United States Food and Drink Report Q3 2009

The economic downturn looks like it could possibly prompt a wave of consolidation in the US soft and alcoholic drink industries. In the soft drink sector the downturn has prompted PepsiCo to launch a bid for its bottlers in an effort to revitalise sales. Meanwhile, in the alcoholic drinks sector the sprits producer Brown-Foreman is rumoured to be considering a tie up with Bermuda-based Bacardi - a move which would create a firm with scale to take on global market leaders, Diageo and Pernod Ricard.

In April 2009, soft drinks giant PepsiCo launched a takeover bid for its two largest independent bottlers, Pepsi Bottling Group (PBG) and PepsiAmericas. The cash and share offer represented a premium of around 17% on both companies' closing price on April 17 and would mean PepsiCo controls around 80% of its North American distribution. The move is a sharp shift in strategy - investor pressure actually led to PepsiCo spinning off PBG in 1999 - but has been deemed necessary to respond to the economic downturn and changing consumer tastes, which have had a substantial impact on PepsiCo's North American sales.

So far the two bottlers have been reluctant to accept the terms of the deal. PBG has said the bid is substantially below PBG's intrinsic value as well as the value implied by similar transactions. PBG also suggests that PepsiCo's estimate for synergies - of around US$200mn - is inaccurate and that the actual cost savings are likely to be 'multiples' of this figure. To defend its position and prevent PepsiCo appealing directly to shareholders instead of negotiating with the PBG board, the company has installed a 'poison pill' defence that gives existing investors the right to buy shares at a 50% discount if PepsiCo acquires more than 50% of the company. PepsiAmericas has taken a similar tough stance. However, with both firms seeing their sales and profits hit hard by the economic downturn, BMI does believe that both are likely to be stronger as part of a larger group and that the deal is eventually likely to go ahead.

Meanwhile, in the alcoholic drinks sector reports have emerged that Bermuda-based drinks group Bacardi and US-based Brown-Forman, the maker of Jack Daniels and Southern Comfort, may be mulling over a merger. The reports emerged shortly before Brown-Forman announced it would be cutting around 6% of its workforce and embarking on a cost-cutting programme in response to the economic downturn. A merger between Bacardi and Brown-Foreman certainly has strategic merit. Both are medium-sized family businesses that would benefit from the increased distribution and marketing muscle that being part of a larger group would facilitate.

Over the last 20 years the spirits industry has been consolidating around a handful of firms. However, UK-based Diageo and France-based Pernod Ricard have now secured the top two positions and appear to be gradually moving away from the chasing pack. This unparalleled scale gives them a distinct advantage when negotiating supply contracts and results in economies of scale that could gradually mean the margins of smaller producers are eroded. The larger firms are also in a stronger position to invest in emerging markets, from where the majority of future sales growth is expected to stem.

A merger would create an entity with revenues of US$9bn, which would see the new group slot neatly into third spot, with revenues only slightly below current number two Pernod Ricard, making it truly capable of challenging on a global scale. The lack of overlap in the two groups portfolios - with Bacardi focused on rum, and Brown-Forman deriving the majority of its revenues from bourbon - would also suggest a merger would be mutually beneficial. Neither would it result in the need to prioritise one firm's set of brands at the expense of the other.

Despite the merits, any merger deal could be scuppered by unwillingness of the founding families to cede control. However, even if the current rumours turn out to be mere speculation, it is easy to see that the move makes long-term strategic sense and the factors forcing the companies together are only likely to increase as time passes.