Coke's big move alters two Atlanta giants

By Jeremiah McWilliams

The Atlanta Journal-Constitution

The strategy shift is simple, yet dramatic. Coca-Cola Co. plans to take over responsibility for making and distributing most of its beverages in North America, after decades of relying on its largest independent bottler for that work.

The goal: help Big Red better cope with a relentless slowdown in U.S. soda sales by getting drinks consumers want to market more efficiently.

Coca-Cola announced Thursday that it plans to buy Coca-Cola Enterprises’ North American operations in a complex deal worth about $12.4 billion.

The deal will markedly change two Atlanta corporate giants, assuming it closes as planned later this year. Coke will take on production and transportation work it has long left to CCE, as well as a chunk of its 70,000 employees. CCE will be left as a smaller bottling company focused on Europe, though executives say its home offices will remain in metro Atlanta.

As part of the deal, CCE agreed to buy Coca-Cola’s bottling operations in Norway and Sweden, with the additional right to acquire a Coca-Cola bottler in Germany. That will give CCE an expanded footprint in Western Europe, which Coca-Cola is targeting as a growth market.

But the real motive is to give Coca-Cola more control of distribution and production in the highly profitable but mature North American market, where shifting consumer tastes have taken a toll on its core soft drink sales.

“We are ushering in an exciting new era of winning,” Coca-Cola chief executive Muhtar Kent said on a conference call to announce the deal. “We are taking decisive actions.”

Analysts said the deal validates PepsiCo’s plan, announced last year, to buy its two largest U.S. bottlers. Coke had voiced happiness with its bottler set-up, but on Thursday both Coke and CCE executives insist they were discussing a potential deal even before PepsiCo moved.

The deal overturns Coca-Cola’s longtime “franchise” distribution system, which was designed for moving large volumes of a few brands, chiefly carbonated soft drinks.

Now, beverage companies feel the need to sell a panoply of non-carbonated products such as waters and teas for niche markets. Subsuming their largest bottlers is intended to gain better control of distribution while also eliminating certain costly duplications.

“There is no denying that the North American beverage business is as competitive as any you will find in the world,” John Brock, CEO of Coca-Cola Enterprises, told the AJC. “The fact is, the system here in North America needs to get streamlined.”

Industry observers expect most change to be behind the scenes. Coca-Cola might ship more cases of Dasani bottled water to retailer warehouses instead of sending them to big-box stores via CCE, for instance. That might enable Coke to compete harder on price with private-label bottled water.

Coca-Cola might also be able to eliminate situations in which three or four Coke or CCE representatives call on one retailer. After the transaction, Coca-Cola will have direct control over about 90 percent of its total North America volume.

CCE shares, which will continue to trade on the NYSE, shot up almost 33 percent Thursday, to $25.48. Coke shares fell 3.7 percent to $53.12, as some analysts noted the change means a greater share of its revenue will come from the slow-growth North American market.

Tom Pirko, a longtime consultant to beverage companies, said Coke’s move carries risk. He said Coca-Cola’s and PepsiCo’s expertise is marketing and building brands, not running trucks or hitting the pavement to push products. The beverage giants will now have responsibility for running and modernizing bottling plants, he added.

Some analysts were surprised by the timing of Coke’s move, given that the company seemed to dismiss PepsiCo’s earlier announcement.

“Coke seemed to make it very apparent at their analyst meeting last November that they were sticking with the franchise system,” J.P. Morgan analyst John Faucher wrote on Thursday. “Even those of us who thought this would happen eventually will be shocked by the timing.”

Stifel Nicolaus analyst Mark Swartzberg wrote that it is “an indication that North America’s growth and mix challenges are deeper than previously advertised and/or believed in the minds of Coke leadership.”

Bill Pecoriello, of Consumer Edge Research, wrote that, ultimately, Coke couldn’t sit back while PepsiCo delivered hundreds of millions of dollars in savings and transformed its U.S. business model.

Kent, Coke's CEO, noted that Coca-Cola’s North American business structure has remained essentially the same since CCE was created in 1986. But the market has changed dramatically in that time. Non-carbonated drinks now account for about 30 percent of the company’s volume. Retailers are also becoming more powerful: About 40 percent of the company’s packaged volume now goes to its 10 largest customers.

“Our franchise business cannot remain static,” said Kent. “This new structure is going to enable us to run the most effective and efficient operation in North America.”

Coca-Cola said the deal will generate immediate cost savings, with expected savings of $350 million over four years. It said the purchase, which is expected to be completed mainly without cash outlays, is expected to add to earnings per share by 2012. The company predicted the deal will close in the fourth quarter.