PLANO, TEXAS — While the explosive growth of Bai Brands in recent years is undeniable, does the business merit the $1.7 billion price tag Dr Pepper Snapple Group will be paying for the specialty beverage business?
After all, the acquisition is expected to add only $132 million in incremental net sales and $43 million in incremental income from operations to Dr Pepper Snapple Group’s current 2017 estimates, said Martin M. Ellen, chief financial officer of Dr Pepper Snapple. Projected Bai Brands sales are $231 million in 2016, up 139% from $108 million in 2015.
The Plano, Texas-based company announced plans for the acquisition in late November. As a distributor of Bai for about three years, Dr Pepper Snapple is familiar with the business, executives said. In a presentation at the time to investment analysts, Dr Pepper Snapple touted Bai’s attractive qualities, including its meteoric growth, its portfolio of on-trend, better-for-you and rapidly expanding categories, and a strong innovation pipeline targeting consumer demand for “great tasting and low-calorie beverages.”
While acknowledging the acquisition will be dilutive to earnings (only slightly — 3c per share) in 2017, the company expects Bai to be earnings accretive in 2018, even without accounting for any potential cost synergies. Dr Pepper Snapple is projecting Bai sales of $425 million in 2017 and $500 million by 2018.
Still, during the conference call, Kevin Grundy, an analyst with Jeffries L.L.C., asked management directly about valuation considerations.
Mr. Ellen said management looked deeply across the entire Bai portfolio to evaluate growth potential and to establish an appropriate valuation. Using discounted cash flow analysis, adjusting the price for the time value of money on business already secured through a distribution agreement, the purchase price was far lower than $1.7 billion, he said. To begin with, the price was $1.3 billion, net of tax benefits.
“Obviously there’s a fairly large early-on growth rate in the valuation that was pretty clear when we said this morning that we expect the sales to more than double in the next two years,” he said. “What I would tell you is, Kevin, if you (peek) behind the tent in terms of our valuation analytics and you look at our assessment of the value of the business, which as I said to Vivien a minute ago, started with a really deep inspection of where the different products in the portfolio are today in terms of distribution, what their velocities look like by channel, in some cases by major customer, and across all channels, we built up our expectation of the future very carefully.
“If you looked at the discounted cash flow analysis associated with that, versus what we paid for the business of $1.3 billion, we probably paid about $180 million. If you think about $180 million to, in essence, value the profits we already had. That seems to be a pretty low (price) to secure in perpetuity the distribution profits we already have. It will take a couple, three years to get above on annual basis our cost to capital, given that today the businesses is smaller than we think it is going to be a couple years from now, clearly. But I think that should help you understand our comments earlier. We think we’ve been very disciplined on this.”
Mark D. Swartzberg, an analyst with Stifel Nicolaus & Co., New York, appears to have found the analysis convincing. Stifel currently rates Dr Pepper Snapple a “buy.”
“This is a fairly priced transaction that validates D.P.S.’s allied brand strategy and probably improves D.P.S.’s long-term growth potential,” Mr. Swartzberg said in analysis published following the conference call.
Investors seem to be echoing Mr. Swartzberg’s sentiments. In trading on the New York Stock Exchange since Nov. 18, shortly before the acquisition was announced, Dr Pepper Snapple shares climbed to $88.55 as of the Dec. 7 close, a 6% gain. The advance bested a strong overall stock market that rose 2.7% (the S.&P.500) over this same period.
Notwithstanding the confidence, integration risks hang over all acquisitions, particularly when large corporations acquire rapidly growing entrepreneurial companies. A primary concern in acquisions of up and coming companies is whether growth rates will be sustained as anticipated. The risk may hang particularly visibly over Dr Pepper Snapple. The 1994 acquisition of Snapple Beverage Co. by Quaker Oats ranks among Investopedia’s “Biggest Merger and Acquisition Disasters in History.” The episode was the subject of a 2002 article in the Harvard Business Review. Snapple was a rapidly growing brand in 1993 when Quaker agreed to pay $1.7 billion (yes, the same price Dr Pepper Snapple is paying for Bai). Under the ownership of Quaker Oats, not only did the brand fail to grow to Quaker’s expections, Snapple sales declined every year, until the brand was sold to Triarc Beverages in 1997 for only $300 million. According to the H.B.R. study, the failed acquisition was blamed both for the departure of Quaker’s top leaders and for contributing to a loss of independence for Quaker — acquired by PepsiCo, Inc. in 2001. Snapple ultimately snapped back to life. Triarc sold the brand to Cadbury Schweppes in 2000 for about $1 billion.