Let my Fritos go: The Pepsi challenge: keep the company in one piece

Let my Fritos go: The Pepsi challenge: keep the company in one piece

Mar 1st 2014 | From the print edition

COMPARED with most documents bearing a corporate letterhead, Nelson Peltz’s 37-page argument for the break-up of PepsiCo, published on February 20th, is a good read. The drinks and snacks firm has “lost its entrepreneurial spirit” and is “shifting to a plodding, ‘big company’ mentality”, it claims. Its managers “may fundamentally misunderstand the business”. The answer is to spin off PepsiCo’s successful snacks division, Frito-Lay, from its battered beverages business. Each would recapture its competitive zeal and gain the freedom to act on it. It is a refreshing change from PepsiCo’s blather about driving choice in the “macro-snack universe”.

Mr Peltz’s fusillade is also a broader claim about how companies with lots of consumer brands should be structured. Whatever synergies there may be from packaging pretzels and bottling cola under the same corporate roof are undone by bureaucracy and extra cost. The share prices of focused companies like Hershey’s (sweets) and L’Oréal (cosmetics), not to mention Coca-Cola, which concentrates on drinks, are a higher multiple of earnings than those of diversified PepsiCo and Procter & Gamble. Trian Partners, Mr Peltz’s investment vehicle, used similar arguments to push for the separation of another drinks firm, Schweppes (now Dr Pepper Snapple), from Cadbury, a British confectioner, in 2008, and for the 2012 split between Kraft’s North American and international food businesses.

A few weeks ago it looked like Pepsi’s boss, Indra Nooyi (pictured), had seen off the challenge from Mr Peltz. But his fresh onslaught will oblige her to work harder to show that the two product lines are “better together”. Mr Peltz says that since 2006, when Mrs Nooyi took over, PepsiCo has delivered total shareholder returns of 47%, compared with an average of 103% for shares in the S&P consumer-staples index.

Not only have Americans been guzzling fewer fizzy drinks in recent years, but Pepsi’s share of those falling sales has slipped. Coca-Cola’s diet version overtook regular Pepsi as the number two soft drink in 2010. Pepsi has failed to match Coca-Cola’s prices and was slow responding to Coke’s “Freestyle” soda fountain, which lets people pick their own flavours. Frito-Lay’s fat American profit margins unhelpfully spare the beverage businesses from pressure to trim costs, says Ali Dibadj of Sanford C. Bernstein, a research firm. If it were a separate company it could invest more in fast-growing emerging markets.

All this does not mean that diversification is doomed, or that focus is inherently good. There is no “black and white” case for separating snacks from drinks, says Richard Webster of Bain & Company, a consulting firm. The focus championed by Mr Peltz works best in big developed markets, where each category can be bewilderingly complex (think of shampoos, conditioners and hair dye) but the number of retailers which sell the stuff is relatively small. In less developed countries, with fragmented retailing, it makes more sense to have a broad product range and a big sales force. That argues against breaking up global companies, says Mr Webster.

Doritos with Mountain Dew

Among the blessings of togetherness, Mrs Nooyi claims $800m-1 billion of annual costs saved because of synergies (though she gives few details) and extra clout with retailers. The clinching argument comes from the way Pepsi views its market: two-thirds of the time people consume snacks and drinks together. Pepsi thinks its sales will increasingly come from exploiting such “demand spaces”. One recent promotion aimed at videogamers paired a “limited edition gamer pack” of Doritos with Mountain Dew “game fuel”.

Mrs Nooyi hired “the best bankers and consultants” to consider the case for breaking up this happy union. In February she told Mr Peltz that he was wrong. He now promises to create a “groundswell of support” for divorce among shareholders. Mrs Nooyi must convince them that the snacks and drinks teams, which are headquartered in separate states, can work together without cramping each other’s style. If she can do that, she may save the marriage.


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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