Dr Pepper Snapple Group, Inc. (NYSE: DPS) — market cap as of 24/11/2016: $16.031bn
Introduction
On November 22, 2016, Dr Pepper Snapple Group Inc., an American beverage producer, agreed to acquire Bai Brands, another American beverage producer focused on antioxidant beverages, for $1.7bn. The deal emerges as traditional customers sway away from sugary drinks and as a means to tap into the growing segment of health-conscious consumers. The deal seems to be appealing as Dr Pepper, given its financial resources, can realize Bai Brands’ full potential and soften the pressure on its own brand portfolio caused by a shift in consumer preference.
About Dr Pepper Snapple
Dr Pepper Snapple Group, Inc. (Dr Pepper) is a leading producer of flavoured beverages in North America and the Caribbean. It was established in 2008 following the spinoff of Cadbury Schweppes Americas Beverages (CSAB) from Cadbury Schweppes plc. In turn, CSAB had been formed in 2003 by bringing together Cadbury Schweppes’ four North American beverage businesses, Dr Pepper/Seven Up Inc., Snapple Beverage Group, Mott’s LLP and Bebidas Mexico: this led to the unification of more than 50 leading brands under the third-largest beverage business in North America.
Today Dr Pepper owns renowned brands such as Dr Pepper, Snapple, 7UP, A&W, Canada Dry, Clamato, Crush, Hawaiian Punch, Schweppes. It is the market leader in the flavoured carbonated soft drinks category, as well as a key player in the fast growing ready-to-drink tea and juice drink markets. The company operates 22 manufacturing and bottling facilities in North America and more than 100 warehouses and distribution centres.
Dr Pepper posted net sales of $6.3bn in 2015 (+2.6% YoY) and income from operations of $1.3bn (+10% YoY). Operating cash flow stood at $991m as opposed to $1,022m in 2014.
About Bai Brands
Bai Brands, LLC (Bai) is one of the fastest growing beverage brands in the U.S. Founded in 2009 and headquartered in Hamilton, New Jersey, it offers a wide range of beverages positioned in the low-calories segment. Its product categories are experiencing high-profile growth and include enhanced water, carbonated flavoured water, coconut water and premium ready-to-drink teas. The brand portfolio encompasses Bai, Bai Bubbles, Cocofusion and others.
In October 2016, a new push has been given to Bai Brands: Justin Timberlake joined the Bai team as an investor and as the company’s first Chief Flavour Officer. According to Ben Weiss, the Bai’s Founder and CEO, Justin Timberlake will also star as the face of the brand in a $100m marketing campaign.
Not a wonder that such a ‘sexy’ company is expected to earn over $300m in revenue this year, and is in the top-20 of America’s Most Promising Companies, taking 13th place according to the Forbes.
Deal Rationale
The major strategic rationale behind the acquisition can be traced back to a significant shift in consumer demand towards the so-called “better-for-you” beverages. These include low-calories, antioxidant drinks and even plain water. According to research by Beverage Marketing, by 2017 bottled water consumption may indeed surpass soda, whose estimated per-capita consumption reached its 30-year low in the U.S. last year. Moreover, the recent vote of major American cities such as Chicago and San Francisco on the introduction of a new tax on sugary beverages furtherly highlights the growing concern towards health issues associated with sugar consumption.
Dr Pepper Snapple’s President and CEO Larry Young defined Bai as capable of continuing “to meet the needs of consumers seeking great tasting, low-calorie beverages with natural flavours and no artificial sweeteners.”
Bai Brands had actually been part of Dr Pepper Snapple’s “allied brands” since 2013, when DPS bought a 3% stake in it and started acting as its main distributor. Being familiar with Bai’s portfolio of products, Dr Pepper Snapple decided to exploit the company’s full potential in order to strengthen its position in the industry and to seize a significant share of the growing low-calories beverage market.
As far as the financials are concerned, the deal is expected to add $132m in incremental sales to Dr Pepper Snapple’s 2017 expected net sales and $43m in incremental income from operations in 2017. Based on its 3-year net sales historical CAGR, Bai is expected to grow its net sales to $425m in 2017 and its income from operations to $79m as a result of the integration with DPS.
Deal Structure
After months of negotiations, Dr Pepper Snapple Group agreed to purchase Bai Brands in an all-cash transaction valued at approximately $1.7bn including $400m worth of tax benefit. According to the company’s press release, this benefit comes out as a result of a step-up in basis: the restatement of Bai’s assets at market value will indeed let the merged entity save taxes on capital gains and increased depreciation. The terms of the deal therefore value Bai Brands at 3.1x its expected 2017 net sales.
The deal will have a $0.03 dilutive effect on the 2017 pro-forma EPS because of the marketing expenses needed support the brand. However, the deal will have an accretive effect on the company’s EPS starting from 2018.
Dr Pepper Snapple will finance the deal through $150m of commercial paper and unsecured notes. Despite this expensive endeavour, the acquirer aims to maintain a strong investment-grade credit profile: the company’s debt-to-LTM EBITDA multiple will indeed be 2.9x. Furthermore, the company will continue to pay dividends
The transaction has been approved by the board of directors of both companies but is still subject to customary closing conditions. As a consequence, collaboration between the firms and the regulators is essential, in order to ensure closure in the first quarter of 2017. Bai Brands will continue to be governed by the Founder and CEO Ben Weiss and will remain a key player within the packaged beverages industry.
Market Reaction
Dr Pepper Snapple’s share price jumped 2.6% on the day of announcement, signalling investors’ confidence in the potential strategic upsides of the deal despite the initial dilutive effect on earnings per share.
Advisors
Credit Suisse is Dr Pepper Snapple’s exclusive financial advisor. Bai Brands is being advised by J.P. Morgan.
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