Coca-Cola Strikes First in Next Round of the Soda Wars

For years, the soft drink market has been highly competitive but not terribly innovative. Coca-Cola (KO 0.31%) and PepsiCo (PEP -0.41%) have dominated the global soda market, while smaller companies such as Dr Pepper Snapple (DPS) and Monster Beverage have much smaller market share. 

This relatively static competitive environment saw the first signs of disruption when SodaStream International (SODA) successfully rolled out its home soda carbonation system. Whether it was the three dimensional advertising (shown below) that resulted in a lawsuit from Coca-Cola or the commercial featuring Scarlett Johansson during the most recent Super Bowl, SodaStream certainly caught the attention of Coca-Cola.

Source: SodaStream via Forbes

Coca-Cola and Green Mountain partner on Karbon
SodaStream's success around the world made it clear that home soda carbonation is not a fad. This week, Coca-Cola officially legitimized in-home carbonation by entering into a strategic partnership with Green Mountain Coffee Roasters (GMCR.DL). Green Mountain, which is best known for its single-serve Keurig coffee makers, has trademarked the name "Karbon" for a line of home carbonation appliances that it intends to launch in the next couple of years.

As part of the partnership, Coca-Cola will invest $1.25 billion for a 10% ownership stake in Green Mountain and a will create a 10-year relationship during which Green Mountain will be the "exclusive partner for the production and sale of The Coca-Cola Company-branded single-serve, pod-based cold beverages." 

This deal is a game changer for the entire industry and a win-win for both Coca-Cola and Green Mountain. The power of Coca-Cola's brand, the third most valuable in the world according to Forbes, instantly makes Karbon a front-runner in home soda making even without any known details regarding price, features, and technology.

The end for SodaStream?
SodaStream's revenue of $528 million over the past year is dwarfed by Coca-Cola's revenue of $47 billion. So, the sudden reality that a market giant like Coca-Cola is partnering with a competitor presents a significant risk for investors to monitor.

However, it isn't time to write SodaStream off just yet. Shares actually rose the day following the Coca-Cola and Green Mountain announcement. Aside from decisively putting an end to the argument that home carbonation is a fad, this deal highlights the attractiveness of SodaStream in a number of ways.

SodaStream is a well-established and profitable business with a significant network of distributors already in place. In contrast, the Karbon is not expected to be rolled out for at least a year. This first-mover advantage provides a significant competitive edge to SodaStream; the company's products are selling while Karbon is still in the process of being designed.

Additionally, a large base of loyal SodaStream users will continue to prefer SodaStream's healthier flavors, the option to make larger batches of soda, and the ease of making sparkling water. All signs point to SodaStream continuing to have this differentiation compared to Karbon, since it is unlikely that Coca-Cola would alter its recipes to lower sodium, eliminate aspartame, or use natural sweeteners.

Pepsi's response
Coca-Cola's move to partner with Green Mountain forces the remaining players in the soft drink industry to react quickly. Given SodaStream's well-established business, the company is the most logical option for Pepsi. A market capitalization of just $800 million makes SodaStream an affordable acquisition target for Pepsi as a response to Coca-Cola's agreement. Rumors of a Pepsi acquisition of SodaStream swirled around the market last year, but now there is far more reason for Pepsi to pursue the company than ever before. With no known competitive alternative in the pipeline, Pepsi will be highly motivated to respond.

Be a pepper?
While most investors are immediately jumping to the conclusion that Pepsi and SodaStream will join forces to combat Coca-Cola and Green Mountain, there are other alternatives. For example, this situation presents an excellent opportunity for one of the smaller beverage companies like Dr Pepper Snapple to make a move. With a market capitalization of almost $10 billion and a manageable $2.5 billion in debt, Dr Pepper has a capital structure that is sufficiently large and flexible to make a move. 

Alternatively, a partnership between SodaStream and Dr Pepper Snapple would create a complete array of soda flavors that would compliment SodaStream's existing partnerships with brands including Ocean Spray, Crystal Light, Country Time, and Kool Aid.

Watch the story unfold
At this point, all that is really known is that Coca-Cola and Green Mountain are going to partner to leverage Coca-Cola's brand to ensure that home carbonation is here to stay. How this impacts Pepsi, SodaStream, Dr Pepper Snapple, and others is yet to be seen. It is unlikely that there will be just one winner in the transition to home soda making, but it is also unlikely that every competitor will be able to launch and maintain a successful home carbonation platform.

Investors must stay tuned over the next few months for additional developments that will help predict how this latest iteration of the soda wars will play out.