Quick Thoughts – KO, Rumor, Trees and the Forest
The push back that we received when we included KO in our list of consumer staples M&A candidates was fairly intense – but not unexpectedly so – KO isn’t a controversial stock at this point, but rather one that investors seem to have left for dead.
While we continue to think that the path to an ABI/KO combination is the eventual, natural conclusion to continued multi-year global brewer consolidation that could leave ABI as KO’s largest and most important bottler, the other part of our thesis was no less important – that KO, as a company, has become complacent with respect to both costs and growth.
We certainly aren’t in the habit of endorsing spivvy rumors, and this morning’s speculation on KO won’t be any different (LBO, of interest to 3G and current shareholder Warren Buffett, the sheer size of such an undertaking makes us highly skeptical). The market seems to have largely and correctly ignored it as well.
o We should point out that this speculation is neither new, nor original, with Whitney Tilson having suggested it as recently as the Berkshire Hathaway annual meeting just over a month ago:
o “I think that Warren Buffett and 3G will team up again to buy Coke,” he said. “Anything that shakes up corporate boards is a good thing, because there are a lot of companies that are just fat and poorly run. Take Heinz.”
o So, we are happy to ignore the tree today.
Our takeaway from this morning’s rumor is to embrace only what we see as the underlying reality (the forest) – that there exists opportunity at KO for aggressive cost cutting, reinvestment and renewed growth. While KO would certainly be a whale in terms of targets for corporate activism, there are more than a few whale hunters out there.
Our criteria for activism in staples leans heavily on Nelson Peltz’ view (and common sense):
o An attractive risk/reward profile;
o Sizable market capitalization;
o Strong balance sheet;
o Significant free cash flow;
o Formidable industry leadership;
o Secular tailwinds
KO checks a number of boxes, but for the last one, and we would argue that the trends weighing on carbonated beverages are first world in nature, and that a great deal of the developing world enjoys per capita consumption levels of CSD’s that leave substantial room for growth.
While Mr. Peltz is otherwise occupied at the moment, we continue to see opportunity over longer durations at KO. Free cash flow and brands – ultimately, management needs to get it right, or someone (activist, strategic) will get it right for them.