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Coke vs. Pepsi: Ask Warren Transcript - Part 6

Warren Buffett, Coca-Cola's largest shareholder, engages in some friendly sparring with PepsiCo CEO Indra Nooyi.

This is part six of the transcript and video of Warren Buffett's 'Ask Warren' appearance on CNBC's Squawk Box on Monday, March 1, 2010.

CLICK HERE FOR PART FIVE

QUICK: Good morning again, everyone, and welcome back to SQUAWK BOX here on CNBC, first in business worldwide. I'm Becky Quick in Omaha, Nebraska, this morning. This is Piccolo Pete's restaurant, and that means we are on Warren Buffett's home turf. This is a place that Warren brings many of his friends, names you know; people like Bill Gates and GE CEO and chairman Jeff Immelt. Joe Kernen and Carl Quintanilla are back at CNBC world headquarters this morning, and we have one more hour left to get most of your e-mail questions for the legendary investors, following up on that annual Berkshire Hathaway shareholder letter. We've covered a lot of topics so far, a lot of ground, everything from the markets, the government and Coca-Cola's bottling deal. But, Joe, we have much more to come.

KERNEN: Yeah, we do. Warren is Coke's largest shareholder. We're going to introduce him to Ms. Pepsi in a moment. PepsiCo CEO Indra Nooyi will talk to us exclusively after just, coincidentally, those bottling deals, PepsiAmericas and PBG, both closed today.

QUINTANILLA: Yeah, reaffirmed guidance. Or affirmed guidance.

KERNEN: And this was--I know she may take a little bit of a victory lap. I mean, she won--she's already closing the deal, as Coke is barely scratching...

QUINTANILLA: Where have you guys been?

KERNEN: Yeah. You know, they're trying to catch up.

QUINTANILLA: Copycat.

KERNEN: I don't--yeah, yeah. Oh, `What's Indra doing? Let's--what else can we'--no. You've got the headlines, though, for us, right?

QUINTANILLA: I do, a couple quick headlines today.

(News headlines)

KERNEN: Let's get to this, PepsiCo announcing the completion of its mergers with its two largest bottlers, Pepsi Bottling Group and PepsiAmericas. Joining us now in a special SQUAWK exclusive, live from their headquarters in Purchase, New York, Indra Nooyi, PepsiCo chairman and CEO. It's always great to see you, Ms. Nooyi, and...

INDRA NOOYI (PepsiCo Chairman and CEO): Good to be here, Joe.

KERNEN: And do I--can--I guess I congratulate you, not only on the completion of the merger, but, you know, on doing it so much sooner then Coke . Can you--can you go into some details on what it does for Pepsi and how it's going to help, I guess, rationalize the assets? That's what Warren called it.

NOOYI: Well, you know, Joe, as you know, we announced this deal in April of last year, and we are bringing in Pepsi Bottling Group and PepsiAmericas into PepsiCo. Today's the first day of the new PepsiCo--the new PepsiCo, which is about $60 billion in revenue. And, you know, it's full operational control of almost 80 percent of the bottling system. And as we mentioned in our call in April when we first announced the deal, the beverage business in North America has changed substantially over the last decade or two. It's not growing as much. And the nature of the business itself has gone from a few megabrands to a bunch of fragmented new products, noncarbonated vs. just carbonated drinks. And the old model of separating the franchise company from the operating company became almost a relic of the past. And last year, when we were looking at the dynamics of the industry and looking at where it was evolving to, it became clear to us that this separation of the franchised company and the bottling company wouldn't last. And a franchised company cannot grow at the expense of the bottling company, and a bottling company clearly cannot grow unless it has the support of the franchise company. So we decided to put the profit pools back together. The good news is as of Friday the deal as closed, which means today is the birth of a new PepsiCo, and we are very optimistic about our prospects. Our press release this morning indicated that for the next three years we expect low double-digit EPS growth, which in today's times is pretty good. And in 2010 we reiterated 11 to 13 percent EPS guidance.

KERNEN: All right. I kind of understand a lot of that, how, you know, you don't want the two companies competing. But there was a rationale at one point to do it that way, and Mr. Buffett had pointed out the different--you know, it's a low margin bottling business vs. a high margin syrup business. What exactly changed? Why--you are going to deploy more capital--or you have deployed more to own the bottlers. Why not leave them owned by someone else with a lower margin business? What's changed? You say something's changed to make it make more sense.

NOOYI: Yeah, that's a great question, Joe. So 10, 20 years ago, the market--the beverage market in North America was essentially carbonated soft drinks, and there were a few megabrands that controlled the business, and the market was growing 6, 7 percent in terms of volume. Fast-forward to today. Carbonated soft drinks are now less than 50 percent of the total market, and that's a very highly profitable part of the whole market. And the overall liquid refreshment beverage business is growing in volume about minus 2 percent and in value about 1 percent positive. So this is not a huge growth business. It's a big market, it's about $100 billion category. But it's not growing in leaps and bounds like it used to a couple of decades ago. When you have one or two publicly listed companies positioned as growth companies trying to fight over a profit pool, that's not a very good situation, especially if the profit pool is not growing enough to feed the appetites of two or three publicly listed companies. So the only way to compete and stay ahead of competition in this environment is to bring the profit pools back together and figure out how to operate more efficiently. And I go back to a point that Warren made, and if I may digress for just a bit, it's a privilege to be on this show with the Oracle of Omaha. Warren, it's unfortunate that you and I haven't met, but I know everybody around you, so I feel like I know you. It's an absolute joy and privilege to be on the show with you. And thank you for sharing some of your time with me. But let's come back to the bottling transaction. Warren said something very important in one of the early segments. He said it's a operating intensive business and it's a lower margin business. And, you know, companies will have trouble integrating the bottling company into the franchise company. I think the big advantage PepsiCo has here is because of Frito-Lay North America and the overall salty snack business around the world, we are an operating company. We operate 18,000, 20,000 routes in Frito-Lay. We never lost that operating discipline. And so the post...(unintelligible)...integration of bottling into PepsiCo was a breeze. We got it done flawlessly. And we had the wonderful advantage of retaining Eric Foss to run our bottling business. Eric used to be the CEO of PBG. We retained him. And so it's almost like bringing all the bottling people back home to PepsiCo. So we feel great about our prospects, and we think it's just reuniting a company that was always peripherally part of PepsiCo.

KERNEN: Yeah, I want to definitely get Becky and Warren Buffett in on this. You know, Warren, if you didn't have such a long and fruitful relationship with Coke, Pepsi's right in your wheelhouse. I think the way the company's run, the products that it has. Are you precluded in some kind of antitrust from owning both, or?

BUFFETT: No, I don't think the government would come after me. It--Pepsi--it's a wonderful company. And particularly, I mean, Frito-Lay is a fabulous business. I'd love to own it. I eat Fritos, I eat Cheetos, I eat their potato chips; I even eat Munchos, which are kind of hard to find. But I always drink Coca-Cola with them.

NOOYI: You know, Warren, I read your book, the biography on you, and it said that you started life drinking Pepsi, and those were the most joyful moments in your life. I loved that. I think that's what keeps you so youthful, because Pepsi's about youthful cultures.

BUFFETT: Well, I happen--I have to say, Indra, that I started drinking Pepsi when I was about six or seven years of age in the '30s. And if you remember, at that time it was twice as much for a nickel, too. Pepsi gave you 12 ounces for a nickel...

NOOYI: Uh-huh.

BUFFETT: ...and Coke gave you six and a half ounces. So I would definitely say that at half the price, it--Pepsi was a good buy at that time, marked down 50 percent.

KERNEN: I...

NOOYI: Warren, let me assure you, at any price, Pepsi's a great product.

KERNEN: Yeah. All right, now I--now I understand, you were able to--Warren, you're going to buy the--to drink you're going to buy the cheaper soft drink, but to buy the company, you're going to buy the one that charges twice as much. It makes perfect sense now, now that I see how your--how your mind is working.

BUFFETT: Joe, let me--Joe, there's a comic book--Action Comics was the first Superman book that sold for a dime in 1938, and it now sells for a million dollars. And if Pepsi were half the price, you know, I--all I had to do was at, you know, in effect, save an extra nickel there twice. And that 10 percent--that 10 cents turning into a million, though, incidentally, is only a 25 percent compound. It's kind of interesting. If you'd bought that comic book in 1938 and compounded your money at 10 cents at 25 percent, you'd have a million dollars now without owning the Superman comic.

KERNEN: Wow, that's...

BUFFETT: So I had a very good reason to try and save money when I was eight years of age. And 12 ounces for a nickel was different than six and a half ounces.

KERNEN: Hey, Indra, you know, Coca-Cola I think is leaving the--some of the nondomestic bottling assets separate. Is that because over in Europe and Asia, that things are still growing quickly enough? Is it the same with Pepsi, where you still have the--that rapid growth which allows that model to make sense?

NOOYI: Well, Joe, you know...

BUFFETT: Are you asking--go ahead.

NOOYI: ...east of the Middle East, as I said, the--go ahead, Warren.

BUFFETT: No, I think he was directing at you, Indra. No, go ahead.

NOOYI: No, east...

BUFFETT: I'm saying...

NOOYI: I'm sorry.

KERNEN: I want both of you to answer.

NOOYI: East of the Middle East, the markets--east of the Middle East, the markets are still growing extremely rapidly, Joe. And, you know, the first thing I should say to you, the companies are very different. We are a large food and snack business in addition to beverages, so the two companies, you really can't compare them directly. East of the Middle East, the economies are doing quite well. How long that'll continue, we'll have to watch and see, but they're doing very, very well. I think Western Europe and Eastern Europe are still troubled markets. GDP's down, unemployment rates are extremely high, and I don't think you can link a bottling transaction to the economy. You know, they had a different strategy, we had a different strategy. But in Europe we are a very, very large food and beverage company because we have a large snack business, we have a huge juice business. We are huge in Russia, we're huge in Western Europe. So I think the companies are very different and our strategies, fundamental strategies are very different.

KERNEN: Warren, you were going to talk about the Coke strategy abroad, right, with their--I guess they're not buying in those assets, right?

BUFFETT: Well, the--no. The franchise operation works extremely well around the--around the world. And, I mean, you take somebody like Coca-Cola FEMSA in Mexico, I mean, the per capitas there are incredible. I think they're up close to 500 or thereabouts. And so the franchise system in just country after country, 200 countries around the world, has developed the market in a way that's been very good for the bottlers and very good for Coca-Cola. And actually, in many countries the bottling operation has been considerably more profitable than it has been in the United States, partly because of the growth aspect that Indra mentioned. So it's not a system that needs fixing at all around the world. There can be an occasional spot where the bottler isn't doing the job and the Coca-Cola company will buy it and then--and put it back on its feet and then resell it to somebody in that country. But having local bottlers really works pretty darn well around the globe.

QUINTANILLA: Warren, some people...

QUICK: Warren, there--right.

QUINTANILLA: Some people have been saying that you--people historically bought Coke as an international growth play. Now all the sudden North America's an awfully bigger piece of the pie. Does it dilute some of the reasons that people got into the stock in the first place?

BUFFETT: No. In terms of where the money is being made, you know, Coke makes, I don't know exact percentage, but 80 percent of its money around the globe, and it's growing and just in country after country. Coke has been gaining share really quarter after quarter around the world. And add--none of that volume's going away, or none of that growth is going away because they're integrating the bottling system in the United States. It does--it means a concentration more of assets in the United States, but it does not take away from the profit growth that is occurring around the--around the world. I think Coke earned like 9 billion pretax last year, and I think well over 7 billion of that was from outside of North America. And that 7 billion is going to have the same kind of growth rate, which has been substantial, whether or not--you know, wherever the bottling system in the United States is owned.

KERNEN: Mm-hmm.

QUINTANILLA: And, Indra, the other--I guess the other concern, if there are concerns about these types of deals, is the degree to which big companies like yours now have to worry about the logistics of getting bottles around the--around the country, perhaps distracting you from investing in and nurturing the magic of the brand. Any truth to that?

NOOYI: Not really. I mean, PepsiCo, as I said, is an operating company. We know how to focus on brands and operations. We've done it extremely well with Frito-Lay around the world. So we don't see any issues in terms of focusing on the franchise company and the bottling company, which are now both under PepsiCo ownership. In fact, we think this is the right strategy. And, Warren, I'll just come back to a point you made about the franchise system around the world. I think the franchise system works as long as the market and the category are growing. When the market slows down, when the category growth rates slow down, the franchise system always runs into issues because there are two companies that are fighting over a very, very limited profit pool. Now, if the bottling companies can be repositioned as utilities, that's a whole different issue, because they essentially are utilities. But if you position a bottling company as a growth company and the franchise company as a growth company, I think when the category slows down you're running into issues.

BUFFETT: Well, fortunately, the category's not slowing down in most parts of the world. It's just amazing, the growth. I--Mexico is an extreme example. China, I mean, I think in the last quarter of 2009, there was 29 percent unit growth for Coke in a place like China and 22 percent in India. So the rest of the world, they like the same thing I like. And they like Pepsi, too. I don't...

NOOYI: No, I--Warren, I agree with you.

BUFFETT: And they love Frito-Lay.

NOOYI: No, I agree, and I appreciate your consuming our Frito-Lay products. I think you're right, China's growing very rapidly. India grew 50 percent for us last year, so we feel very good about our prospects there. I'd worry a bit about Western and Eastern Europe, because there, the category growth rates are sluggish right now with the economy. And one has to worry about the health of the bottling system because, you know, both companies are fighting over a limited profit pool. So these are just, you know, watchouts that one has to keep in mind as we look at the troubled economies around the world.

KERNEN: Indra, you had to deal with--you had to deal with some private label competition. I think about just the overall competition from all these, I don't know, new age drinks, whether it's tea or water or, you know, what is that, acai berry something. There's so many strange things out there...

NOOYI: Acai.

KERNEN: ...that aren't sugary soda that, you know, I wonder about the long-term prospects, long, long term for both Pepsi and Coke. I guess, you know, they've been sold short before...

NOOYI: Yeah.

KERNEN: ...but certainly the sugary soda isn't--that market isn't what it used to be.

NOOYI: Yeah, I mean, I wish you wouldn't just call it sugary soda. Let's just talk about soda. Used to be 80, 90 percent of the market. It's now down to, you know, 40 percent of the market. So noncarbonated drinks are growing much more rapidly than carbonated soft drinks. And even carbonated soft drinks, I mean, you've got diet sodas, you've got a whole range of flavors. You've got lightly sparkling soda, well sparkling sodas, you've a whole range of innovation coming there. But let's stay with the noncarbonated beverages. That's--it's true. I mean, acai berry, all these new products are coming into the marketplace. I think owning the bottling system is most strategic in this new environment because, in the past, every time you wanted to launch a new product, the bottling system would look at it and say is it as profitable as my core soda?

Will it sell, you know, tens of millions of cases? And then this negotiation would start between the franchise company and the bottling company that would last months before you actually brought a product to market--to the marketplace. I think that time spent on unproductive discussions with the bottling system is now going to be a thing of the past. The franchise company, which continues to innovate rapidly--I mean, I taste top products in our laboratories. We have more innovation ready to go for the next three, five years than I've ever seen in the history of our company. So now we can start bringing these products to market quite rapidly, especially more niche products, which tend to be more health and wellness focused. So Joe, Carl, Becky, and Warren, please stay tuned for the innovation from Pepsi and PepsiCo. And, Warren, you know what? Just as you talked about eating Cheetos and Fritos and Lay's potato chips...

BUFFETT: Well...

NOOYI: ...I hope I can get you on TV one day to say you drank one of our Pepsi products and loved it.

BUFFETT: Well, I will probably--I will eat some Cheetos and Fritos today, but I will--I will also drink five Cokes.

QUINTANILLA: One thing's for sure, Beck...

QUICK: You just touched on a point...

QUINTANILLA: Beck, you, me and Joe, we have got to get into that testing lab at Pepsi, right?

QUICK: Oh yeah.

QUINTANILLA: We would have a blast.

QUICK: That's right. I can see us all there.

QUINTANILLA: I would just go crazy.

KERNEN: I was just actually fantasizing about a way to make a nutri-salt, something that didn't hurt you, but would have a salt taste...

QUINTANILLA: Mm-hmm.

KERNEN: ...like a sweetener, like a fake sweetener, because--but I'm not even convinced...

QUICK: That sounds like Olestra.

KERNEN: Yeah.

QUICK: And you know what Olestra does to you, Joe.

KERNEN: Ooh, that's right, that's right, that's right.

NOOYI: Joe, if you came to our laboratories, you'd be like a kid in a candy store.

KERNEN: It's true.

NOOYI: I assure you.

KERNEN: It's true.

QUINTANILLA: Come hungry and come thirsty.

BUFFETT: We've got a real candy--Joe, we've got a real candy store for you, See's Candies.

KERNEN: I love you two...

BUFFETT: Don't settle for anything except See's candy.

KERNEN: I love you two fight, though.

QUINTANILLA: Yes.

KERNEN: I can come--I have time. I can come to See's and to--and to Frito Land. There should be a theme park for me.

BUFFETT: Yeah, we'll fly you back--we'll fly you back and forth in a NetJet too, Joe.

KERNEN: Now you're talking.

QUINTANILLA: At the end, there's a doctor waiting for you.

KERNEN: Yeah.

QUICK: Indra, you brought up a point where you just said please don't call these things sugary sodas, though. And both to Indra and Warren, do you feel like you are under assault from governments that now are looking at sugary drinks or carbonated drinks or beyond and thinking of ways to tax? I think of the state of New York, and I think about Muhtar Kent's op-ed piece that he wrote last year, towards the end of last year, where he said that governments are looking at this the wrong way. You can't just blame the soda companies, you have to look at the kids who aren't exercising, the way we set up some of these issues. Do you feel like you're under assault, Indra?

NOOYI: You know, look, I think governments are looking for ways to raise revenue. Governments are looking for ways to reduce childhood obesity in particular. And I think it's important that we encourage governments to look at the problem holistically because it's a very complex issue. Clearly, the sedentary lifestyle has had an impact and what they eat and drink has had an impact. So I think it would be irresponsible for us to say we're not the problem or we are the problem. I think what we have to do is work constructively with governments to come up with a solution, and that's why we were co-leaders in forming this healthy weight commitment, which is a consortium of manufacturers and retailers working with the Robert Wood Johnson Foundation as an independent evaluator to really look at options to transform all of our portfolios to reduce salt and sugar levels, take out the fat in our products so that products can taste great, yet are healthier than fun-for-you products. We're talking about nutrition education, calorie labeling. We're looking at a whole range of options. The other thing I tell you, Becky, is the food and beverage industry in the United States, in particular, is a very responsible industry. And I think we're looking to work with governments, the federal government, state government, all of the organizations to come up with the right solutions for the American consumer.

KERNEN: OK. I think we're almost done.

QUICK: Warren, same question.

KERNEN: Oh, sorry.

QUICK: Go ahead.

KERNEN: They told me we were done.

QUINTANILLA: (Unintelligible).

KERNEN: You got something more?

QUINTANILLA: I got one more.

KERNEN: You go ahead.

QUINTANILLA: Indra...

QUICK: Well, can I just get a real quick question, same question.

BUFFETT: If I eat more than 2500 calories a day, I'm going to gain weight. If I eat less than 2500 a day I'm going to lose weight. I'd like to choose the 2500 calories that I eat, and if, you know, if I--it's just a question of how many calories you stuff in your mouth, basically, and there's a lot of ways to do it.

QUICK: Hm.

BUFFETT: And if somebody told me that I live a year longer by eating nothing but broccoli and asparagus from now on, I would just say, it would just feel like I'm--every day will seem like as long. I'll stick with--I'll stick with the Cheetos and the Coke.

QUINTANILLA: Indra, I hope you won't mind a quick macro question. The last week or so we here who sort of pay attention to markets on a day-by-day basis have seen some pretty lousy data on housing and consumer confidence. We sometimes rely on you and your radar. Are you--are you seeing echoes of that in at least the very concurrent data when it comes to convenience stores and so forth? Is the consumer nervous again?

NOOYI: I think the consumer, (clears throat) excuse me, I think the consumer environment is very, very soft. And I think what we have is people still don't have the confidence to go out and spend money, and they're just waiting to see what's going to happen before they open their wallets. Savings rates are going up, which is a good thing. The question is, when is it too high? And we want people to spend, not just spend, you know, borrow and spend. And I don't think the consumer's there today. So I am a bit worried about the next 12, 18 months because unless we get those jobs back and the hourly worker, the construction worker, back on his feet, I'm just worried that consumer confidence won't come back. So I like what the government is doing about long-term programs, fixing health care, addressing energy, talking about the overall taxation. I like all of these long-term programs. My concern remains, you know, on the next 12, 24 months because you need those jobs back to get the engine of the economy going, but you need that to get consumer confidence up. And let me just say one thing to Warren. Warren, Cheetos, Fritos and Doritos taste fantastic and even better with Pepsi.

KERNEN: Boy, this is--this is kind of a smackdown.

QUINTANILLA: Yes.

QUICK: It is a smackdown.

QUINTANILLA: A hard sell.

KERNEN: Warren, it is too bad that Coke never, you know, you do have to go out of the Coke family to get a snack, and I wonder why they didn't realize salty snacks, drinks, salty--I mean, that's like--that's like peanut butter and jelly. That seems like a slam dunk to have thought of that.

BUFFETT: Indra may know this better than I am. My understanding's that Herman Lay went to Coke, I don't know, 40 years ago or so, and if a deal had been made, he would've owned more stock than Mr. Woodruff, and Mr. Woodruff didn't like it. But I don't know whether that's an old wives' tale or not. Indra, do you know the answer on that?

NOOYI: I think the answer is that PepsiCo has always been strategically much better than anybody else out there.

KERNEN: Oh, I love it. All right, we've got to go. We've got to go.

QUINTANILLA: Ouch!

KERNEN: We've got to go, Indra, but just--we asked pharmaceutical companies, what's the most exciting drug in your pipeline? What's the most exciting new salty snack at that testing place you were talking about? Do you have one in particular?

NOOYI: Yeah, Joe, I'll make a deal with you.

KERNEN: All right.

NOOYI: You come and host your SQUAWK BOX out of Frito-Lay and we will let you taste all of our new products. How's that?

KERNEN: I hate to hear people talking with their mouth full, but we may have to--we may have to do that because that would be the problem. Thank you very much, Ms. Nooyi.

NOOYI: Thank you.

KERNEN: It was great to have you on the show for an extended period of time and seeing you and Warren Buffett in that two box, it's just a cool looking thing, isn't it?

QUINTANILLA: Other shows have...

NOOYI: And, Warren, I look forward to meeting you sometime.

BUFFETT: Good enough. I'm looking forward to it, too.

KERNEN: There it is again. I love that.

NOOYI: Thank you.

KERNEN: All right, Beck.

QUICK: All right, Indra, thank you very much.

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