Getting It Right: PepsiCo’s Acquisition of Quaker

While many companies bungle their m&a communications, those that get it right stand to reap big rewards for their shareholders – starting on the day of the announcement and over the longer term. A good example is PepsiCo Inc.’s formal announcement of its $13.4 billion acquisition of Quaker Oats Co. in December 2001. PepsiCo had to overcome significant communications problems before that deal could be consummated. Reports had been floating in the market for weeks about a not-so-private auction of Quaker, with Coca-Cola Co. and Groupe Danone SA of France being the other suitors. After PepsiCo offered to pay a 20% premium for Quaker, it exercised unusual discipline by not raising its bid, even in the face of competing offers. PepsiCo’s announcement was received very positively by investors – its shares rose more than 6% in the days after the announcement and have continued to outperform the shares of its peers over time. PepsiCo got off to a good start with a detailed press release and investor presentation, supported by a lengthy analyst/investor call and a Web cast. It also sent letters to employees, customers, and bottlers to address the concerns of these various constituencies. Not only did PepsiCo promise that the transaction would be accretive to earnings in the first full year after closing, it went so far as to express expected results in terms of return on invested capital (ROIC), saying that it would increase by 600 basis points over five years. While sophisticated investors understand this language, it is rarely seen in merger press releases. Additional detailed materials outlining the deal’s synergies were available on the company’s Web site. PepsiCo’s investor presentation had three key hallmarks: * Clear, understandable “base” cases; * Trackable and defendable synergy targets; and * A credible management team already in place. Establishment of the base cases At the outset, PepsiCo spelled out to investors what the company already had promised concerning revenue, operating profit (EBIT), earnings per share, and ROIC growth. Thus, the case for improvements – the synergies – could then be clearly expressed as increases in profitable growth. Trackable and defendable synergy forecasts PepsiCo described in detail where it realistically expected synergies, differentiating these expected gains from those it anticipated but did not include in the investor model. The investor presentation compared the revenue, EBIT, EPS, and ROIC growth rates it expected for the integrated company with PepsiCo and Quaker as stand-alone entities. The presentation described but didn’t include any assumptions about the benefits of selling Quaker Oats’ Gatorade beverage line through the Pepsi network. Rather, emphasis was given to the benefits that Gatorade brought to PepsiCo’s Tropicana business. The presentation erred on the side of modest cost savings assumptions. A total of $230 million of synergies was identified and expressed in terms of their respective contributions to operating profit: $45 million from increased Tropicana revenues; $34 million from Quaker snacks sold through the Frito-Lay system; $60 million from procurement savings; $65 million from cost savings derived from selling, general, and administration expenses (SGA), logistics, and hot fill (beverage temperature when packaged) manufacturing; and $26 million saved by eliminating corporate redundancies. It was clear what investors and employees could expect in every major part of the business. They could easily see how the deal would produce improvements in operating profit, more efficient use of capital, and reductions in tax rates – more than justifying the modest 20% acquisition premium of about $2.2 billion. Clarity of leadership and reporting relationships PepsiCo announced that president Steve Reinemund would become the new chairman and CEO, Indra Nooyi would become president and retain her CFO responsibilities, and Roger Enrico and Robert Morrison (the former chairman and CEO of Quaker) would become vice chairmen and report to Reinemund. The management team articulated clearly how it planned to integrate Quaker Oats – and all of its brands – into Pepsi and how capabilities from both companies would be leveraged to achieve additional growth. Moreover, Roger Enrico, Pepsi’s out-going chairman and CEO, stressed frequently that management used conservative estimates for cost savings and revenue synergies. Despite senior-level management changes at the top of the company, virtually every constituency understood how it would be affected by the transaction. The December conference call announcing the deal generated a positive initial perception that persisted because of the process that followed the deal closing on Aug. 2, 2002. At that time, PepsiCo released, in EXCEL format, the restated financial statements for the combination and reviewed all the changes that had occurred since the original presentation. It also hosted a full-day investor conference reviewing the synergies and growth opportunities. Because of the clarity PepsiCo achieved during the closing process, the company actually increased the value of anticipated synergies to $400 million from $230 million. Using well-prepared documents, a very successful investor conference call, and careful follow-through at closing, PepsiCo was able to paint a rich strategic and financial portrait of the transaction and the effects on the company. Copyright 2003 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com