Breakingviews: Pepsi’s fizzy water deal may have flat aftertaste

Indra Nooyi is handing her successor a fizzy leaving present. One of the final acts of the outgoing PepsiCo chief executive is to buy Israeli-based SodaStream for $3.2 billion. Diversifying into the faster-growing carbonated water market has strategic logic. But incoming boss Ramon Laguarta will need some sparkling top line growth to make the deal as financially attractive.

The purchase announced on Monday is part of Pepsi’s low sugar future. The company is paying $144 a share in cash for SodaStream, which sells sparkling water makers. That represents a 32 percent premium to the Israeli group’s volume-weighted average share price over the past month.

Dipping into the sparkling water market makes sense. Carbonated water sales are fast outstripping sugary drinks, having grown nearly 6 percent last year, compared to other fizzy rivals which only grew 3.7 percent last year, according to data from Euromonitor. Consumers are turning their back on drinks like Pepsi’s own Mountain Dew in favour of zero calorie options like carbonated water. SodaStream also appeals to environmentally conscious customers as it cuts out the need to buy plastic bottled water.

Yet with the purchase price almost two-thirds higher than where SodaStream shares traded last month, Pepsi is initially looking at a fairly flat return. SodaStream’s operating profit is forecast at $119 million in 2018, according to I/B/E/S from Refinitiv. Taking off around 20 percent in tax implies a return of under 4 percent. Pepsi can juice that up if it manages to deliver cost synergies, but is yet to identify any.

Nooyi could argue that the drinks giant can easily afford a bit of experimentation given it generated over $7 billion of free cash after capital spending last year, when it hiked the dividend by 15 percent and bought back shares. But if Laguarta wants a bubbly return of around 10 percent by 2020, he will have to grow the top line annually by nearly 15 percent, according to Breakingviews calculations. That’s not impossible given I/B/E/S data from Refinitiv revenue estimates of just under 10 percent. But he will still have to provide more fizz than he might have liked.

_______________________________________________________________________

Request a free trial of Breakingviews here.