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A New Pepsi Generation?

Monday, 20 Apr 2009 | 4:12 PM ET

A new Pepsi generation may be dawning.

In major shift in strategy, PepsiCo unveiled a plan to buy back control of two of its largest bottlers for $6 billion. If successful, the move is likely to continue to shake-up the beverage industry for some time.

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PepsiCoCEO Indra Nooyi is making the case that the deal is needed to improve Pepsi’s competitiveness and growth prospects.

It’s oversimplifying to say that in the decade since, Pepsi spun off Pepsi Bottling Group as an independent company a lot has changed in the beverage business. Most notably, consumers continue to look for more variety and increasingly prefer noncarbonated beverages. The breadth of the portfolio has made bottling more complex. Retailers also have consolidated. In this environment, a stand-alone bottling company may not make as much sense as it once did.

However, some things haven't changed. The bottling business remains a risky and expensive venture, and the same arguments for keeping the costs of distributing soft drinks off the balance sheet, particularly in weak economic times, are still the same.

Still, the move will give PepsiCo more control over its destiny, and with a large direct store delivery network that it uses to bring its Frito-Lay snacks to market and a separate warehouse delivery system it already uses for the bulk of its Gatorade beverages, PepsiCo may be at an advantage. Bringing more products through the DSD system and simplifying its distribution network could reduce costs at a time when beverage makers are seeing slow growth.

But PepsiCo may have to cough up more cash to get this deal done.

As it stands now, PepsiCo owns 33.1 percent of PBG and 43.2 percent of PepsiAmericas . (PAS Chairman & CEO Bob Pohlad and his affiliates control another 10.4 percent of PAS.)

PepsiCo's proposed purchase price, which will be half in cash an half in stock, is a 17.1 percent premium over where each of the two bottlers’ stocks were trading before the deals were announced.

The shares of both PBG and PAS surged on the news and up more than 20 percent in a sign that investors think Pepsi will need to sweeten the bid to get this deal done.

The move also may have ramifications for rival Coca-Cola . There has been speculation on and off for years that Coke might buy its largest bottler Coca-Cola Enterprises . Industry newsletter Beverage Digest said Coke has studied this issue, but CEO Muhtar Kent and the Coke board have not favored this approach in the past. However, Pepsi’s move forward could change things.

"It will force a reaction," says Tom Pirko, president of industry consultancy Bevmark.

Although Pirko sees that there are risks inherent in the decision to acquire the low-margin bottling business, there are also "strong advantages for Pepsi." The consolidation will give Pepsi a greater ability to cross-market its products and to act nimbly to market changes.

"The fall-out for anyone below Coke and Pepsi is very severe," Pirko warns.

Take Dr Pepper Snapple . Many of its products are distributed through the Pepsi and Coke bottlers. If PepsiCo buys the bottlers back, there will be questions about the future distribution of these brands.

One battleground has been Dr Pepper Snapple's Crush, which competes with Pepsi's Tropicana Twister. Stifel Nicolaus analyst Mark Swartzberg estimates that since PBG and PAS began distributing Crush, its availability in retail stores has risen from about 40 percent at the end of last year to nearly 100 percent now. He estimates that the additional distribution may add 6 cents a share to Dr Pepper Snapple’s earnings this year, or about 3.5 percent of this earnings estimate for this year.

“Neither DPS nor any parties in the Pepsi system have formally commented on this risk,” says Swartzberg. “However, the new Crush distribution agreements are perpetual and as we understand it, do not provide outs for a change of control. A such, we would be surprised to see any change in control of PBG and PAS result in a loss of Crush distribution for DPS.”

It will be an interesting situation.

PBG is the No. 2 Dr Pepper bottler, and PAS is the No. 4 Dr Pepper bottler. Diet Dr Pepper was one of only two top 10 carbonated soft drink brands to post any growth last year. (Pepsi’s Diet Mountain Dew was the other.)

More from Consumer Nation:

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