M&A Watch - The Options Available to Cott Corp
What options is Cott Corp considering for the future?
On the back of weak results in the first nine months of 2013, Cott Corp confirmed last week that it has appointed Credit Suisse to evaluate all strategic options that “would enhance shareholder value". Stefan Kirk, from M&A practitioner Glenboden, examines some of these options, including geographic diversification, consolidation and private equity.
Geographic diversification a big challenge ...
On the face of it, geographic diversification is the obvious way forward for Cott, since North America and the UK currently account for 95% of its sales. Surely there's major scope for Cott to grow by following its multiple retail and A-brand customers into continental Europe, or BRIC or other emerging regions?
However, as its starting point, Cott's only experience of moving beyond its ‘safe havens’ of North America and the UK, namely into Mexico, has been poor. Apparently the group lost money for five years after entering that market, through a JV in 2002, and Mexico still delivers only 2% of total sales.
Then, there’s the problem that the relatively ‘safe’ continental European market exhibits growth rates that fail to excite Cott's management. Besides which, the group would have to face Refresco Gerber in any acquisition battleground in Europe - an aggressive player that’s grown from nothing to over 20 plants and nearly EUR2.5bn in sales, in 15 years.
... with emerging markets still too small
As for the burgeoning markets of the world, the most exciting, notably the BRIC countries, are still too under-developed in their retail sectors for a predominantly private label player like Cott to achieve significant volumes.
From recent assignment work, we have found that the group took a close look at central Europe, which offers both market growth and a relatively developed retail sector. However Cott concluded inter alia that the bottling industry is still too fragmented in that region; even a target business with only EUR25m turnover is quite big in Poland, for example.
We believe, then, that geographic diversification can be excluded from Cott's strategic options for superior performance, at least in the near term.
So, how about racier options for enhancing the group's shareholder value, like consolidation or private equity ?
Limited consolidation opportunities ...
A year ago, the biggest deal for Cott would have been a merger with Refresco, a parallel business covering continental Europe like Cott that covers the Anglo-Saxon world. However, in 2013, Refresco acquired Gerber Emig, thus radically changing its product and geographic mix and increasing group sales revenue by over 50%. It will take quite a while for Refresco to digest that merger, and then to look beyond it.
Looking instead at Cott's home market, in theory a tie-up with one of the big four national branded players, notably Dr Pepper Snapple Group, would consolidate the market, alleviate competitive pressures and enhance bargaining power with the multiple retailers. One of the biggest drags on Cott's results, after all, is the heavy and sustained promotional activity by branded competitors in North America.
And yet, there is a fundamental mis-match between branded players like Dr Pepper Snapple, and contract bottlers like Cott. Apart from the obvious conflict of interest inherent in the same organisation pitching both branded drinks and private label equivalents to retailers, Cott might no longer be able to bottle for other branded players, like The Coca-Cola Co.
So, Cott's consolidation options may be limited to 'mopping up' more small players, like they have been doing in recent years in the UK market through the purchases of Sangs and Calypso. The group’s net debt, currently at 2.5-times EBITDA, also restricts the size of potential new bolt-on deals.
Also, such deals only provide incremental benefits for the group, without any major shareholder value lift.
... and private equity buy-out unlikely
Recent pre-mandate work for Cott and Refresco in central Europe has demonstrated to us that the private equity community has its cashier's window firmly closed for private label soft drinks bottling businesses, at this and, arguably, any time.
That's largely because private label and A-brand bottling are inherently low-margin businesses, given the low retail price-points of the former and the extra player in the value-chain of the latter. As Steve Kitching, MD of Cott UK, told us: "You're lucky to get a 6% operating margin" in soft drinks bottling. The results show the group’s EBITDA margin in 2013 to be only 9%, in spite of Cott being the biggest private label player in its markets.
On top of that, there's no pathway to significantly raise profitability through restructuring for private equity buyers, because private label bottlers are almost by definition very lean operators; without strict cost management, they wouldn't be in business in the first place.
Retailer vertical integration for the biggest bang ...
Back-integration into manufacturing is a growing story among multiple retailers, who see benefits in areas like supply chain optimisation, efficient capacity utilisation and food safety assurances (a significant issue now, especially in the energy drinks segment).
In Europe, the Schwartz Group, which owns the Lidl multiple retailer, is a proponent of vertical integration, having acquired a significant soft drinks supplier, MEG Gruppe of Germany, in 2005. Meanwhile in the US, Kroger's own manufacturing network, which supplies 40% of that retailer’s total private label sales, also includes the America's Beverage Co. and Springdale bottling operations.
In a vertical integration scenario, who is the most likely merger partner for Cott amongst multiple retailers ? Cott's largest customer by far is Walmart, which in 2012 accounted for over 30% of its total sales; no other customer accounted for above 10% of the group's sales revenue. So, Walmart is an obvious candidate.
Apart from being the best party in town in terms of realising value for Cott’s shareholders, tying up with a big retailer could also bring some stability to Cott’s sales and profits performance, which has been lacking in recent years.
... but with a modest valuation
For a number of reasons, Glenboden believes that the value of Cott in a merger with a retailer would only be in the single-digit EBITDA multiple range, in spite of the group's large scale.
Cott's growth rate looks reasonable, despite its heavy sales weighting in developed markets. However, much of that was generated by the acquisition of Cliffstar in 2010. In addition, the group's profitability has been up-and-down in recent years, which inevitably depresses value.
Then, there's the fact that a vertical-integration transaction with a retailer would not deliver the cost synergies that a consolidation play with another producer would bring. Such a move also presents the risk of loss of business with branded soft drinks suppliers; additional factors for a lower valuation.
- Deal size - US$1.50bn
- Sector - soft beverages
- Asset quality - North America no.1 private label
- Seller - Large plc
- Buyer - Large plc
- P/S - x0.7
- P/EBITDA - x8.0
- Type - Enterprise Value estimate
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