Activist investing and special situations for the retail side.

Why Billionaire Nelson Peltz Should Push Together Mondelez (MDLZ) And Pepsi (PEP)

Added on by Lee Ho Fook.
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Be sure to check out our detailed stock analysis (click here). Billionaire Nelson Peltz runs the activist hedge fund Train Partners, and recent news suggests that he might be pushing for a merger of two food and beverage industry giants--PepsiCo (NYSE: PEP) and Mondelez (NASDAQ: MDLZ). Although everything is hearsay at this point, the thought is worth entertaining: what does this mean for Pepsi? What would this mean for Coca-Cola (NYSE: KO)?

Peltz did not have a stake in either company as of the end of 2012, but speculation is that Peltz might have been building up stakes in each company over the past few weeks, according to Britain's Daily Telegraph. The paper also noted that Peltz had may have spent at least $2 billion on his Pepsi and Mondelez share purchases (check out Peltz's newest picks).

The benefits of a merger

With a merger, Pepsi would bring Mondelez's brands -- Cadbury chocolate, Oreo, Trident, Carte Noire coffee, etc. -- under its roof. But the real advantage will be greater international diversification. For 2012, Mondelez derived nearly 45% of revenues from the developing markets of Latin America, parts of Asia Pacific, and Central and Eastern Europe, another 35% from the rest of Europe, and only 20% from North America. 

Pepsi is heavily weighted toward North America, and so a merger with Mondelez would be a great diversification tactic. About 70% of Pepsi's revenues are a result of its North American beverages and food segments (read about Pepsi's latest move into the energy drinks).

What's more is that Mondelez would bring a different snack dynamic to Pepsi. In 2012, Mondelez generated more than 30% of revenues from its biscuits category and 27% from its chocolate segment. Meanwhile, another 15% was from gum and candy. 

Another possible idea for Peltz is to push for is a spin off of Pepsi's diverse business operations. Kraft Foods completed a similar spin off, which resulted in Kraft Foods Group running the North American grocery business and Mondelez the international snacks. Pepsi's 1965 merger with Frito-Lay placed it at the forefront of the snack industry, and now the company generates a large portion of its revenues from snack foods. Pepsi's food brands includes Lay's potato chips, Cheetos, and Quaker-brand cereals and snacks.

What makes Pepsi great?

Pepsi is the largest food and beverage business in North America and the second largest in the world. The real competitive advantage lies in its offering of both snacks and beverages, which are complementary food categories. The company is also expecting to boost its advertising and marketing expenses at a greater rate than revenue growth over the interim as it tries to expand its global footprint. 

Although Coca-Cola has a market-cap ($178 billion) well in excess of Pepsi ($121 billion) and Mondelez ($52 billion), Pepsi generates 35% more revenues ($65.5 billion) than Coca-Cola ($48 billion), and Mondelez is not too far behind with $35 billion in revenues. 

More about Coca-Cola

Pepsi has a robust beverage and snacks portfolio, compared to Coca-Cola's beverage-concentrated portfolio. Coca-Cola operates primarily in North America, with nearly 50% of revenues from the region, while bottling operations accounts for some 15% of revenues. The key initiative for the beverage company includes its plans to make emerging markets a bigger part of its business. Emerging markets currently make up around 20% of revenues, but the company hopes to lift this segment to over 33% by 2020. 

Although Coca-Cola doesn't have a snack foods segment, it is looking to use bottling as a way to diversify operations. Yet, its recent acquisition of Coca Cola Enterprises' North American bottling operations weighs the company even greater toward North America. On the positive side, management expects the acquisition to generate synergies of at least $350 million over the next four years (see the only reason you need to buy Coca-Cola).

What to do? 

Billionaire Peltz has proven himself a worthy activist investor, and his ability to unlock shareholder value at Pepsi and Mondelez would indeed be a positive for both companies.  However, I believe that either stock is worth investing in regardless of Pelt's pursuits. Mondelez is an underrated dividend and growth opportunity (see why Mondelez is a buy), while Pepsi is heavily diversified and pays investors a 2.8% dividend yield.