Caroline Levy and Michael Lavery from CLSA (affiliated with Credit Agricole Securities) said in a note that they believed that PepsiCo was more valuable as “separate focused entities” than as one.
“Like many investors, we have been dissatisfied with ‘Power of One’ initiatives and believe PepsiCo is more valuable than its parts,” the analysts said.
Announced by PepsiCo chairman and CEO, Indra Nooyi, last September as a “strategically critical” move, ‘Power of One’ saw the firm co-ordinate sales, marketing, distribution and back office operations for both food and beverage ‘operating systems’; it also involves exploring complementary products across the two businesses.
But earlier this week, activist and investor Ralph Whitworth took a $600m stake in PepsiCo, and the CLSA analysts said they believed that – given his reputation as a value-creating, corporate governance expert, “we believe the PepsiCo board will re-examine splitting the company and take action sooner rather than later”.
Beverage spin-out or sale
Whitworth’s style – as principal of Relational Investors – involved deep due diligence on a firm’s operations and financials and regular meeting with management to drive “operational and sometimes structural improvement”, Levy and Lavery said.
“With his involvement, along with pressure from other major shareholders, PepsiCo is more likely to consider structural moves, such as a spin-off of Americas Beverages (or global snacks), in the near future,” they added.
Value creation levers for PepsiCo were many, the CLSA analysts said: it could spin-out Americas Beverages (including Gatorade, Tropicana, Lipton, Pepsi, Mountain Dew,7 Up) under separate, focused management, or sell it to another beverage company (perhaps in the beer world).
“It could spin out its American Snacks [including Lay's, Doritos, Cheetos] which we believe would trade at a large premium to most food and beverage stocks given superior returns and growth prospects (in both North and South America)," they added.
“We believe PepsiCo’s recent struggles to grow, and now activist involvement, make one of these scenarios more likely than not over the next year.”
Given an estimated earnings per share (EPS) decline for 2012 ($4.1, 2011: $4.29), Levy and Lavery said they believed a company split could create value.
Pressure from Coca-Cola
But even if spin-off or split-up was announced, Levy and Lavery said they were mindful of the time it took to execute a “meaningful operational turnaround” – given that Coke’s stock was trading at $51 in June 2004 when turnaround Neville Isdell took over, but did not exceed that level until June 2007.
“That said, if Pepsi’s operating profits don’t improve, we believe structural changes are more likely.”
Despite setting a new positive 12 month price target for PepsiCo’s stock of $75 (up from $66), Levy and Lavery also noted competitive pressure from Coca-Cola that could prevent PepsiCo from gaining market share despite increased spending.
“Continued macroeconomic softness in developed markets could slow revenue growth. If overall investor confidence weakens and general market conditions erode, there could be risk to reaching our target price in the near term.”