Should Investors Be Wary of the New Keurig Dr Pepper?

Keurig's merger with Dr. Pepper Snapple (DPS) surprised much of the business world, because on the surface, the deal appears to offer limited benefits. The two companies will gain $600 million in annual cost-savings (an optimistic projection), but what else do they gain from coming together?

In this video, Vincent Shen and Motley Fool contributor Daniel B. Kline consider how each company might help the other. They also talk about why being public might benefit Keurig and whether there are more moves ahead for JAB Holding Company, which will own a controlling stake in the new Keurig Dr Pepper.

A full transcript follows the video.

This video was recorded on Jan. 30, 2018.

Vincent Shen: Alright, Dan, we're peeling back some layers now on this deal. I'll first pose this question to you, and that is: Why? Why Dr Pepper Snapple? Do you feel like the hot and cold, soda and coffee combination makes sense?

Dan Kline: If you ignore the fact that it's a public company where only 13% of it is actually going to be traded, you can say, alright, there's some distribution benefit here. Keurig is in every grocery store. Obviously, some of the top Dr Pepper Snapple brands are, but maybe Bai isn't carried. Then, when you look at convenience stores, there's obviously a very strong Dr Pepper Snapple area, where maybe there's some room for Keurig products. There's absolutely a ready-to-drink component here, where you look at some of the Keurig brands and really some more of the JAB brands like Peet's and Caribou, where you could go into a convenience store and compete with Dunkin' Donuts and Starbucks. So there's some small benefits, like in, hey, I know who to call at this company. But I don't see a real reason to do this.

Shen: If I boil that down, you're saying distribution capabilities, more so on the Dr Pepper Snapple side. And Keurig is undoubtedly the leader in terms of that single serve coffee space with the machines and their pods. And in the presentation, they tout having a more established footprint in e-commerce and other less traditional retail partners.

Kline: Keurig is very good at e-commerce. But are you going to buy a Dr Pepper online?

Shen: That what it comes down to. I feel like this is an odd combination in that Dr Pepper Snapple is still dealing with declining popularity of their sodas. They've been late to the game in terms of adopting the more health-focused strategy with their Bai acquisition, for example, when their bigger competitors, Coke and Pepsi, have been on that and spending heavily in that space already for some time now.

Keurig has improved its financial and operational standing in the two years since it's gone private. Management actually shared some details about the progress that they've made since going private under JAB. Pod volume is up 3%, but revenue is down 3%. But in terms of their operations, they've certainly been streamlined. Profitability is up, their operating margin, I think they mentioned, is up 7 percentage points, so pretty significant. But these are not high-growth businesses, as far as I can tell. And I'm curious and struggling to see how they power each other for shareholders.

Kline: Also, it didn't open up any new markets. There's some Dr Pepper strength in Mexico, so maybe Keurig could expand a little bit into there. But, I could see if Keurig bought something that gave it access to Europe, where it has almost zero market share. Same thing with Dr Pepper Snapple, those brands have very little --

Shen: Yeah, they're both very U.S. and North America-focused businesses.

Kline: Yeah. So you look at this, and either the goal of this is just about creating a public company, which gives them more flexibility going forward, or there's another shoe that's eventually going to drop. If you look at what JAB has been doing, this is not a short-term strategy. They didn't accidentally find themselves owning 35 different coffee companies.

Shen: [laughs] Yes.

Kline: They clearly have a long-range vision, and their coffee brands are global. So there might be something else. Maybe Nestle's coffee business. Who knows what it might be. But, there's obviously, or very likely, something else to come. And being public gives them more flexibility when it comes to buying a bigger company.

Shen: And management mentioned that the penetration in the U.S. of the brewers is up 3 percentage points from 17% to 20% in the U.S., and they see the ultimate end target and potential for that penetration level to be much higher, as much as two or even three times higher.

Kline: You know I vehemently disagree with this.

Shen: Yes.

Kline: Keurig is a mature product. There was a point, and I'm sure you remember it, where if a friend got a Keurig, you went to his house, like, it was awesome. Now, everyone has a Keurig. A lot of them are with the Crock-Pot under the counter. I know you and I both have Keurigs, but I have two of them, they're both in cabinets, I never use them, I go out for coffee.

Yes, there's market share to gain. They can go from 20% to 23%, maybe to 25%. Are they really going to go to 40% or 60%? It seems preposterous to me. And those numbers are based on the European market. But the difference is, there are different coffee traditions in different countries. And Keurig introduced the idea of a fussier but also convenient coffee at home here. We've seen Nespresso and Starbucks try to give you a better product, and it hasn't worked, so I just don't see that there's a huge group of Americans to be tapped that still don't know what Keurig is.