Will PepsiCo Merge With Mondelez?

Jessica is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Activist investor Nelson Peltz, who owns significant stakes in soft-drink maker PepsiCo (NYSE: PEP) and snacks giant Mondelez International (NASDAQ: MDLZ), recently went public with his suggestion that PepsiCo should acquire crackers and sweet snacks giant Mondelez for $35 to $38 a share (roughly $67.8 billion) in an all-stock swap.

So, should Mondelez owners be getting excited? Maybe. Peltz has plenty of experience in revamping food and beverage companies (his turnaround of Snapple is now a Harvard case study) and a history of pushing through changes he wants over the objections of entrenched management.

Snacks are a growth business

At first glance, the deal makes sense. Pepsi is already the No. 1 snack maker in the world, and snacks are a growth business. Though Americans consume $34 billion worth of snacks each year, Europe is the largest global snacks market by value. Most of the world's population are only now warming up to packaged snacks in low-income, high density areas like Eastern Europe, India and Indonesia.

According to widely cited marketing research company companiesandmarkets.com, the global packaged snacks industry will be worth $330 billion per year by 2015. The snacking habit is also on the rise: In 2009, 24% of participants in a SymphonyIRI Group’s State of the Snack Industry Report survey said they consumed snack foods three or four times per day. By 2012, that number was up to 43%.

Merging with Mondalez – assuming Pepsi could work its way around any potential antitrust violations – would add Oreo, Chips Ahoy!, Ritz, Nabisco, Triscuit, Nilla, Honey Maid, Newtons, Cadbury, Trident, Certs, Dentyne, Halls, Chiclets, Philadelphia Creme Cheese and a dozen other top shelf brands to Pepsi's Frito-Lay empire and cement Pepsi's position as the global snacks powerhouse. Today, Pepsi's Frito-Lay division controls 62% of the U.S. salty snack category, employs 48,000 people and brings in $13 billion in sales per year. Its existing global footprint is massive, with exports to 79 countries around the globe.

Is it time to end the Cola Wars?

The endless Cola Wars with their taste-test tactics (The Pepsi Challenge), celebrity-endorsement arms races – think a manic Bill Cosby, Michael Jackson's hair on fire – and other unspeakable atrocities (New Coke) may leave some investors with the mistaken impression that Coca-Cola (NYSE: KO) and Pepsi are the corporate equivalent of the US and the Soviet Union during the height of the Cold War, fighting for hearts, minds, and global real estate on every conceivable front.

In reality, Coca-Cola's dominance is almost entirely limited to soft drinks. The company's prospective partnership with Procter & Gamble was signed off on in 2011, and to date has yet to bear fruit. PepsiCo has exactly the opposite problem. While the company enjoys a commanding domestic position in snacks, it seems destined to remain a distant third in the soft-drink category. Pepsi's flagship product now trails both Diet Coke and Coca-Cola Classic by a wide margin. The reason for this growing disparity has nothing to do with celebrity endorsements and everything to do with the fact that the wider availability of Coca-Cola products leads to a virtuous circle that Pepsi is unlikely to break.

The diagram below illustrates the self re-enforcing competitive advantage that Coca-Cola's distribution system has enjoyed for more than a century:

By ceding the field in favor of creating a global snacks empire, Peltz argues, Pepsi would unlock more value for the company's investors while retaining a significant foothold in the beverage market. Pepsi's “Power of One” campaign, which attempts to drive sales increases by associating the Pepsi brand with the company's other mega-popular brands the company owns – like Doritos – was originally launched 13 years ago, with only incrementally higher unit sales to show for it.

And while Pepsi's stated future objectives of making healthy drinks and snacks that people will want to consume by the truckload is certainly laudable and attractive in theory, it's also exactly what the global package foods industry has been trying to accomplish for the past 40 years. The idea that Pepsi food scientists will somehow crack the code in the near future is highly speculative at best.

Foolish takeaway

Ultimately, Peltz will have to sway major Pepsi stakeholders like BlackRock who aren't yet sold on the idea in order to force a merger. That doesn't mean that these institutional investors -- 95% of Pepsi's outstanding shares are owned by only 741 institutional entities – can't be persuaded to approve a Pepsi/Mondalez merger in some form. 37 of the top 40 Pepsi shareholders also own significant stakes in Mondelez.

The problem is that Peltz' proposal doesn't unlock enough value for the world's largest money manager to risk alienating its fellow board members. Mondelez also derives 39% of its sales from Europe at present. While that dependence may turn into a net positive once Europe recovers, at the moment its the biggest drawback to Peltz' merger proposal, and one that's likely to send him back to the drawing board. In this Fool's opinion, investors would be better served by selling the rumor than by buying into it -- at least, at this stage of the game.

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Jessica McCann has no position in any stocks mentioned. The Motley Fool recommends BlackRock, Coca-Cola, and PepsiCo. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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