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Morningstar | Pepsi's Acquisition of SodaStream Should Enhance Its Water Portfolio; Shares Remain Attractive

Wide-moat Pepsi has announced that it will buy SodaStream, the leading manufacturer of home beverage carbonation systems, for $3.2 billion in cash, or $144 per share (roughly 31 times 2017 adjusted EBITDA). From our vantage point, the deal, which is expected to close in January 2019, aligns with Pepsi's recent efforts to build out its water portfolio, including the launch of its Bubly brand sparkling water earlier this year. Further, it reflects the company's ongoing focus on more natural and nutritious offerings. As of 2017, 43% of Pepsi's beverage portfolio volume had 100 calories or fewer from added sugars per 12-ounce serving; it aims to have this fare account for two thirds of beverage volume by 2025. Our view of Pepsi's prudent capital allocation also remains intact, as it had nearly $14 billion of cash on its balance sheet as of June. That said, we don't expect the acquisition to have a material impact on our outlook for Pepsi, given that SodaStream posted just $543 million in sales in 2017, or less than 1% of Pepsi's revenue, and plan for little change to our $123 fair value estimate, which factors in our expectation for 3% top-line growth and high-teens operating margin on average over our 10-year forecast.

While Pepsi's beverage business has posted tepid organic volumes as of late (down 2% in North America and flat globally in the first half of 2018), we've attributed this to the firm underallocating resources to its core beverage brands, including trademark Pepsi and Gatorade, relative to smaller brands rather than a deterioration in the underlying equity of these brands. As evidence, organic volumes in the North American beverage declined 2% in the second quarter, an improvement from the roughly 3% declines over the trailing 12 months, on a 1% improvement in price/mix. We continue to expect improving performance in the back half of the year, as the firm's new product innovations and reinforced brand investments take hold.

In contrast, SodaStream's sales have been growing at a rapid clip, with sales up 14% in 2017 driven by 24% unit growth in its sparkling water makers. We appreciate SodaStream's leading position within the sparkling water category, which we surmise is poised for further growth as consumers increasingly opt for lower-calorie, more natural products. In this context, carbonated soft drinks (which have been facing categorywide declines for more than a decade in the U.S.) make up less than a quarter of Pepsi's sales, and we expect this deal to further diversify Pepsi's product set away from these offerings.

We posit that increased active household penetration of SodaStream's sparkling water makers (which the firm estimates to be a low-single-digit percentage in the U.S.) and increased usage of higher-margin consumables (carbon dioxide cylinders and refills, flavors) will allow for further top line momentum. We also see opportunity for Pepsi's brands to expand SodaStream's flavor portfolio; Pepsi had partnered with the company in the U.S. on a trial basis in 2014, but many of its flavors remain proprietary. These more familiar flavors could also help the firm's offerings better resonate with U.S. consumers. We contend that SodaStream will benefit from Pepsi's entrenched relationships with retailers and vast resources (with advertising and research and development expenditures of nearly $5 billion in 2017, or more than 7% of sales), which should support the product innovation needed to maintain its positive growth trajectory.