to be precise.
A so-called “Plan A” would see PepsiCo buying Mondelez International in a deal worth something over US$60bn. PepsiCo would then merging Mondelez with its Frito-Lay snack business and then spinning off its beverages unit. According to the logic of Peltz’s Trian Fund Management investment vehicle, shareholders in both groups would benefit. PepsiCo would be paying a 15% premium for Mondelez shares, while the move could cause PepsiCo shares to increase in value to $175 – almost double their current valuation.
Falling short of this, a Plan B would see PepsiCo simply spinning off its drinks business. This scenario, Peltz suggests, would see PepsiCo stock hitting $145 a share.
Peltz – who holds significant stakes in both Mondelez and PepsiCo – claims the latter is at a “strategic crossroads”. He does not see the benefit of PepsiCo operating a high-growth snack business in conjunction with the low-growth carbonated soft drinks business.
“While it has a leading portfolio of 22 billion-dollar brands, PepsiCo has underperformed its peers as it grapples with the differing needs of its fast-growth (snacks) and slow-growth (beverages) businesses and the resulting inherent conflict in allocating its resources,” Peltz says.
The argument is a familiar one. It is similar to the rationale behind the split of Kraft Foods that created Mondelez last year, a slimming down that ultimately makes Mondelez a far more digestible takeover target. It also has echoes of the division of Cadbury Schweppes in 2008 – a move Peltz was at least in part an architect of and one that made Cadbury a far more palatable takeover target for the then Kraft Foods to force through its hostile takeover bid two years later.
Peltz, who insists he is a fan of PepsiCo CEO Indra Nooyi, nevertheless believes the company is limited by its conglomerate status. He suggests many people – analysts and investors included – associate PepsiCo with its namesake beverage. Indeed, one only has to listen in to a conference call to see the Q&A dominated by questions on the US drinks market.
However, the majority of the company’s value lies in its food portfolio, which include mainstay brands such as Lay’s, Quaker and Doritos. This side of the business, Peltz suggests, is key to PepsiCo’s future growth potential – especially as the company continues to slowly adjust its focus towards healthier products.
The drinks business, on the other hand, is facing considerable structural issues. The most challenging of these is health and wellness – people suddenly seem to be cottoning on to the fact that cola is little more than water and sugar. Mounting concerns over obesity have seen CSD volumes in developed markets flat-lining. And, even as PepsiCo has attempted to boost its focus on healthier products, the commoditised nature of the juices market limits the short-term potential for brands like Tropicana.
Meanwhile, looking to Mondelez, Peltz emphasises the group is struggling to get its margins up to standard. Even on a stand-alone basis, Peltz insists Mondelez can get its margins moving in the right direction – and a lot more quickly than management has targeted.
According to Trian’s analysis, the investment firm has identified a 400 basis point margin opportunity. This is consistent with management’s long-term 14-16% margin target. However, Peltz is apparently working to a different timetable. As he said at CNBC‘s Delivering Alpha conference last week, he is “not getting any younger”.
“Mondelez expects to deliver just an average 20-30 bps of expansion during the next three years, given significant reinvestment plans in its emerging markets businesses. We suspect Trian would likely push for the full magnitude of margin, albeit on a much more truncated time table,” Barclays Capital analyst Andrew Lazar notes.
According to Peltz, an acquisition of Mondelez by PepsiCo would be immediately accretive to the latter’s earnings. It also carries a longer-term strategic rationale.
Both Mondelez and PepsiCo would boost their presence in emerging markets, as each firm would benefit from the other’s distribution channels. At the same time, PepsiCo’s strength in the US would calm investor jitters over Mondelez’s exposure to higher growth – but higher risk and more capital intensive – emerging markets.
The combined group would also benefit from a stronger snack portfolio: combining PepsiCo’s might in salty snacks with Mondelez’s hefty position in confectionery and sweet biscuits.
PepsiCo management has, however, been vocal in its opposition to such a move, insisting the group sees no need for “large scale” M&A. This could prove a significant stumbling block for Peltz’s plans.
Stifel analyst Mark Swartzberg sees a break-up of PepsiCo’s drink and food arms as more likely than a merger with Mondelez. “We… believe Nelson Peltz’s track record is difficult to ignore and that his Alternative B (a split of the business) is not far from the course already being pursued by PepsiCo management,” Swartzberg says.
However, on the Mondelez acquisition he adds: “We think it is difficult for this transaction to happen any time soon seeing as PepsiCo management remains opposed to it and Mr Peltz’s leverage boils down to persuasion in the court of investor sentiment.”
BlackRock, an investment vehicle with a 5% PepsiCo stake, has already thrown its weight behind PepsiCo’s management. In an interview with CNBC, BlackRock chairman and CEO Larry Fink said Trian had done a “good job finding value” but suggested its analysis took a short-term view of the company. “Indra Nooyi has done a very good job of reorientating PepsiCo… I question how [Trian’s plan] would add long-term value.”
Likewise, Bernstein analysts conclude the push from Trian is unlikely to result in a merger between PepsiCo and Mondelez any time soon. “On balance, we are not convinced [the] news greatly changes the deal landscape for PepsiCo or Mondelez,” the analysts write. “We believe the deals may make strategic sense, but pose significant practical hurdles.”
Nevertheless, Trian’s headline-grabbing “White Paper”, which sets out the case for combining the two businesses, has prompted M&A speculation to step up in other areas.
According to some commentators, Coca-Cola Co. could present itself as a potential suitor for Mondelez. Any such deal would allow Coke to offset some of the structural weaknesses associated with being a pure-play CSD group, while Mondelez – already pouring resources into developing its emerging market footprint – would be able to piggy-back off Coca-Cola’s comparatively strong distribution channels in markets like China.
Long-running speculation that brewer Anheuser-Busch InBev could make a play for PepsiCo’s underperforming drinks unit has also been revived. By taking on PepsiCo’s drinks business, A-B InBev would expand its presence in the US and potentially benefit from opportunities to link beer and soft drinks in Latin America.
While the M&A waters around Mondelez and PepsiCo have been muddied, what is clear is both groups are coming under mounting pressure to improve their performances – and fast.
For its part, Mondelez needs to prove it can look beyond the broad sweeps of strategic direction and focus in on the detail of execution. The message from frustrated investors seems to be that margins need to improve more quickly than management believes possible.
PepsiCo must demonstrate it is able to balance the needs of its food and beverage units. The group must show it is not taking funds out of the former and using them as a tourniquet to fund the promotional activity that currently seems to be preventing a sales haemorrhage on the drinks side. All eyes will turn towards Purchase in New York tomorrow as PepsiCo delivers its first-half numbers.