Three of Coca-Cola's (NYSE:KO) bottlers -- Coca-Cola Enterprises (NYSE: CCE), Coca-Cola Iberian Partners, and Coca-Cola Erfrischungsgetränke (Germany) -- recently agreed to merge their operations into a new Western European bottling company called Coca-Cola European Partners.

The new company will become the largest independent Coke bottler in the world, and is expected to generate $12.6 billion in annual revenue and $2.1 billion in EBITDA. It will operate over 50 bottling plants across 13 countries, and serve over 300 million consumers. Since the three bottlers have overlapping operations, the elimination of various redundancies could generate pre-tax savings of about $350 million to $375 million over the next three years. The deal is also structured as a tax inversion, which lets Coca-Cola Enterprises reduce its exposure to U.S. taxes by relocating its headquarters from Atlanta to London

Coca-Cola will own 18% of Coca-Cola European Partners' new shares, which will be reported under its "Bottling Investments" division. Coca-Cola Enterprises investors will receive a single share of Coca-Cola European Partners and a one-time cash payment of $14.50 per share. Let's take a closer look at this massive merger, and how it could help Coca-Cola cut costs in the near future.

Source: Coca-Cola.

Why bottlers matter
Coca-Cola sells its beverage concentrate and syrup to their licensed bottlers. The bottlers then add water and other ingredients, then sell the drinks in cans and bottles. Back in the 1980s, Coca-Cola bought up many of those bottlers to gain tighter control over supply chain costs. But since the businesses were more capital-intensive than making and selling concentrate, Coca-Cola eventually spun off some of its bottling operations to numerous "anchor" bottlers, like Coca-Cola Enterprises, across the world.

But in 2010, Coca-Cola increased its exposure to bottlers again by buying Coca-Cola Enterprises' North American operations in a $12.3 billion deal. Coca-Cola did this to exercise tighter control of packaging options and reduce supply chain costs across North America, where sales volume of soft drinks had declined annually since 2005.

Source: Pixabay.

Over the past two years, Coca-Cola changed course again and started refranchising its bottling operations to independent bottlers. It now aims to hand two-thirds of its North American bottling operations back to franchisees by 2017, up from about a quarter today. This can help Coca-Cola boost sales in certain regions by handing over more control to regional bottlers, which have a clearer understanding of local tastes, demand, and marketing strategies.

This is a delicate balancing act for Coca-Cola. When it wants to exercise more control over the supply chain but doesn't mind increasing capital expenditures, it buys up bottlers. When it wants to lower capital expenditures and give bottlers more freedom to apply different strategies worldwide, it refranchises them. 

How does this help Coca-Cola?
Placing more control of the business in the hands of regional bottlers can help Coca-Cola respond more quickly to changing consumer tastes in certain countries. The consolidation of multiple bottlers across large regions like Europe would also increase efficiency across the supply chains, sales, and distribution channels.

Since large independent bottlers can operate more efficiently than dozens of smaller ones scattered across a region, Coca-Cola has been pushing regional bottlers to consolidate their operations with other bottlers.

Last year, SABMiller, the second-largest brewery in the world, combined its African bottling operations with bottler Coca-Cola Sabco to form a new bottler which now distributes 40% of all Coca-Cola sold in Africa by volume. That deal followed a wave of Coke bottling mergers across other countries, including Spain and Japan.

A step in the right direction
The consolidation of regional bottlers comes at a time when Coca-Cola is struggling to generate more profits per ounce as soda sales decline. Coca-Cola has tried to curb those declines with sales of more non-carbonated drinks and selling sodas in smaller cans.

In Europe, shipments of non-carbonated drinks rose 7% annually last quarter, but shipments of carbonated ones remained flat. Sales of concentrates to the region rose 2%, but net revenues and pre-tax income still respectively declined 9% and 7%. Therefore, a reduction of bottling expenses, optimizing distribution channels, and catering to regional tastes across Europe could strengthen those numbers. Improved efficiency at the bottlers will also strengthen Coca-Cola's Bottling Investments business, which reported a 6% decline in revenue and 9% drop in pre-tax income last quarter.

The key takeaway
Coca-Cola's recent moves to refranchise its bottlers and encourage consolidation will help it respond more quickly to regional challenges. This can help it cut costs and improve its net income, which rose 20% annually last quarter. That, in turn, will help ensure that Coca-Cola remains a "Dividend Aristocrat"-- a company which raised its dividend annually for the past 25 years.

Unfortunately, refranchising doesn't really solve Coca-Cola's core problem of weak demand for carbonated drinks, which still account for nearly 70% of its revenues. To address that issue, Coca-Cola must keep introducing more non-carbonated drinks or "healthier" sodas to diversify its product portfolio.

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