An Opportunity in Soda

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

PepsiCo (NYSE: PEP) is rumored to be in talks to purchase SodaStream (NASDAQ: SODA). The deal would be an expensive but interesting way to gain a new business line. And Coca-Cola (NYSE: KO) probably couldn't pull it off as well.

Fickle consumers

The beverage business is a tough one. It is dominated by two companies, but has many smaller players. Although there are notable barriers to entry, consumers have a tendency to get bored with existing fare. That leaves them flitting from hot product to hot product. Every time a new fad comes along, the industry bellwethers have to ape the new product or buy their way into the emerging sector.

PepsiCo famously bought Quaker Oats for over $13 billion to gain control of Gatorade when sports drinks were the rage. That said, the other brands and products that came with that purchase have probably provided as much benefit over the long-term as Gatorade has, deepening and diversifying the food giant's reach inside the grocery isle.

A hot product

Right now, one of the hot products is SodaStream. The company sells a machine that carbonates water and a collection of drink flavors. Carbonating water isn't new, soda siphons have been around for ages. However, building a system around this old technology has fascinated customers.

Although coming from a small base, sales and earnings have more than doubled over the past three years to $436 million. The stock, meanwhile, went from the mid-$20s at its IPO to over $70 a share within a year. It fell back to the $30 range just as quickly, but is again in the $70s after a run that started late in 2012. Its trailing P/E is over 30, though doubling earnings in three years suggests that valuation isn't outlandish. But only if impressive growth continues.

Fad or real?

SodaStream looks in some ways like The Singing Machine, which sells karaoke devices. Although its sales never took off like SodaStream's, it latched onto a fad and its stock ran up on that alone. After trading in the $30 to $40 range, the stock is currently selling for less than a dollar a share. If SodaStream is little more than a fad, it isn't worth $70 a share and there's notable downside risk here for investors.

Rumors

Reuters recently reported on rumors that PepsiCo was looking to buy SodaStream for $2 billion. PepsiCo has stated there's no truth to the rumor. However, PepsiCo is the perfect company for such a deal.

Partly because of the Quaker purchase, PepsiCo has a widely diversified product portfolio. Although selling devices is a little outside the company's focus, selling the consumable syrups would fit right in. Moreover, it would give PepsiCo another avenue for entering people's homes.

And with the marketing heft of PepsiCo behind it, SodaStream could find itself going mainstream. It isn't too far fetched to suggest that, with the right backing, SodaStream could experience at least a portion of the success that the Keurig coffee system has seen. Imagine if PepsiCo was able to get soda competitors to sell syrup for the machine. It could be a massive business opportunity.

Not needed

For sure, PepsiCo doesn't need SodaStream. The company earned $65.5 billion in 2012. Adding SodaStream's revenue would be little more than a rounding error. The allure of a hot new drink fad, however, might make it worth the effort. And Coca-Cola would have a harder time pulling off such a deal because of its clear focus on drinks.

That isn't to say that Coca-Cola couldn't buy SodaStream, just that it doesn't have as deep relationships with grocery stores and other outlets. Even though the rumor is that SodaStream wants to pit the two beverage giants against each other, Coca-Cola has purposely tried to remain focused and selling small appliances is just too far afield.

Part of that focus is because of the impressive profit margins in selling glorified water. Indeed, Coca-Cola's profit margins are in the low 20s while PepsiCo's tend to be in the low teens. SodaStream, meanwhile, had a profit margin of just 10% in 2012.

Long-term buys?

SodaStream, as a stand alone company, is too risky for most investors. Momentum types might like the fad nature of the stock, but a keen eye will be needed to figure out when to jump ship. PepsiCo, meanwhile, is a great company with or without SodaStream.

It is important to keep in mind that PepsiCo is much more than just a drink company, however, because that gives it a leg up on Coca-Cola for those seeking diversification. Both recently yielded around 2.80% and have long histories of annual dividend increases. So, in many ways, that diversity is the biggest difference between the two. That said, investors seeking direct exposure to beverages would be better served with Coca-Cola.

SodaStream's carbonation technology sounds simple, but this razor-and-blade company offers an intriguing opportunity for growth that could very well disrupt the soda industry. The Motley Fool's premium report on SodaStream explains the opportunities as well as the risks in the company. The report comes with a year’s worth of updates, so just click here to get started.


Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, PepsiCo, and SodaStream. The Motley Fool owns shares of PepsiCo and SodaStream. 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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