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Salty and Sweet? A PepsiCo - Mondelez deal is no substitute for creating real economic value

By David Bailey on Mar 30, 13 05:48 PM in


It was investor Nelson Peltz who via his investment firm Trian Partners agitated for the splitting up of what was then Cadbury Schweppes back in 2007 which subsequently led to a demerger and Cadbury becoming a much smaller player.

The demerged Cadbury was subsequently 'in play' as a takeover target and was gobbled up a few years later by Kraft. Of course, what was good for Nelson and his chums in extracting value didn't necessarily equate with either long term business success or wider economic benefits.

He's at it again, it seems. Peltz has reportedly taken big stakes in PepsiCo and Mondelez (the owner of Cadbury since the Kraft split ), supposedly with the goal of putting them together or - more likely I feel - splitting off part of PepsiCo to merge with Mondelez. (Of course it could just be a passive investment and everyone could be getting far too excited - I hope so).

The exact size of the stakes taken in the two firms is not known but reports suggest that Peltz had spent some $2bn on shares in them. However, the size of the holdings under Peltz's control could be even larger as it is understood that other investors have been providing backing as well.

If PepsiCo acquired Mondelez, their combined market capitalisation would be as high as $170 billion - and if so PepsiCo is likely to be the acquiring company as it has a market capitalisation of around $117 billion - way higher than that of Mondelez.

Such a huge takeover is the last thing Cadbury needs given the significant disruption the last one (by Kraft) caused, with a brain drain of top executives from the firm, and the imposition of a top-down hierarchy on what had previously been a fleet-of-foot Cadbury operation. Top bosses left in droves.

But I'm not sure Peltz is planning this. Rather, he may be looking instead to force PepsiCo to break itself up (as he did with Cadbury Schweppes) and sell part of its business to Mondelez. Some investors are thought to have already asked for PepsiCo to pursue this strategy; so far, though, PepsiCo's CEO Indra Nooyi has opposed the demerger idea.

Mondelez of course was split off from Kraft last October. The idea was to put the slow growth but profitable grocery business into (new) Kraft, and the less profitable but faster growing brands like Oreos and Cadbury chocolates into Mondelez.

Of course this demerger trashed the original logic for the Kraft takeover of Cadbury which was that 'big is beautiful'. That takeover logic never stacked up, of course, and Kraft CEO Irene Rosenfeld was quickly forced in a massive strategic u-turn.

With over 40% of revenues coming from emerging markets and 75% of its portfolio in snacks (of which consumption grows as incomes rise) then Mondelez was meant to be positioned as a high growth business.

But since the demerger, the share price of this 'fast growth business' has gone nowhere fast while the grocery-orientated Kraft's share price is up by some 15% (ignoring the recent Mondelez share price spike as speculation over a tie up with PepsiCo kicked off).

Since the demerger, Mondelez sales have been lacklustre - particularly in terms of chewing gum, which was meant to be a dynamic market segment. Gum saw steep revenue declines in developed markets in quarter four of 2012-13. CEO Rosenfeld appears to blame the fall on slow economic growth, youth unemployment and margins being cut by aggressive pricing.

Perhaps Mondelez simply isn't innovating and delivering new gum products quick enough, in contrast with the stream of innovations coming out its Bournville chocolate R&D centre.

Mondelez's overall poor performance should have been no surprise as I'd argued some time ago. Indeed, as the commentator Joe Cahill commented in a great piece for Chicago Business back in September when Kraft split into two:

"the endless dealmaking reflects the uncomfortable truth for many big consumer products companies. They have all but given up on creating real economic value through new products and better marketing".

"There's an upside in all this for the daisy chain of senior executives, investment bankers and hedge fund operators who collect fees, option payouts or quick trading profits on the deals. But the short-term stock market high always fades when the company's real-world results debunk the theory du jour. That process already has started at Kraft, which recently jolted investors by dialing down growth forecasts for the companies it's hatching in the split-up".

And he presciently noted that "long-term investors needn't worry as the Kraft offspring slide toward the food industry's slow-growing mean, however. Somewhere, I'm sure, a bright mind is noodling out a rationale for the next big deal".

But while some investors hope for a PepsiCo takeover so as to put pressure on Mondelez to perform after turning in disappointing results, that "next big deal" is actually likely to be not a full blown PepsiCo take over of Mondelez but rather a demerged PepsiCo sliding its snacks business into Mondelez. Indeed, PepsiCo has been under pressure for some time to spin off its snack business. So it may be that Peltz could be thinking of this rather than a full-blown merger.

And remember that Pepsi Co's snacks business includes Frito-Lay, which Mondelez CEO Irene Rosenfeld ran before going to Kraft. So Peltz may be trying to engineer a Frito-Lay sale to Mondelez, returning the business to the boss who used to run it, leaving Pepsi to focus on drinks.

Some argue that a tie-up in particular between the snack business of PepsiCo and Mondelez has a 'strategic logic'. It's argued that a Mondelez-PepsiCo tie-up could allow the firms to 'leverage' their distribution infrastructure in emerging markets, thereby extracting 'synergies'. In so doing, a merger, it's argued, might calm investors who are concerned over Mondelez's reliance on emerging economies post Kraft split.

And mixing PepsiCo's strength in salty snacks with Mondelez's sweet offerings in biscuits and confectionery is also seen by 'analysts' as making sense with little overlap or competition concerns for authorities.

But of course that way too simplistic a view of things as bringing together two different businesses with different distribution systems in different markets would probably take a huge amount of management time and efforts - time and effort better spent on serving customers.

Big deals usually don't deliver, as Mondelez's recent poor form is itself showing. Not that the deal makers are bothered about this, of course, as that just opens up further opportunities down the line for yet more takeovers or demergers of businesses that aren't delivering what was promised. Such is the logic of the market for corporate control.


Professor David Bailey works at Coventry University Business School

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