Coke Chooses to Embrace, Not Fight, At-Home Disruption
The beverage maker’s long-term partnership with GMCR is a good deal for the firm and will help cement Coke as the leading global soft-drink brand.
Coca-Cola (KO) and Green Mountain Coffee Roasters (GMCR) have entered into a 10-year collaboration deal that will introduce Coca-Cola brands for use in GMCR's soon-to-be released Keurig Cold at-home beverage system. The system and Coke pods will be sold around the world. In connection with this agreement, GMCR will issue Coke 16.7 million newly issued shares at $74.98 per share, representing 10% of the GMCR. Coca-Cola's equity investment will total $1.25 billion, and given the surge in GMCR's stock price following the announcement, Coca-Cola has already garnered more than $800 million of paper profits. We believe that by entering this new premium channel the Coca-Cola brand will continue to be viewed as the leading global soft drink brand, and consequently continue to maintain our wide moat rating on the company and our $45 fair value estimate.
GMCR will be Coca-Cola’s exclusive partner for the production and sale of Coca-Cola branded single-serve, pod-based, cold beverages. We expect that the Coca-Cola pods will be available during 2015, and as such are not yet incorporating the associated equity income of GMCR in our Coca-Cola valuation model. Green Mountain will be able to sign on other cold beverage brands, and we suspect that they are actively courting Pepsi (PEP), Dr Pepper (DPS), Red Bull, and Monster (MNST) to join the ecosystem.
We believe that SodaStream (SODA) is viable benchmark for sizing the at-home soda market. Currently, Soda Stream has 6.5 million active households, 1.3 million of which are in the United States. This equates to a penetration rate of around 1%. We believe that GMCR’s Keurig Cold system could approach this level of penetration by 2019. Given the convenience of the product, we expect the price per serving will be materially above the typical 2L or 24-pack consumers typically purchase for at-home consumption. Should this system reach 6.5 million households, and each household averages 2.5 people who drink 200 Coke-pods per year (roughly one half of the average American’s annual Coke Consumption), we estimate that the Pod system could amount to slightly less than 1% of Coke’s global beverage volumes. However, given that this will be a premium product it could eventually surpass 2% of Coke’s sales.
The K-Cup has proven to be a growth juggernaut in other categories (such as coffee), in the past 10 years, GMCR’s annual sales have grown from $137 million to more than $4.3 billion. We suspect that Coca-Cola is drawn to this disruptive innovation, and would rather be a part of it, than fighting it. Although we expect much of the Coca-Cola pod volume will be incremental, we do suspect some of the Coke-pod sales will cannibalize traditional Coke SKUs. Consequently, one potential risk to this venture is that Coca-Cola’s bottling partners may see this as channel conflict.
The Keurig Cold platform will be able to produce a variety of sodas, energy drinks, sports drinks, teas, enhanced waters, and juice drinks. GMCR estimates that the cold beverage category is roughly 7 times larger than the hot beverage category. We note, however, that GMCR will have to convince consumers to first purchase the machine and then to dedicate counter space to the device. As such, we believe that the majority of American households will continue to purchase their soda the traditional way.
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Thomas Mullarkey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.