Coke v. Coke

April 30, 2007

Coca-Cola's Brand Bonds

In an earlier post I discussed "Sears Brand Bonds." What's the difference between these and the “Bowie Bonds” of ten years ago? In short the royalties were paid under contract to an independent third party. But there may be a way to make Eddie Lampert’s bold idea pay-off … by releasing Coca-Cola and its bottlers from “Marketing Hell.”

It's widely known that 60% to 80% of the market cap of public companies is due to intangibles. Jonathan Knowles in his 2005 presentation to the CMO Council on "Brand Equity and Shareholder Value" reported that:

In 2003, the net tangible assets on the balance sheets of the companies comprising the S&P; 500 accounted for only 22% of their market value.

For a quick rundown on the components of intangible value see my audio slide show on Enterprise Marketing Expenses.

What's less widely known is which companies have the lion's share of their market cap driven by intangibles. Many of these companies are identified in my paper on Marketing Meets Finance (see Table 4, page 12). Coke, of course, is one of those companies.

The Coca-Cola Company (KO) had a market cap ($50.28 per share times 2.32 billion shares) of $117 billion on April 10, 2007. The book value of its assets was $30 billion. The book value of its intangible assets was $5 billion including $1.4 billion in Goodwill.

Subtract Coke's intangibles from total assets and assume the remaining $25 billion book value of tangible assets is a fair approximation of their replacement cost. This puts the market value of the company's intangibles at around $92 billion, or 79% of its market cap. Notice that the book value of Coke's intangibles (that $5 billion) is just 6% of their market value. This reflects the challenge accountants face in valuing intangibles.

Can the Coca-Cola Company and its bottlers escape "Marketing Hell" by issuing "brand bonds?" Consider the possibilities of blending the approach taken by Bowie Bonds with that of the Sears Bonds.

Interbrand calculated the 2006 intangible value of the Coca-Cola brand at $67 billion. If this number is correct, compared with the company's $92 billion intangible market value, the remaining $25 billion represents the intangible value of the company's other brands.

Did you know The Coca-Cola Company offers more than 400 brands in over 200 countries? Well, we do! From Inca Kola, a soft drink found in North and South America, and Samurai, an energy drink available in Asia; to Vita, an African juice drink, and BonAqua, a water found on 4 continents, our product variety spans the globe!

Coca-Cola's other brands are marketed in six major categories: Energy Drinks, Juices, Soft Drinks, Sports Drinks, Tea & Coffee, and Water. In soft drinks alone there are fifteen brands and only three of these bare the Coca-Cola logo (Classic, Light, and Zero). Some of the other brands are Barqs, Fanta, Sprite and Fresca.

So why not monetize their value by assigning ownership of the other Coca-Cola brands to a new independent company "OCC IP" (Other Coca-Cola Intellectual Property). Like Bowie's songs, these other brands are probably not worth enough individually to monetize. But taken as a group they are. And since the Coca-Cola brand remains the property of Coke, its market value likely will not be diluted.

Like the Sears bonds, OCC IP would license both the Coca-Cola Company and Coca-Cola Enterprises to use the brands in exchange for ongoing royalty payments. Unlike Sears bonds, OCC IP would not be subsidiary of Coke. It would float the brand bonds at marketable coupon rates, face values, and maturity dates. So the market will determine the value of Coke's portfolio of other brands. The result would be an immediate increase in the enterprise value of both companies. And they would split the proceeds, reinvesting the cash to increase their shareholder value. Will this allow Coke and its bottlers to escape marketing hell? Please share your thoughts on this concept.



April 01, 2007

Marketing Hell Redux

Shoartly after my previous post on "Marketing Hell," I received an email from a friend who said:

Your point about monopoly pricing on syrup is right on the money. When I was doing work at KO this was a constant source of tension between the company and the rest of the Coca-Cola bottling system.

Then he added this really important question:

How do you take into account the components of Pepsi's business that are not competitive with Coca-Cola (e.g. Frito-Lay division)?  Isn't this an apples and oranges comparison?

The answer depends on whether you're talking about Coke and Pepsi's competition for customers. Or their competition for capital. I'm talking about their competition for both customers and capital. Because success (or failure) in capital markets feeds back on success (or failure) with customers. And vice versa.

An article on how "Buffet Helps Pepsi Beat Coke to get Gatorade" had this to say about Pepsi's 2000 acquisition of Quaker Oats:

So long the underdog to the ubiquitous Coca-Cola, Pepsi is starting to fight back. Last week saw PepsiCo, the world's second-ranked soft drinks maker, steal a march on its old rival by agreeing a takeover of Quaker Oats, the US company that controls the hugely successful Gatorade brand -- considered one of the hottest properties in soft drinks worldwide.

This article "Quaker Acquisition a Big Winner for Pepsi" recently appeared in Chicago Sun-Times:"

Five years ago, Pepsi bought Chicago-based Quaker to get its hands on the Gatorade brand. Today, the Quaker portion of the Quaker Tropicana Gatorade division is performing like a champ, with revenues up 10 percent. The food line is not quite out of the shadow of the powerhouse sports drink, but it's doing well enough to get its parent's attention -- and praise.

What decisions that carry an important enterprise marketing component have the biggest, most immediate (as well as long term) impact on a company's market cap? The answer is mergers and acquisitions.

Wait you say, those are just financial decisions! That's precisely the problem. One of the reasons 50% to 80% of otherwise carefully vetted mergers and acquisitions fail to produce the predicted windfall to shareholders is they are treated as purely financial decisions. Even though they also have an important enterprise marketing component.

Unfortunately, CMOs are so focused on traditional marketing questions (read campaigns and segmentation) they rarely are consulted on M&A opportunities. Never mind identifying these opportunities in advance. And merger specialists are so focused on the financial details they fail to consider the enterprise marketing challenges.

Robert Bruner, Dean, Darden School of Business, in a post to his blog on March 11, 2007 titled "Sometimes Learning is Costly" concluded:

... my years of experience as an educator and my studies of merger failures and financial crises suggest that large errors tend to emanate less from shallow depth (the failure to dig deeply into arcane technical matters) than from too-narrow breadth (the failure to ask fundamental questions, often borrowed from other perspectives and disciplines).

After all, Warren Buffet, one of the greatest financial minds in the country and Coke's biggest shareholder at the time, reportedly blocked its intended acquisition of Quaker Oats on the belief that the foods division was a dog! As a result Pepsi won the bidding war for the company.

My friend's email concluded with this important comment:

Before its public offering Pepsi owned their bottling system in the US (COBO) outright unlike KO that "unbundled" their ownership of the heavy fixed capital parts of the system (i.e. Bottling plants).  This was all part of Doug Ivestor's "49 percent solution" back in the 80's.

Here's what Morningstar had to say about Pepsi's public offering in 1999:

In spinning off its major bottler but retaining an equity interest between 20% and 50%, PepsiCo follows the lead of its rival Coca-Cola KO, which did the same thing back in 1986. Coke's spinoff of Coca-Cola Enterprises CCE was engineered by an accounting whiz named Douglas Ivester, who's now the company's CEO; it gave a considerable boost to the company's margins, since Coke's bottling operations are just as low-margin and capital-intensive as Pepsi's.

The author went on to explain how there's enough accounting magic in the parent retaining an "equity interest" in a spin-off to make up for the marketing hell created with its bottlers:

The reason has to do with the differences between the consolidation accounting method (used when the parent owns 50% or more) and the equity method (used when it owns 20%-50%). … The amount of profit is ultimately the same under the two methods, but reported revenue is less under the equity method, increasing the company's net margin (profit divided by revenue).

How did the 1999 spin-off of Pepsi's company owned bottling group fair in the stock market? On December 31, 2006 the Pepsi Bottling Group (PBG), 42% owned by Pepsi, had a value/revenue ratio of 0.57; not much different that of Coca-Cola Enterprises (0.49) on the same date.  Coke's v/r ratio was 4.60 and Pepsi's was 2.94. Looks like marketing hell is in the DNA of syrup based cola's! How do you avoid the syrup trap? Return the bottling companies to private ownership and get into health drinks and bottled water! Or, float brand bonds!


March 27, 2007

Marketing Hell


The predecessor of Coca-Cola Enterprises (ticker symbol CCE) made one of the greatest deals of all time. It happened in 1889 when two lawyers from Tennessee paid $1.00 for exclusive rights to bottle and market Coke. They then divided the country up into regions and sold the rights to other investors.

Over the years a vast network of independent bottlers developed. Two of the largest were the JTL company and the bottling division of the Beatrice Companies. In the fall of 1986 the Coca-Cola Company (ticker symbol KO) borrowed 2.4 billion to buy both bottlers. Then management immediately packaged their new assets for an IPO and sold a 51% interest to the public for 1.5 billion.


For all its virtues the 1986 marriage of Coke and CEE was made in marketing hell. The battle between Pepsi and Coke for shelf space in supermarkets was punishing. And CEE was caught in the cross-fire.

Coke wants to be the best buy on the shelf because the lower its shelf price the more it sells. Of course, that means more syrup sales to its bottlers. CEE wants to maintain shelf price because that's the only way to keep its margins from shrinking. Who wins in this battle between shelf price and syrup volume?


When marketing people talk about "the" market they're referring to the company's products. When finance people talk about "the" market they're talking about the company's common stock. This is a telling example of the fundamental disconnect between marketing and finance within the enterprise.

The markets for stocks and products are separate but equally important to the enterprise. And until marketing and financial managers begin to talk about how one market affects the other, they're missing half the information they need to make sound decisions. A close look at the cola wars will show you what I mean. Want to know the theory behind this analysls? Check out Y'all Buckle That Seat Belt. This Adobe Connect slide show runs 18 minutes.


On the last trading day of 2005 CCE had a market capitalization of $9.1 billion. The company's sales revenues were $18.7 billion. On that same day in 2005 the Coca-Cola Company had a market cap of $95.5 billion. The company's sales were $23.1 billion. Pepsi (PEP) weighed into the fight with a market cap of $97.8 billion and sales of $32.6 billion. The market cap of all eight public companies engaged in the cola wars was 2005 was $207.6. The sales revenues of all eight companies added up to $79.8 billion.


Now, we've got the data we need to take a first look at how the players in the cola wars are doing in both markets – we can easily calculate their share of market value and share of sales revenues. Comparing the results leads to surprising results.

CCE: 23% of sales and  4% of value --  a -19 point competitive disadvantage.

KO:   29% of sales and 46% of value -- a +17 point competitive advantage

PEP:  41% of sales and 47% of value -- a + 6 point competitive advantage.

A company's stock price is (approximately) based on investors' expectations about its long-run cash flow, discounted by its riskiness relative to the overall market and adjusted for competitive expectations. There's only one way CEE's market cap could be less than one-half of its revenues -- the main source of its cash flow -- while Coke's market cap was 4.1 times its revenues. Coke must be charging its bottlers monopoly prices for the syrup, thus squeezing their margins, earnings and cash flow while robbing shareholders of the forgone value.


It looks like Coke's management is robbing Peter to pay Paul. Why would they do that? Well, Coke management probably would say that producing and distributing the drink is fundamentally less profitable than making the syrup. But it's more likely that in the trade off between shelf price and syrup volume, Paul has the upper hand. Coke has the power to exact a monopoly price premium from the bottling companies it owns as well as those it doesn't own.

Did it pay off? Sure looks like it did. Until you remember that Coke and its bottlers are married. And then you realize that this unhappy couple generates 52% of the sales revenues, but creates only 50% of the market cap! Combined, they have a -2 point competitive disadvantage, compared with Pepsi's +6 point competitive advantage!

This is just a small example of the dirty linens that surface when you examine the competition for customers and capital at the same time.