What should investors think about the possibility of a merger between the beverage giant Pepsi (NASDAQ:PEP) and its more nimble challenger, SodaStream (NASDAQ:SODA)? A variety of Foolish contributors have debated the merits of such a tie-up, with some bullish on the prospect and others bearish. I fell in the latter camp when I published an article a year ago suggesting SodaStream has the tools to succeed as a stand-alone entity -- without Pepsi or its long-standing rival Coca-Cola (NYSE:KO).
But after Pepsi and SodaStream's recent test partnership, I'm starting to reconsider. Here's why I wouldn't write off a buyout just yet.
SodaStream and Pepsi's rocky start
A few months ago, SodaStream and Pepsi announced they would join forces to test a limited number of new Pepsi flavors in SodaStream machines. It was a trial-and-error experiment relegated to some markets in Florida, and neither company expressed any larger ambitions. Still, investors and beverage industry insiders were intrigued.
By December, however, it looked like the trial could prove to be a flop -- at least from the perspective of PepsiCo's CEO Indra Nooyi. Her reviews on the flavor profile of Pepsi's "Homemade" products weren't exactly glowing at a Beverage Digest conference:
The original Pepsi, the original Sierra Mist, they are all great tasting products. When I go to make my own it is very hard to replicate the taste.
She went on to say that the actual brewing process was too cumbersome when the end product was a subpar soda: "People taste the product at home and say it doesn't taste as good as Pepsi ... and [it] takes too long."
While these uninspiring remarks are a legitimate cause for concern, we probably shouldn't jump to conclusions about the overall partnership. For one, both companies are set to report earnings later this month, and each will elaborate more on how things are progressing. And, even if there's a flavor failure with Homemade Pepsi, that's not to say the two companies can't find some common ground.
Pepsi starts singing the same tune
As it turns out, the lackluster reception of these flavor capsules could steer both Pepsi and SodaStream in a similar direction. First off, Pepsi's obviously interested in countertop soda machines since it's pursuing a variety of technologies in this category, including the Bevyz drink maker. But SodaStream is -- to my knowledge -- the only one Pepsi is actively conducting consumer tests with.
This is crucial because Pepsi realizes it needs to offer an alternative to Keurig's (UNKNOWN:GMCR.DL) upcoming Keurig Cold product launch. Pepsi's other cola counterpart, Dr Pepper Snapple (NYSE:KDP), has also joined forces on that much-hyped machine.
At the same time, Nooyi shared some thoughts on her vision of the future of soda, and they dovetail with SodaStream's new strategy. As traditional soda products continue a decade-long decline, customers are looking for something different and more natural than syrupy sodas.
Pepsi seems keen on trying its hand in the craft soda movement, for example, but it also sees opportunity in making healthier, less heavily sweetened beverages. Nooyi put it this way in her conference presentation: "Health and wellness was fashionable to talk about three to five years ago and today has become very mainstream." Last year, she called Pepsi's gradual transition a move from purely "fun-filled" to "good-for-you" products.
Health and wellness, meanwhile, has become the focal point of SodaStream's revamped marketing effort. In a recent partnership with celebrity chef Paul Liebrandt, SodaStream is creating "Sparkling Gourmet" flavors like blackcurrant lime, raspberry lychee rose, and green apple coriander that it hopes will spark interest thanks to an overall healthier profile. The nutritional information on these products has not been disclosed, but SodaStream attests they are "low-calorie" and "all-natural."
With this move, SodaStream is repositioning from a mass-market audience to what it calls "opinion-leader" consumers. In other words, it's trying to make sparkling water seem innovative and cool.
Whether this will work is yet to be seen. Nooyi, however, agrees that the soda category needs a breath of fresh fizz. From her perspective atop one of the world's largest food and beverage companies, traditional soda has lost its "cool factor," and it will take a unique twist on cola to recapture that allure.
What if water pops?
Breathing new life into water could also do the trick. SodaStream's actually working hard to distance itself from soda in the minds of consumers. The more it connects the brand to water, the less consumers associate its product with the struggling mainstream soda market.
But if flavored sparkling water does become the next big thing in beverages, how will SodaStream plan to make the leap from a high-end niche market to mainstream, especially as it pulls its less upscale machines from everyday stores like Macy's?
Meanwhile, I wouldn't expect Pepsi to miss the sparkling water trend, as it is admittedly "rolling the dice on a lot of new ideas right now." Could one of those ideas include a buyout of SodaStream?
Their budding relationship, similar health-centric agenda, and desire to differentiate from Keurig and Coke could pave the way to a more integrated strategy. Not to mention that SodaStream's stock slump puts the company's market cap ($415 million) at less than one-fourth the size of a single quarter's earnings ($2 billion) for Pepsi. Behind the scenes, I wouldn't be surprised if Pepsi and SodaStream are crafting something bigger than a new beverage syrup.