Mergers are notoriously difficult, as Quaker Oats found out not long ago. How will Pepsi integrate Quaker into its line up? With few apparent financial problems, some strong synergies, and a couple of ex-Marines running things, this could be one of the most successful food mergers in recent memory.
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So far, the merger of PepsiCo (NYSE: PEP) and Quaker Oats (NYSE: OAT) looks like a great deal for Pepsi. Mergers are notoriously difficult to accomplish, as Quaker discovered a few years ago with its purchase of Snapple Iced Teas. Problems can crop up in all sorts of areas -- on the balance sheets of the companies involved, in the new combinations of people in the workplace, or in the mechanics of integrating two companies with different products and distribution channels, just to name a few. When looking at the financial statements for both companies, nothing extremely negative jumped out at me. Quaker's debt is not significant to Pepsi now, even without Quaker's cash reserves or other assets taken into account. Pepsi expects an increase in interest payments, but Quaker has generated over twice that amount of operating cash in just the last nine months. Quaker's margins for the last nine months are pretty strong for a food and beverage company, with both businesses enjoying operating profit margins above 17%. Nabisco (NYSE: NA) was around 10% and Bestfood's (NYSE: BFO) operating profit margins were recently at 15%, for comparison. (Jeff Fischer took a look at consumer food and beverage makers in our new Industry Focus 2001.) Finances, then, are not the biggest worry for Pepsico investors. The biggest historical problem for merging companies has been personnel and corporate culture issues. This is much harder to gauge from an investor's perspective, but there are several factors that bode well for Pepsi's ultimate success. Both companies have spent the last few years restructuring and refocusing on their core businesses. This could be beneficial, as employees of both companies have already been working in a fluid environment, so the merger won't be disturbing years of entrenched habits. Part of this personnel problem has been the difficulty in getting people in the acquired company to work comfortably with their new bosses. There is no easy cure for this problem. Pepsi pointed out, however, that the entire Quaker team is coming over to Pepsi to run Quaker's businesses. These managers are the folks who have turned Quaker around in the last three years, and Pepsi wants to keep that expertise. Additionally, Pepsi will maintain many of the current salary and bonus strategies, which should make the employees of Quaker more comfortable with their new employer. Among the people who have already agreed to stay with the merged entity is Quaker Chairman and CEO Robert Morrison, who will be co-vice chairman with current Pepsi Chairman and CEO Roger Enrico. Enrico will step down from his current posts once the merger is closed. After the deal closes, Pepsi will have some extremely talented and experienced people running the company, which bodes well for the merger's success. The mechanics of integrating the two companies is another significant problem Pepsi will face. The company will need to combine bottling and distribution capacity, as well as revamp its selling channels. Two of the great strengths of the "new" Pepsi will be the number of top brands in its stable and improved distribution scale. Integrating the products into the distribution channel could be a complex task. All of these points pale in comparison to one last problem that must be resolved. According to someone on the conference call, Bob Morrison's preferred soft drink comes in a distinctive red can originating from Atlanta, Georgia. Future CEO and former Marine Captain Steve Reinemund may have to pull rank on this former Marine. The fact that I don't see any obvious merger-killing problems right now does not mean the problems aren't there. Once the deal closes, investors will need to watch Pepsi closely. Watch grocery stores to see if Pepsi delivers on its new "power aisle" ideas and if it seems to be dominating the non-carbonated drink market. Watch the financial statements to see when some of the sales, profits, and cost-saving synergies begin to appear there. Finally, keep an eye on the news wires to watch for any managers leaving the new company. All of these areas will give investors clues as to the health of the new "new" Pepsi, and the success of the Pepsi-Quaker merger.
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