The company we know as Coca-Cola (NYSE:KO) is about to become much smaller, as the business refranchises its massive bottling operations. At the same time, the century-old company is on the prowl for tiny brands, which it can scale through its massive distribution system.
In this segment of Industry Focus: Consumer Goods, Motley Fool analysts Vincent Shen and Asit Sharma take a look at both Coke's changing business model and the in-house venture capital arm it uses to make those acquisitions.
A full transcript follows the video.
This podcast was recorded on July 19, 2016.
Asit Sharma: In terms of Coke's strategy for dealing with this gradual decline of sodas, they want to become a smaller and more profitable company. This will take many of our listeners by surprise, because it's the goal of every multi-national conglomerate to become bigger, right?
Well, Coke is actually going the other way. They're going from a 120,000 employee company to roughly 40,000 employees. They are going to go from a $43 billion company perhaps all the way down to a $28 billion company. This is going to be a sea change. It will be a bigger story next year and in 2018.
Essentially what Coke is doing is they're selling off all of their bottling operations to their global bottling partners. They're going to become a more nimble company, a company which markets more than it manufactures. They'll hold onto their concentrates business and in becoming smaller, again, they'll have the ability to grow more quickly again. I think that's a brilliant stroke on the part of management. It shows a lot of long-term thinking on their part, and I think that this will be a success.
Not many people are talking about it today, but we'll see as those financials change over the next several quarters. You'll see profits go up, but revenues actually declined as it leaves off the bottling revenue that it has right now.
Vincent Shen: Yeah, absolutely. They actually have a slide in their investor presentation from a consumer conference, which was just last month actually, touching on how adjusted for after they do all these refranchising of the bottling operations, which was a huge focus I might add of that presentation. The revenue is falling from $44 to about $20 billion, but you mentioned profitability. Gross margins potentially going up 7 percentage points from 61% to 68% forecasted. Operating margins an even bigger jump, going from 23% to 34%.
It does sound crazy sometimes for a leading company like this to say, "Hey, we want to be smaller," but obviously there is a lot of incentive to do that on their bottom line.
Sharma: Sure. Let's circle back really quickly to how they're acquiring those smaller companies. Coke has its own venture capital arm. It's called Venturing and Emerging Brands. This company seeks out really tiny labels, mom-and-pop operations that have innovative products. For Coke, once a product hits about $10 million and $20 million in revenue, it starts to become interested. If it sees that a brand can grow maybe up to $50 million in a year, or $70 million or $100 million, then it really takes interest.
Because for Coke, the Holy Grail is to find a brand which they can just run through that enormous, worldwide distribution system, and if anybody can scale a brand up literally overnight from $50 million to the hundreds of millions or make it $1 billion product, it's Coke. This group, VEB for short, is basically an investor. They're the company that takes minority interests, if you're familiar with Honest Tea, that was a VEB venture, and it's now wholly owned by Coke.
Again, another way that the company strategically addressing how to diversify its overall portfolio and lean more toward these still beverages which have sustainable, natural, healthier bent to them that consumers are clamoring for.
Shen: Yeah. I'm really glad you brought up Honest Tea as well because I feel like I tried it maybe once a few years ago, but then once they had the investment from Coca-Cola they got the extra leverage with distribution and things along those lines, I see them everywhere now in all the convenience stores, anywhere. A lot of different, for example, restaurants too. That is something on the menu that's available.
Some other ones that may or may not have been specifically under their VEB unit, but ZICO Coconut Water for example is another one I remember really took off obviously with the partnership that they had. They've also been using some of their acquisitions just to get access to other markets outside the U.S. where the sugary drinks or the sodas aren't still, are doing OK or they're still seeing some decent volume growth.