Coca-Cola-Keurig Green Mountain Deal: A Win-Win Situation For Both

The Coca-Cola Company (NYSE:KO) became the largest shareholder of the Vermont based K-Cups maker, Keurig Green Mountain (NASDAQ:GMCR), after it announced raising its stake in the company to 16%, earlier this month. ^[1] As a result, shares of GMCR jumped 7.5% to $119.07. On the other hand, Coca-Cola’s stock rose 0.7% to $41.11. Under an accelerated purchase agreement with Credit Suisse, Coca-Cola beneficially owns about 26 million shares of GMCR, up from 16.7 million as of February 27. Coca-Cola has already bought 2.8 million of those shares, and has plans to buy the remaining 6.5 million within the next nine months. Short Interest in GMCR’s stock dropped to 8% in May, as compared to 22% at the start of this year. Evidently, the deal strengthens the relationship the two companies had outlined back in February, and is a bonus to GMCR’s shareholders as Coca-Cola’s purchase drove up the share price.

In February, Coca-Cola had initially bought a 10% stake in the company for $1.25 billion, after the release of GMCR’s first fiscal quarter report. Eventually, shares of GMCR skyrocketed by 53% within the next two weeks touching its peak stock price of $123.74, before retreating back to $90 over the three month period. To incorporate the value creation as a result of the deal between Green Mountain and Coca-Cola, we have added a new division called the ‘Keurig Cold’. This division includes the royalty income generated through the sale of single-serve packs compatible with the upcoming ‘Keurig Cold’ brewers, in addition to brewer sales. After the release of GMCR’s second quarter report last week (May 7th), its stock price is back on the rising trend due to strong figures posted by the company.

We have a $80 price estimate for Green Mountain Coffee Roasters, about 20% lower than the current market price. For Coca-Cola, we have a price estimate of $41, almost in line with the current market price.

See our full analysis of GMCR here

At-Home Carbonation Market Gets Bigger

Basically, Coca-Cola and GMCR have entered into sort of a joint venture, where two companies are together developing the Keurig Cold. GMCR is well known for its technologically advanced brewer systems and user-friendly portion packs and K-Cups. Keurig Cold will be designed to dispense single servings ranging from carbonated drinks to non-carbonated beverages like juice drinks and iced teas. Beverage giants such as Coca-Cola and PepsiCo have been struggling with sales of carbonated soft drinks (CSD) in developed markets due to increasing health concerns. Consumers are shifting towards alternatives like iced coffee, juices and sports drinks. However, according to our estimates, CSDs still constitute about 43% of the 30 billion gallon liquid refreshment beverage (LRB) industry in the U.S., forming the largest segment. ^[2] Keurig Cold provides an added platform for Coca-Cola to reach its large CSD consumer base, apart from other beverage products, which are high in demand lately. This means the consumption rates of avid customers could grow, come the Keurig Cold machine.

Keurig Cold will provide its users the convenience of at-home carbonation technology and the ease of carrying compact flavor sachets, rather than the bulky PET bottles from retail stores. The leader in at-home carbonation market, SodaStream, sold close to 4.4 million soda maker units in 2013, with close to 36% of annual sales coming from the American geographies. ^[3] The company’s revenues have almost quadrupled in the last four years, suggesting that people are interested in the concept of preparing cold beverages at home. Moreover, GMCR has Coca-Cola as soda partners, whereas SodaStream has no such soda partner as of now. In the long run, this could help GMCR grab a vital market share and grow in the beverage industry.

Potential Boost to Keurig Cold’s Initial Sales

Over the last two quarters, GMCR has posted strong revenue growth owing to the success of Keurig 1.0. Moreover, GMCR’s partnership with Coca-Cola has already generated significant hype about the upcoming product, Keurig Cold, to be released in the latter half of this calender year. GMCR has gained goodwill among consumers, due to the success of its products in the U.S. Additionally, its partnership with Coca-Cola, the world’s third most valuable brand, could bolster demand for the Keurig Cold Beverage system and related accessories. This has acted as a useful marketing tool, which is likely to boost sales during the initial period.

Keurig Cold Royalty division includes only the revenues earned as royalties. GMCR will earn royalty through the sale of third-party products compatible with its ‘cold’ brewers, and since royalties do not involve any cost of goods, gross margins for this division would be very high. Also, this product gives an opportunity to GMCR to enter the cold beverage space, which is four times the hot beverage market. ^[4] Seeing how margins for the new division are high, this should effectively raise the overall profitability of the company.

Keurig Green Mountain’s Valuation May Remain High

There are speculations that Coca-Cola’s investment in Keurig could be seen as a precursor towards an eventual acquisition. Coca-Cola previously took equity stakes in small brands like Zico coconut water and Honest Tea, eventually acquiring both the companies. However, compared to both these brand, GMCR has a much larger market cap. Coca-Cola’s move to increase its stake raised investor confidence, as it underscores Coca-Cola’s faith in Keurig Cold. One cannot accurately predict the impact of Coca-Cola’s branded products on GMCR’s revenue and cash flow, but the potential for increase in these figures seems realistic as of now.

Irrespective of Coca-Cola’s intention, this deal and the whole speculation could undoubtedly boost GMCR’s valuation. The company’s market size has increased from $11.24 billion at the start of 2014, to around $19 billion after the release of the Q2 report, an increase of over 80%. The company’s growing size and goodwill cannot be neglected, making it a possible candidate for an acquisition.

Scope For Expansion

Considering Coca-Cola has a more widespread consumer base than GMCR in the U.S., and the coffee brewer specialists are yet to expand internationally, this partnership could be an incredible opportunity for GMCR to expand its consumer base. The soft drink industry represents an $11 billion industry in the U.S, and $100 billion market worldwide. ^[5] Once the Keurig Cold machine is out, GMCR might look to utilize Coca-Cola’s strong distribution channels. Keurig can also take advantage of Coca-Cola’s global brand appeal to expand its presence internationally, particularly in the budding ready-to-drink coffee and ready-to-drink tea segment, which is the most dominating market in Asia-Pacific, whereas North America is the fastest growing market in this segment. ^[6]. The global market for Ready-to-drink tea and coffee in terms of revenue was estimated to be worth around $69 billion in 2011 and is expected to reach $125 billion by 2017, with an estimated compounded annual growth rate of 10.9% from 2012 to 2017.

The incremental purchase of GMCR’s shares by Coca-Cola indicates the increasing interest and continued faith in growth potential of the coffee brewer company. This deal seems like a win-win situation for both the companies as it not only provides Coca-Cola the added platform for the sales of soft drinks but also provides GMCR a potential scope for growth in the domestic as well as international markets.

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1. SEC filing, May 8th, 2014 [↩]
2. U.S LRB Market, www.beveragemarketing.com [↩]
3. SODA 6-K, annual report 2013 [↩]
4. Analyst at Seeking Alpha [↩]
5. Cold beverage market [↩]
6. RTD tea and RTD coffee market, www.marketsandmarkets.com [↩]