Coca-Cola (KO +0.96%) is adding Costa coffee to its broad empire, and with the deal comes retail stores, a vending machine business, and significant production capacity for hot beverages.
In this Industry Focus segment, the team covers what exactly Coke gets from the deal and how moving into coffee benefits the company. They also look at how the beverage giant can plug this product category into its existing portfolio.
A full transcript follows the video.
This video was recorded on Sept. 4, 2018.
Vincent Shen: On the last Consumer and Retail show, new Fool Nick Sciple and I talked about the upcoming Eventbrite IPO. We planned to follow up on that discussion today with coverage of one of its major competitors, Live Nation. We're going to put that episode on ice just until next week so that I can welcome Fool.com contributor Dan Kline into the studio. Always a pleasure when you're in town and you stop by Fool HQ, Dan!
Dan Kline: Hey, Vince! Thanks for having me!
Shen: Really great to see you! I know that you have Coca-Cola on your mind. They announced a big deal last week.
Kline: This was stunning. It's very rare we're surprised. Usually, we have a bunch of ideas mapped out -- if something by so-and-so. This one... while we knew this coffee company, Costa, was for sale, we did not have Coca-Cola on our radar as a purchaser.
Shen: It's been about, I was looking through my notes, two years at least since we really looked at Coca-Cola. Today, we're going to hone in on this $5 billion deal they did for Costa Coffee. Then we're also going to look at how the company has transformed in the past few years to close out. I'm going to start things off. To provide the context to our listeners, Coca-Cola's spending, with the conversion, $5.1 billion. This is going to be a push for them into coffee, hot beverages, also brick and mortar, which is something we're definitely going to talk about, because that's a first for Coke. What does the deal look like?
Kline: This is basically Coca-Cola saying, "What areas of the non-alcoholic beverage market do we not serve?" Coffee was a glaring hole. They would go into a business, let's call it a restaurant. And they would say to the restaurant, "We can serve you Coca-Cola products. We can serve you energy drinks and we can serve you iced teas. Whatever your mix is, we can meet it." And they'd go, "Oh, great. What's your coffee platform?" And they'd say, "We don't have a coffee platform." This lets them take a well-known brand in parts of the world, and they can bring that brand to the U.S., especially in situations where the brand isn't the selling point. It's really being able to meet the need. A restaurant generally might tell you they brew Starbucks coffee, but that's not usually a selling point in a nice steakhouse. It just says they have cappuccinos. This allows Coca-Cola to add that business. That's a huge opportunity for the company because it already has relationships across retail and restaurants and all these other spaces.
It also puts Coca-Cola into the retail business, as you mentioned. It's about 3,800 stores, with about 60% of them in England and the United Kingdom.
Shen: I'll stop you there, because we have a lot to talk about with that brick and mortar operation. I just want to add some context. It's a really good point -- they have this big opening with hot beverages, essentially, that the company doesn't really address quite as much, especially when it comes to coffee. We're looking at a category, when you look at global coffee and tea, that's particularly strong. That category has seen some of the stronger growth rates, I think 6% last year. This is a $500 billion market, at least.
Kline: And it's a hedge against declining soda sales. Coke has done some interesting things to shore up the Diet Coke business -- the skinny cans, the different flavors. But long-term trend says that market will probably continue to get smaller as healthier choices -- coffee is a growth market. It just makes sense.
Shen: Yeah. Addressable market for the company, in the presentation materials provided for this deal, takes it from something like $800 billion to $1.5 trillion. It's massive. And I'll stress that at the moment, Coke only operates in the ready-to-drink segment when it comes to coffee. Within that, it only has about 15% market share. If you look at the broad category, Coca-Cola is looking to jump from a 2% market share to the additional opportunities that we'll talk about with Costa Coffee.
The last thing that I wanted to mention, in terms of the seller, an interesting company. It's Whitbread, they're an English company. They're basically parting with this entire division to focus on their hotel and restaurant businesses. Crazy thing, we talk about Coca-Cola being this historic company, at least for the United States. Founded in 1892 or something like that. I saw that Whitbread was founded in 1742. Always puts things in perspective, being such a much older company. That tends to be the case for a lot of these European businesses.
There's going to be the standard shareholder and regulatory approvals that are required for a deal like this. Coca-Cola and Whitbread, they expect the deal to close in the first half of 2019. Coke's going to fund the transaction from the $20 billion of cash that they have on hand.
Before we look more at the strategy for how Coke is going to leverage the assets and the brand here, let's talk a little bit more specifically in terms of what the company's getting. Let's get into the brick and mortar apparatus that they have.
Kline: There's really four pillars to the business. There is a huge vending machine business. 8,200 Costa Express terminals. We were joking about this upstairs, that in the United States, coffee vending is like an old school, gross, hot chocolate and soup come out of the same spout. This is a very high-tech, like you would see at a tech company. Like, at Microsoft, there are coffee vending machines where you could dial up exactly what you want.
Shen: A good analogy within Coca-Cola, they have these freestyle vending machines, right? This is like the coffee equivalent.
Kline: It's very much a coffee version of the freestyle machine, where you get the barista-led flavors. And you do see these at some convenience stores. You could get the real barista experience from a machine where you're pushing the buttons. That is a much bigger thing in the rest of the world than it is in the United States. But it is a huge opportunity.
They're also getting the coffee bean business, which is literally the ability to go to a restaurant and sell them not-ready-to-drink beverages. You're buying the beans, you're brewing them. Maybe you're intentionally differentiating yourself from having Starbucks or one of the other brands. They're also getting 3,800 retail stores in 32 countries. About half of those are franchised, and half of those are company-owned.
They are also getting a huge loyalty program, which is actually something Coke also doesn't have any real experience in. You're generally not buying Coca-Cola from Coke. There's no program where, if I drink a 12 pack every day, I get a free stuffed teddy bear or whatever.
Shen: They sometimes have those contests where, you'd look under the cap --
Kline: They generally have to do that stuff with their partners. Now, they'll have the ability to not just have a direct relationship with a certain percentage of consumers. They also have 3,800 stores that they can test products in, or that they can run a promotion or see if people want different things. It's a really different business for them.
They're taking on about 16,000 employees. They're just getting entry to something that they didn't do, that they have all the apparatus in place to sell.
