Coca-Cola's (NYSE:KO) partnership with Keurig Green Mountain (UNKNOWN:GMCR.DL) sent the latter's stock price soaring. Within days of the the announcement, Coca-Cola's $1.25 billion investment in 16.7 million Keurig shares carried a market value of $2 billion. The market now values Keurig's operations at over $14.5 billion, a sign that many participants believe the company has enormous growth potential.
Coca-Cola's large investment in Keurig indicates that it, too, believes in Keurig's potential. However, Coca-Cola shareholders should not clamor for an acquisition of the company's at-home beverage partner; a Keurig acquisition would almost certainly destroy Coca-Cola shareholders' value. Here's why you should consider selling your Coca-Cola stock if the company buys Keurig.
A limited time frame
Unlike most of its smaller acquisitions, Coca-Cola only has a limited time to act on a Keurig acquisition. The latter's growing market valuation could soon make the company too expensive for Coca-Cola to acquire. Paying a 20% premium to Keurig's $14.5 billion enterprise value would cost $17.4 billion, or $15.7 billion for the remaining 90%; this would be a huge acquisition, even for Coca-Cola. By comparison, self-proclaimed elephant hunter Warren Buffett has only made three acquisitions larger than $15.7 billion -- and one was the leveraged buyout of Heinz in which Buffett invested only $12 billion (the rest was financed by 3G Capital.) If even Buffett, who is actively looking for large acquisitions, rarely makes an acquisition the size of Keurig, a higher valuation would likely push the coffee company out of Coca-Cola's buying window.
In 2012, Coca-Cola was rumored to consider an acquisition of Monster Beverage (NASDAQ:MNST). In what would have been a $13 billion to $15 billion takeout price, the Monster deal would have been the largest acquisition in Coca-Cola's history. However, the deal fell apart because the price was too high. Coca-Cola's largest acquisition to date was its 2007 acquisition of Vitaminwater for $4.2 billion.
Coca-Cola has $17.1 billion in cash and short-term investments, but with $90 billion in total assets, the company needs to keep several billion dollars on hand for emergencies and investments. Coca-Cola also generates about $8 billion in free cash flow each year. Although a $15.7 billion acquisition is feasible, it would stretch Coca-Cola's balance sheet to the limit. A larger acquisition would have to be written off as too large.
Why the acquisition could only be a disaster
Keurig's fate rests in the success of two brewers that have yet to hit the market: Keurig 2.0 and Keurig Cold. Both are scheduled to launch within the next year or two. If the launches are successful, Keurig's stock price will soar, making the company too expensive for Coca-Cola to acquire. On the other hand, if the launches are not successful, acquiring the company may be unattractive.
So, Coca-Cola must decide now -- before any tangible proof of success exists -- whether or not it wants to acquire Keurig. That's why Coca-Cola shareholders should shudder at the thought of a full acquisition. A $15.7 billion acquisition would expand Coca-Cola's asset base by over 16% for a speculative bet on the success of two products that have yet to hit the market. A more expensive investment in several years of a thriving Keurig would be too large for Coca-Cola's balance sheet to absorb. Even if it used stock to acquire the company, Keurig's growth would likely excite the market enough that Coca-Cola would be forced to pay a substantial premium to a lofty stock price. None of these options are likely to create value for Coca-Cola's shareholders.
Keurig may find new life in Keurig 2.0 and Keurig Cold or the new systems may flop. Nobody will know the answer until the products have been on the market for many months. Keurig's reliance on two unproven systems is why Coca-Cola should not acquire the rest of the company now -- and why it may never get the chance. If the new systems are successful, Keurig will become too expensive for Coca-Cola to acquire. Instead, Coca-Cola shareholders should hope to participate in Keurig's success through Coca-Cola's existing stake in the company. If Coca-Cola decides to acquire Keurig, Coca-Cola shareholders should consider selling their shares.