FINA535 -- Case Analysis 2 (Pepsi)

[SIT Kwok Choi, Pitney]

Dear all,

Sorry I may not be available on Thu, and I know Philip & Frances will be on
class on Wed. So may I suggest the following schedule:

- determine how to divide work via email by Tue (anyone has suggestion?)
- each send out some rough work by Wed
- discuss on phone or come out on Thu (but I should be absent, will check
email at midnight)
- someone to consolidate on Fri

See how you think. In fact I have not read the case :P will try to do
something tomorrow night.

BTW, I discover that the Netflix Excel file shown on the class is still on
WebCT Case Exhibit. If you want to download, do it fast la :)

Regards,
Pitney

----- Original Message -----
From: "Vidhan Goyal" <go...@ust.hk>
To: <fina535...@lists.ust.hk>; <fina535...@lists.ust.hk>
Cc: "Yuanto Kusnadi" <yua...@ust.hk>
Sent: Monday, November 20, 2006 1:22 PM
Subject: Re: FINA535 -- Case Analysis 2 (Pepsi)

> FINA535: Pepsi's Acquisition of Quaker
>
> The case analysis that is due this coming Saturday requires you to submit
> stand-alone DCF valuations of both Pepsi and Quaker Oats.
>
> Vidhan
>
> PS: I would also like you to e-mail me your spreadsheets on Saturday.
--------------------------
>> Andy Chow 60101211
>> Pitney 97113112
>> Aslan 94329903
>> Frances 92580866
>> Philip 60781279
>> Joseph 92688812

[Frances Chin]

Hi All,

 

Thanks to Philip and Andy, here we have developed the draft for the Pepsi-Quaker valuation.

 

As advised by Prof., we only need to do the standalone valuation for individual firms.

 

The preliminary result suggested that Pepsi was overvalued whereas Quaker was undervalued at 2000.  Please review and share your thoughts.
 

Thanks & regards,

Frances
 

[Joseph Lam]

Dear all,

Thanks to Francis, Philip and Andy.

Please find the my draft for the case questions.  I also take a "less financial approach" and reference from some articles too.

Cheers,
Joseph

[Aslan Lam]

Thanks All,

 

Regarding the acquisition, I am just thinking of a few questions: 

 

1.   According to case material, the only useful Product line of Quaker to Pepsi is the Gatorade.  Should we do some financial estimation on the Synergy only on Gatorade and its distribution network? 

2.  Will there be some duplication of other business of Quarker and Frito-Lay (i.e. Pepsi)?  And will those businesses in a way worst off Pepsi financial situation?

 

3.  Can we think in another angle if the Pepsi's acquisition is only for Gatorade and not bundle with other business of Quarker, will it be more benefitial to Pepsi?

 

Just some thoughts to share ......

 

Aslan

[andy chow]

Aslan,

I thought it is mentioned in the case that the other healthy products Quaker selling is quite profitable as well.  See page 7, the contribution margin is very high @ 30% and it is growing 12.5% in 1999 due to the more health conscious of the people.  Having said that I agree that there are some segment that is not as attractive, like the flavored rice (Golden Grain) product line.  due to the increasing competition.

 

We can also try to look at the individual values of the product lines and assume that Pepsi co can sell them off to other companies to generate cash after they merge with Quaker.

 

Cheers,

Andy

 

[Joseph Lam]

Agreed that they may sell the cereal line to Nestle and others although it may not worth much.

And that's what happned for Question 3 during the acquisition process:

http://money.cnn.com/2000/11/30/deals/quaker/

Pepsi, the world's No. 2 soft drink concern, first approached Quaker Oats about a merger earlier this month, offering to swap 2.2 shares of its stock for each Quaker Oats share, a ratio that valued the food conglomerate at $103.54 per share, or roughly $13.7 billion, at that time. Pepsi walked away from the discussions after Quaker Oats demanded a "collar," or price protection mechanism to guard its shareholders against a sudden drop in Pepsi's stock, as part of any agreement.

According to the Journal the ratio is now 2.3 shares of Pepsi for each Quaker share, bringing the total value to $14.3 billion.

Pepsi's initial failure to complete a deal opened the door for rival Coca-Cola, which also ultimately walked away from an agreement when its board balked at taking on Quaker's slow-growth food operations in addition to Quaker's prize gem, the fast-growing Gatorade.
___________

http://www.cnn.com/2000/fyi/news/12/04/pepsi.purchase/

NEW YORK (CNNfn) -- Soft drink maker PepsiCo said Monday it will purchase Quaker Oats for $13.4 billion in stock, ending a monthlong courtship to acquire the parent company of Gatorade, the dominant brand in the fast-growing U.S. sports drink category.

The merger ends a roller coaster odyssey for Quaker Oats, which at one point during the last month flirted with merging with Pepsi, Coca-Cola Co. and French food conglomerate Groupe Danone.

The agreement calls for Pepsi to swap 2.3 shares of its stock for each outstanding Quaker Oats share. Based on Pepsi's closing price of $42.38 Friday, that values the Chicago-based company at $97.47 per share, or $13.3 billion based on the 315 million new shares Pepsi said it will issue to Quaker Oats shareholders.

 

In addition, PepsiCo will assume about $761 million in Quaker debt, and will receive a breakup fee of $420 million if Quaker calls off the transaction to go with another partner, according to the Wall Street Journal interactive edition.

[Frances Chin]

Thanks Joseph for the useful information, based on which we know that:

 

1. our valuation of Quaker is pretty close to the expert's estimation (we can make it more closer by making minor adjustment of the assumptions)

 

2. our computation suggests a firm value of 36 billion which is much higher than the estimation (13.3billion) while the per share value ($2x) is far lower than the trading price ($45).  There must be something wrong with (a) the computation of firm value & (b) the number of outstanding shares.

 

Please help to double check the calculation on Pepsi.  Here I attach the updated version of which some errors were corrected. 
 

Thanks very much & best regards,

Frances
 

[Philip Wan]

Hi Frances,

For pepsi valuation, I noticed that you add Amortization in Pepsi's
EBIT calculation, but if you do that, we need to take that out in FCF.
Also, the FCF growth from 2004 to 2005 appears -ve, which cannot be
used as constant growth rate...

I've made some changes to the assumptions, and modified some format
(hope you don't mind....), the per share value for pepsi appears
closer to the share price now.

philip

[Frances Chin]

Dear Philip,

 

Thanks for the modifying the spreadsheet which now looks very good.

 

You've increased the firm value by several billions overnight.... Pepsi should consider to hire you as the CFO...

 

Hi others,

 

Just would like to check with you: apart from the valuations, do we need to submit anything else this Sat?

 

Cheers!

Frances
 

[SIT Kwok Choi, Pitney]

Thanks very much for the great work from Frances and Philip.  I think we don't need a tele discussion then :)

 

Some thoughts:

 

1) For Pepsi, the income statement is as of Sep 2 (not 30 Sep).  Therefore should the full year sales figure be 14028/36 week *52 week or 14028/2*3?

 

2) The assumptions stated in the box are inconsistent with the revised figures.  Seems Amortization is also not 128m since 2000 as only the % of depreciation/sales is assumed to be constatnt.  Also, a bit strange to assume those high growth rates for Pepsi (6% & 5%, which are even better than Quaker (both for sales growth & calculated FCF growth).  In this way, why Pepsi needs to buy Quaker?  Should we still keep the assumptions as Frances' original?  It is OK if intrinsic value is lower than the market price, as investors may already consider the opportunitiy from acquisition, therefore overpricing Pepsi.

 

3) for non-operating asset, should we use the -1% of sales in Exhibit 11 instead of just adding cash + ST inv.  But the difference should be small and I have not changed.

 

Just some thoughts for your consideratoin and I try 1&2 as attached. Please feel free to use back the previous version.

 

Besides, seems Prof just needs us to send these calculations?  For the 3 case study questions, is he going to explain in the coming class as these should be the topics for M&A which we should not know the details?  But we can submit it to Professor also as he said.

 

Many thanks,

Pitney :)

[Philip Wan]

Hi Pitney,

Agree with #1.

For #2, I think it looks weird for Pepsi to have 11% growth in year
2000 and drop significantly to 3% in one year. I revised the growth
rate slightly to show gradual decrease and the value becomes little
bit closer to the current stock price. It may not be too relevance to
compare the growth rate for the two companies directly, there're more
reasons for Pepsi to acquire Quaker: e.g. product line expansion,
utilize it's distribution channel etc.

For #3, i think it is ok to use the 2000 est. figures directly as
we're valuating the company as of year 2000.

philip

[Aslan Lam]

Hi Philip,

 

I am also thinking about the decrease is quite sharp from Year 2000 11% down to 3% for Pepsi.  Just trying to find some information in the web to explain the situation.  But if we adjust the growth rate to decrease gradually, that will also work la.

Aslan

[SIT Kwok Choi, Pitney]

ok for me also.  Thanks.

[Joseph Lam]

Dear all,

Fine with me too.

Jose