There was some big news in the beverage industry as Dr Pepper Snapple (DPS) and privately-held Keurig Green Mountain announced they will merge to create Keurig Dr Pepper, a new beverage company. DPS shareholders will receive $103.75 per share in a special cash dividend and retain 13% of the combined company. KDP will have pro forma combined 2017 annual revenues of approximately $11 billion.
This combination joins together brands such as Dr Pepper, 7UP, Snapple, A&W, Mott's and Sunkist with leading coffee brand Green Mountain Coffee Roasters and the Keurig single-serve coffee system. Management sees the deal as unlocking the opportunity to combine hot and cold beverages and create a platform to increase exposure to high-growth formats.
Keurig Green Mountain is a leader in specialty coffee and single serve brewing systems. Its Keurig brewers and single-serve hot beverages are in more than 20 mln homes and offices throughout North America. In under a minute, Keurig brewers deliver a fresh-brewed cup with just the push of a button. Of note, more than 50 coffee, tea and cocoa brands have partnered with Keurig, joining owned brands like Green Mountain Coffee Roasters and The Original Donut Shop coffee to offer consumers vast personal choice from 500+ varieties.
DPS is a major producer of flavored beverages in North America with more than 50 brands. In addition to its flagship Dr Pepper and Snapple brands, its portfolio includes 7UP, A&W, Bai, Canada Dry, Clamato, Crush, Hawaiian Punch, IBC, Mott's, Mr & Mrs T mixers, Penafiel, Rose's, Schweppes, Squirt and Sunkist soda.
The deal combines complementary portfolios and provides better access to high-growth segments of the beverage industry. There should also be cost savings as KDP targets $600 mln in synergies on an annualized basis by 2021. At the close of the transaction, the company expects to deliver an annual dividend of $0.60 per share. The company believes it will deliver strong cash flow generation and accelerate its deleveraging, with a target Net Debt/EBITDA of below 3.0x within 2-3 years after closing. KDP anticipates total net debt at closing to be approximately $16.6 bln and it anticipates maintaining an investment grade rating.
Just a bit of history, Keurig was taken private when it was acquired by a JAB-led investor group in March 2016 and has made some changes. Since then, Keurig has renewed its marketing investment and improved its new brewer innovation pipeline, which has resulted in renewed top-line volume growth, increasing US household penetration for Keurig brewers to 20%, from 17%, in the last two years.
In the same period, Keurig has added key brand partners into the Keurig system with the help of strategic pod price reductions and value-added services. The combination of those two factors has allowed the company to improve its pod growth from the low-single digits to mid-single digits in 2H17. Keurig also increased its operating margin by 710 basis points in the last two years behind significant productivity improvement programs. The company has also strengthened its balance sheet and significantly reduced its debt/EBITDA to 2.7x as of December 2017, from 5.5x as of March 2016, when the company was acquired.
Of note, JAB also owns Panera Bread, Peet's Coffee & Tea, Caribou Coffee, Einstein Bagels, Krispy Kreme Doughnuts and in Espresso House, the largest branded coffee shop chain in Scandinavia. JAB is also the largest shareholder in Coty Inc. (COTY), a global leader in beauty products.
DPS shareholders will receive a special cash dividend of $103.75 per share and will retain their shares in Dr Pepper Snapple. Upon closing, Keurig shareholders will hold 87% and DPS shareholders will hold 13% of the combined company. JAB Holding and its partners will together make an equity investment of $9 bln as part of the financing of the transaction. Mondelez Intl (MDLZ), which owns a large stake in Keurig, will hold a 13-14% stake in the combined company. Bob Gamgort, current CEO of Keurig, will serve as CEO of the combined company and Ozan Dokmecioglu, current CFO of Keurig, will serve as its CFO.
In sum, DPS shareholder are thrilled with this deal as the stock is rallying sharply today, up about 24%. The stock has been mired in mediocrity over the past year, mostly trading sideways despite a surging overall stock market. The deal provides DPS shareholders with a nice premium and joining with Keurig gets them exposure to faster growing drink categories. We are not entirely sure we see the rationale for Keurig as the carbonated soda market has been weak in recent years and consumers switch to healthier/alternative drinks, including sparkling water. However, it certainly gives them scale, DPS generates a lot of cash, Keurig will get some great brands and the deal should open distribution channels.