Ray Rowlands can see both sides of the PepsiCo spin-off row

Ray Rowlands can see both sides of the PepsiCo spin-off row

Last month, Nelson Peltz of Trian Fund Management sent a 37-page letter to PepsiCo's board urging it to spin off, what he described as, its struggling beverage business. Ray Rowlands of Drinksinfo Ltd looks at the pros and cons of such a monumental undertaking and draws his own conclusions.

Trian Fund Management, headed by 'activist investor' Nelson Peltz, has recently renewed its pressure into trying to persuade PepsiCo into dividing up its beverage and snacks businesses. Trian is reported to have bought 3.9m shares in PepsiCo as of the end of 2012 and PepsiCo is now one of the top five largest value holdings that Trian has. The shares equate to around US$1.2bn in PepsiCo stock.

The core argument in support of a split is that the US multi-national’s beverage operations are reported to be holding back the rest of the company. If Frito-Lay, with brands such as Cheetos, Doritos and Lays chips, was to stand alone, it would make it one of the biggest food groups in the world.

But, are PepsiCo soft drinks really doing so badly?

There is no doubt that PepsiCo sits within the big league in respect of the World's soft drinks market: Its global volume share is estimated at around 10%. In other words, one in every ten litres of soft drinks consumed around the world is a PepsiCo product. That's no mean achievement when considering the multitude of beverage players and brands that are constantly competing with each other for share of throat.

However, it is true that the company’s position has come under pressure in recent years. The mature soda market, in which PepsiCo is a major participant, is slowly losing out to a growing raft of alternative beverages that are aiming to tempt the fickle consumer palate. Moreover, the public is ever anxious about the health issues (actual or otherwise) attached to diet drinks such as Pepsi Max. Thus, consumers are growing both increasingly weary - and wary - of CSDs. They still represent the largest of all soft drink categories, but not for much longer. In a year or two the crown will undoubtedly pass to the bottled water market.

Fortunately, PepsiCo has not placed all its eggs in one basket. Sodas may represented a large chunk of the company’s beverage business but its interests stretch across the soft drinks spectrum, from bottled water (such as Aquafina) to juice (Tropicana), and down to more niche product groupings like sports drinks (Gatorade). Any slack experienced in CSDs should, in an ideal world, be taken up by these alternative drinks.

Unfortunately, that is not quite the case.

Faced by stiff competition from international giants, such as Danone and Nestle, plus a host of national players, PepsiCo’s share of the global bottled water market remains small. It also reflects a heavy bias towards the US, with hardly any presence at all in Europe or South America. And yet, these two regions between them represent 40% to 50% of worldwide consumption.

Largely thanks to the strength of the Tropicana brand, PepsiCo has a more substantial slice of the international juice market. It is a pity, therefore, that this category is in decline having suffered a succession of contractions in recent years, influenced by consumer concerns over calorific and sugar content.

Though smaller in size than the global juice market, sports drinks are proving more of a success, having overcome a recessionary-induced dip in 2008/9. PepsiCo is something of a major international player here, with Coca-Cola’s Powerade as the only real threat to its Gatorade brand. Even so, volume growth is not fully compensating for the slowdown in CSD sales.

As sales of CSDs peak in mature markets, PepsiCo also faces the threat of encroachment in emerging markets, especially by Coca-Cola, which has also struggled with declining sales in developed countries, particularly its homeland. Last year, for example, it was reported that PepsiCo had lost vital share in the Indian soda category to its main global rival, as the two engaged in a price cutting war. 

Fortunately, PepsiCo has met with greater success in the larger Chinese market. According to a company spokesperson, the PepsiCo bottling business in China outperformed its main competitor in 2013. The strategic alliance, formed in 2012 between PepsiCo and Tingyi Holdings, is obviously paying dividends.

There are strong arguments, then, both for and against dividing the company up. For her part, CEO Indra Nooyi has publicly opposed a spin-off, stating that it would not be in the interest of PepsiCo's shareholders.

That said, the firm's shareholders and investment institutions appear divided. An improved focus on leaner individual businesses is a potential advantage, but then what about the loss of synergies? Looking from a consumers view point, keeping the company together makes sense, since they often buy beverages and snacks together. Maintaining the status quo also adds strength in retail negotiations. 

Releasing Frito-Lay may well boost the brand's own sales and margins and even justify the loss of synergies, but what then for PepsiCo’s soft drinks? In its present form, PepsiCo acts as a powerful buffer against global domination by Coca-Cola. On its own, would the beverage business be able to maintain this role, or would we see a process of asset stripping?

Could we see brands like Tropicana and Gatorade being sold off to the highest bidder, thereby weakening PepsiCo’s position in the global beverage industry?

I’d hate to think so, but it is not beyond the realms of possibility.