The strange combination of confection and beverage is no more. Cadbury (NYSE: CBY ) and Dr Pepper Snapple Group (NYSE: DPS ) have parted. Now trading under individual tickers and independently managed, I think the "demerger" (the very British term the company used for the action) is the right strategy for both units.
I have long wondered whether Cadbury and Schweppes were merged in 1969 to create a bunch of old British men who wanted to be known as "the world's coolest grandfathers." After all, if your grandfather owned a company that made candy, what could possibly make him any cooler? That's right, owning a soda pop company. It's a preteen's dream come true.
Sadly, that's about the best connection I can make between the two business units. I always had trouble finding a compelling common thread. The core of Cadbury has always remained confection, with the beverage unit separately managed and related only tangentially.
Managing both units seemed to distract top management from needed focus and might explain the comparatively lousy confection operating margins, as well as myriad restructuring programs that fell short of lofty goals. The distraction may have also contributed to problems that the company has experienced integrating confectionary acquisitions -- although the Adams acquisition, which brought the company Trident and Dentyne gums, was a notable exception and a glowing success.
In my opinion, management took a little too long to separate the beverage business. The company narrowly missed the window to sell the unit during the heyday of private equity and inflated multiples during late 2006 and early 2007, when speculation emerged that the drinks business might be merged with private label soda-pop maker Cott (NYSE: COT ) . A deal never materialized and the capital markets soon dried up, leaving the demerger as the most logical option for the company.
I am not a big fan of the basic dynamics of Dr Pepper Snapple Group. With the company owning the rights to its brands solely in the United States, it will face a tough beverage market. Coca-Cola (NYSE: KO ) owns the rights to the Dr Pepper brand in several countries outside North America, and PepsiCo (NYSE: PEP ) likewise owns the rights to 7-Up in many markets.
This bizarre dynamic is due to the fact that both Coke and Pepsi tried to buy the rights to the Dr Pepper and 7-Up, respectively, within North America during the 1980s, but were denied because of antitrust concerns.
Besides international limitations, Dr Pepper Snapple is also a disadvantage to the Coke and Pepsi systems because a large portion of the company's volume in the U.S. is produced by Coke bottlers, most notably Coca Cola Enterprises and Pepsi bottlers, most notably Pepsi Bottling Group. To make matters worse, the company's core products -- carbonated soft drinks -- seem to be in a state of decline in the U.S.
In contrast, there's a lot to like in Cadbury's confection business. It is currently the largest in the world, at least until the Wrigley (NYSE: WWY ) and Mars deal closes. Cadbury maintains very strong confection-market positions in most major and many developing markets.
A glaring exception is the U.S., where Hershey (NYSE: HSY ) manufactures Cadbury brands. I think that it's a matter of when, not if, Cadbury and Hershey will merge, but issues of control could continue to stall a deal for years.
Even without a Hershey deal, Cadbury has bright long-term growth prospects and profit margins with lots of room for improvement. With a little more managerial focus, this long-hoped-for potential may finally be recognized.
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Coca-Cola and Cadbury Schweppes are Inside Value selections. Check out what the analysts are saying about the demerger with a free, 30-day trial.