Finc Mgmt - Final Assignment

Growth Analysis – Organic & Merger/ Acquisition –

The Coca Cola Company

I. Introduction

Whether a company is just starting out or a company has been in business for decades, most desire to grow their business and expand business operations. There are two ways to reach these growth objectives: organic growth through slow expansion over a longer period of time or a merger or acquisition with a different company to expand business operations as soon as the acquisition is completed (Ferris & Petitt, 2013). Organic growth comes from within a company and can take the form of expansion in emerging markets, new product development or building a new production plant (Baker & Martin, 2011). Organic growth requires an initial investment, which can be financed through new debt issuance or using retained earnings and will take multiple years to show its (hopefully) positive effect (Baker & Martin, 2011).

Growth through a merger and acquisition (M&A) can either be through merger, which means an entire company is integrated within the existing company or as a completely new business entity; or through acquisition, which means the acquirer will purchase a stake in the target (Clayman et al., 2012). This growth through M&A will show immediate results as the company merges all assets and liabilities of the target in its business or as the acquirer adds the equity investment to its financial statements.

The Coca Cola Company has faced declining sales in its core business of carbonated soft drinks and therefore needs to consider new alternatives for growth opportunities. Two possible growth strategies will be analyzed in this paper: organic growth and growth through acquisition.

The Coca Cola Company has successfully grown organically by expanding in emerging markets and the organic growth strategy analyzed in this paper will be a further expansion into the African market by an additional $5 billion investment in the area over the next five years (Vault, 2014). The growth through M&A for The Coca Cola Company analyzed in the following is an expansion into the Smoothie market by acquiring a 10% stake in Jamba, Inc. to further diversify KO’s product portfolio (Munnariz, 2014). After analyzing both growth strategies and comparing them with each other based on the eVal results a recommendation on a growth strategy to pursue will be presented to The Coca Cola Company.

II. Explanation and Analysis of Assumptions and Results of eVal Projections for Organic Growth Strategy

As discussed in the introduction the recommended strategy for organic growth is further expansion in emerging markets to take advantage of the growing middle class in these markets, who has the money to spend on the products KO offers. KO plans to expand its operations in Africa, by investing $5 billion in the bottling partners there. KO wants to “build new manufacturing capacity, develop sustainability initiatives and create jobs” (Vault, 2014). The expansion will take place over the next five years with investments of $1 billion per year. The cash for this investment will be provided through new debt issuance. KO has a very favorable cost of debt of long-term debt of 2.2% (Coca Cola, 2015). KO’s cost of equity is significantly higher at 6% according to the CAPM. The increase in investments in expanding markets is presented through an increase in PP&E of $1 billion per year from 2015 through 2019 – the company wants to expand its manufacturing capacity. The increase in PP&E is possible through an increase in long-term debt by $1 billion a year from 2015 to 2019. The increase in PP&E will gradually increase the Ending Net PP&E/Sales Ratio, assuming an expansion of $1 billion a year the Ratio will increase from 31.8% in 2015, to 34%, 36%, 40%, 41.2%, 44.3% in 2015, 2016, 2017, 2018, 2019, respectively, keeping sales constant for these initial years of investment. Considering the financing of this investment through the issuance of new long-term debt of $1 billion a year from 2015 through 2019, the Long-Term Debt/ Total Assets Ratio will also change. Assuming issuance of $1 billion of new long-term debt per year over the period of the organic growth through expansion in PP&E the Ratio will be 21.9%, 23.9%, 24.6%, 25.2% and 25.6% in 2015, 2016, 2017, 2018 and 2019, respectively. After successfully having expanded its manufacturing capacity in Africa by 2020 and completing the expansion in PP&E the company expects sales to grow by 3.4 percent points in 2020 compared to the growth rate of 0.4% in 2019 before completion of the expansion and 0.25% every following year. The company will have the highest growth rate of 4.8% in 2024 before reaching its terminal growth rate of 3% in the following years. The increased sales growth rate will lead to a substantial increase in sales in the following years as opposed to prior to the expansion. The increase is slow and over a longer period of time, but all other factors kept constant KO can expect its sales to reach $58 billion by 2026 compared to $45 billion in 2015. The Cash Flow from Operations through this expansion shows the initial cost for the expansion by slightly dropping to $8.87 billion in 2015 compared to $8.99 billion in 2014, but will increase to $11.91 billion by 2026.

This organic growth strategy presents a pretty interesting growth opportunity, but considering the slow expansion, with first improved sales growth in 2020 after the expansion is complete and risks associated with exchange currency rates and political instability in some areas of Africa another growth strategy should be considered before making a final recommendation.

III. Explanation and Analysis of Assumptions and Results of eVal Projections for Merger or Acquisition Growth Strategy

The Coca Cola Company completed its first merger in 1960 when the company purchased The Minute Maid Company to expand beyond its carbonated soft drink market (The Coca Cola Company, 2012). This was KO’s first step towards becoming the leader in the nonalcoholic beverage market (The Coca Cola Company, 2012). However, in recent years KO has faced declining sales primarily due to generating almost 70% of its revenues through the sale of carbonated drinks while the consumer market desires healthier products. Considering the beneficial effects the merger with The Minute Maid Company had for KO, the company has expanded its product portfolio in other beverage markets in the past few years. KO acquired a 16.7% stake in Monster Beverage Corporation in 2015 and a 16% stake in Keurig Green Mountain in 2014. Both of these acquisitions have provided KO with a more diversified portfolio and opportunity for growth. Monster and Keurig have seen improved stock valuations since the acquisitions have been completed.

Merger & Acquisitions (M&A) are selected by a company to create value (Ferris & Petitt, 2013). Companies have three main motivating factors for a M&A: operating synergies, financial synergies and managerial synergies (Ferris & Petitt, 2013). This means a M&A is only recommended if the combination of the two businesses or the partnership entered into is more beneficial than each would be separately.

The acquisition considered in this analysis for The Coca Cola Company is purchasing a 10% stake in Jamba, Inc., a smoothie chain. By combining the operations of the acquirer (KO) and the target (JMBA) the following operating synergies are expected:

· Revenue enhancement for KO by diversifying its product portfolio and accessing new markets.

· For JMBA the ability to leverage KO’s distribution network and being able to sell its products to KO’s customers will increase its sales volume. Which, in turn, will provide KO a larger gain through its 16% equity investment in JMBA.

Jamba’s closing price on March 4, 2016 was $13.39 per share with 15.04 million shares outstanding (Yahoo! Finance, 2016). A 10% stake in JMBA equals 1.5 million shares or $20.14 million. Considering an average premium on acquisitions of 20-30 percent of the market price (Ferris & Petitt, 2013), this analysis will assume a 25% premium on the share price, thus KO would acquire a 10% in JMBA for $26.18 million. This acquisition would take place in 2015 and would change the following variables in the eVal Forecasting Assumptions:

· KO recorded its income from its acquisition in Keurig as Other Investments, based on this strategy the acquisition of a 10% stake in Jamba, Inc. will also be recorded as Other Investments at $26.18 million in 2015.

· The investment in JMBA will be financed through a reduction of retained earnings by $26.18 million in 2015.

· The Income earned through the equity stake in JMBA will be recorded under Other Income, thus the Other Income/ Sales ratio will change. JMBA has been able to increase its Net Income by 42.73% from 2013 to 2014 and is expected to further increase its income through the acquisition and the agreement with KO to be able to use KO’s distribution channels. Considering KO would benefit as an equity partner from JMBA’s increased income, KO would receive $363,200 in 2014, considering a continued growth of income by 30% in the following years, KO would receive $472,160 in 2015 and so forth. This would change the Other Income/ Sales ratio from 0% to 1%.

KO would receive Cash Flows from Operations of $12.56 billion by 2026. Sales would reach $51.7 billion by 2026 and KO’s Net Income would slightly increase due to the added Other Income from the 10% stake acquisition of JMBA to $7.5 billion in 2015 compared to $7 billion in 2014.

IV. Examination and Discussion of Comparison of Results of the Growth Strategies

Comparing the Net Income (since the expansion would primarily increase Sales, while the acquisition would lead to Other Income), it underlines the above mentioned slow movement from the organic growth. Net Income first drops in 2016 after making the first $1 billion investment in expanding the PP&E in the Africa area, by 2020 Net Income reaches pre- expansion levels and by 2026 an increase is 30% compared to the beginning of the expansion. Looking at the Net Income after the acquisition of 10% stake in Jamba, Inc, the Net Income increases immediately at the point of purchase in 2015. Net Income continues to increase until it reaches over $10 billion in 2026. The acquisition growth strategy provides KO with an increase in Net Income of almost 35%.

Looking at the Cash Flow from Operations, so how much the different growth strategies will provide KO in Cash Flows, it seems to be a similar result as the Net Income already indicated. From 2015 to 2026 the Cash Flows from Operations increased by 34% through the organic growth strategy and by 34.5% through the acquisition growth strategy.

Considering both increases in Net Income and Cash Flow from Operations the acquisition provides KO compared to the expansion, it seems like this growth strategy offers KO more increase in value. To make a final recommendation other factors need to be considered as well. The expansion strategy would require KO to issue additional long-term debt and exchange rate fluctuations as well as political instability in certain areas in Africa make the expansion organic growth strategy even less attractive.

The growth strategy through acquisition of 10% stake in Jamba, Inc. offers KO the ability to further increase its product portfolio, to take advantage of a fast growing market, new distribution channels and can use some of its retained earnings to pay for this equity purchase.

V. Recommendation and Justification of Most Appropriate Growth Strategy

Considering all of the factors discussed above, it is recommended for KO to continue to grow through acquisition of stake in other beverage companies. KO should acquire a 10% stake in Jamba, Inc. and pay for the $26.18 million with a part of the company’s retained earnings. The company will benefit from increased Net Income of 35% over the next 10 years and increased Cash Flow from Operations of 34.5% over the same period. The expansion carries too many risks with it while also costing KO more. Furthermore, while consumers in Africa might have more funds available to purchase Coke products it is not guaranteed how long the demand for carbonated soft drinks will stay the same in the area. So far, KO has acquired equity stake in Monster Beverages, ZICO Inc. and Keurig Green Mountain and has been able to benefit from the partnership these acquisitions have provided. KO has now a wider variety of nonalcoholic beverages and the potential to benefit from the growing markets these companies are positioned in. Furthermore, KO can now add Jamba, Inc. in the smoothie market to its portfolio and does not have to take on additional debt to finance this acquisition. Growth through mergers and acquisitions has been a very beneficial strategy for KO over the past few years and is expected to continue to be.

References

Baker, H., & Martin, G. (2011). Capital Structure and Corporate Financing Decisions. John Wiley & Sons.

Clayman et al. (2012). Corporate Finance: A Practical Approach, Second Edition. John Wiley & Sons.

Coca Cola. (2016). SEC 10 K Filing. Retrieved from http://services.corporate-ir.net/SEC/Document.Service?id=P3VybD1hSFIwY0RvdkwyRndhUzUwWlc1cmQybDZZWEprTG1OdmJTOWtiM2R1Ykc5aFpDNXdhSEEvWVdOMGFXOXVQVkJFUmlacGNHRm5aVDB4TURjM01EZzVOQ1p6ZFdKemFXUTlOVGM9JnR5cGU9MiZmbj1UaGVDb2NhQ29sYUNvbXBhbnlfMTBLXzIwMTYwMjI1LnBkZg==

Ferris, K. & Petitt,B. (2013, August). Valuation for Mergers and Acquisitions: An Overview. Retrieved from http://www.ftpress.com/articles/article.aspx?p=2109325

Munnariz, R. (2014, August 20). What Company Will Coca-Cola Drink Up Next? Retrieved from http://www.dailyfinance.com/2014/08/20/coca-cola-potential-acquisition-targets/

The Coca Cola Company. (2012, December 21). Minute Maid: The Day Coca-Cola Became the Company It Is Today. Retrieved from http://www.coca-colacompany.com/stories/minute-maid-the-day-coca-cola-became-the-company-it-is-today/

Vault. (2014). THE COCA-COLA COMPANY. Retrieved March 06, 2016, from http://www.vault.com/company-profiles/food-beverage/the-coca-cola-company/company-overview.aspx

Yahoo! Finance. (2016). JMBA Key Statistics. Retrieved from http://finance.yahoo.com/q/ks?s=JMBA+Key+Statistics