Coke Adds Coffee to Its Drinks Mix in $5.1 Billion Deal

Soda giant to buy U.K.-based Costa coffee chain and plans to roll out its cappuccino vending machines

Coca-Cola Co. KO -0.01% made the largest brand acquisition in its history, saying Friday that it would pay $5.1 billion for British coffee-shop chain Costa as the soda giant moves further from its soft-drink roots and joins a growing group of consumer-goods companies that are betting big on coffee.

The deal gives Coke a large brick-and-mortar retail presence and puts it in direct competition with Starbucks Corp. , which has more than 27,000 cafes around the globe. Costa serves its red-and-white cups of coffee through its roughly 3,800 cafes, including about 2,500 in the U.K. and a growing presence in China. Founded in London in 1971, Costa also sells coffee in grocery stores and gas stations.

Some analysts questioned the rationale for paying what they said was such a steep price for Costa given that it is so heavily concentrated in the U.K. and little-known in many other big markets. They also questioned why Coke would enter the crowded world of physical retail, where it has no experience.

In an interview, Coca-Cola CEO James Quincey said the transaction was a bet on the fast-growing and still fragmented global coffee business. This is a coffee strategy, not a retail strategy, said Mr. Quincey, a Briton who took over as Cokes CEO in May 2017.

Mr. Quincey said Coke has no current plans to open Costa coffee shops in the U.S., but the company will bring Costa coffee vending machines and beans to U.S. gas stations, college campuses and quick-service restaurants.

The CEO acknowledged that expanding into retail would pose a challenge for the beverage manufacturer, which currently relies on distributors, grocers and restaurants to sell its drinks. Retail is clearly not our expertise, he said, adding that Coke would keep Costas retail management team in place.

Consumers continue to want to spend more money on beverages, Mr. Quincey said. They just want greater diversity including coffee in its various formats.

Coke and its soda rivals have been searching for growth as consumers shift away from sugary soft drinks. PepsiCo Inc. in August agreed to buy seltzer-machine maker SodaStreamInternational Ltd. for $3.2 billion. Smaller rival Dr Pepper Snapple merged this summer with Keurig, the coffee company that popularized single-serve K-cups.

Coke already sells Dunkin Donuts bottled coffee in the U.S. and a ready-to-drink coffee brand called Georgia that is popular in Japan, but Mr. Quincey said the company was missing out on the much larger hot-coffee market. In a conference call Friday, he said Coke plans to expand Costas network of cafes in developing markets including China and use Costas self-serve vending machines, which grind beans and steam milk, to sell hot drinks around the world. It also will sell Costa-branded bottled drinks and coffee beans. Rival PepsiCo has a longstanding partnership with Starbucks to sell its ready-to-drink beverages.

Coffee has recently been a hot industry for deal making. Nestl SA this year bought the rights to sell Starbucks in grocery and retail stores for more than $7 billion. JAB Holding Co., a European holding company, has also moved aggressively to buy up coffee assets.

Coke is buying Costa from British leisure groupWhitbread PLC, which also owns the Premier Inn hotel brand in the U.K. and Germany. The company, which first flagged a possible Costa spinoff in April, said it would return most of the money to its shareholders. Its shares closed up nearly 15% on Friday.

Whitbread had been pressured by activist investors to split with its coffee business. Coke approached the company about a potential acquisition in June, executives said.

Whitbread Chief Executive Alison Brittain said that Coke wasnt the only interested party, but suggested that the U.S. drinks giants global reach allowed it to offer the most attractive deal. The agreement, expected to be completed in the first half of 2019, was signed just eight minutes before it was announced early Friday.

Costa generated revenue of 1.3 billion ($1.69 billion) in the year ended March 1 and earnings before interest, taxes, depreciation and amortization of 238 million. About 72% of its revenue came from its U.K. stores, according to a Coke presentation. By comparison, Starbucks had $22.4 billion in revenue in its last fiscal year and Coca-Cola had $35.4 billion.

Costa same-store sales have been flat, though overall sales have continued to grow as the company added outlets, including overseas, and expanded its express-coffee-machine network. Some of the sales through those machines there are more than 7,000 in the U.K.have cannibalized business from existing outlets, Ms. Brittain said on a conference call.

Costa has more locations in the U.K. than Starbucks but the brand is little known in North or South America, where Starbucks has more than 16,000 locations. Costas biggest international market is China, where it has about 450 stores, but there too it is dwarfed by Starbucks approximately 3,000 locations.

Costas presence in China presents a growth opportunity for Coke, GlobalData analyst Jonathan Davison said. Hot-drinks-sales volume has more than doubled in volume there over the past five years, said Mr. Davison, who estimates the Chinese retail hot-drinks market will reach $34 billion by 2022.

Coke said it expects the deal to add slightly to its earnings the following year. The company said it wasnt changing its long-term financial targets.

When Mr. Quincey took over Coke from longtime leader Muhtar Kent, he pledged to speed the development of products beyond its namesake cola brand. The companys revenue has declined for several years, as it shed bottling operations and battled slowing soda volumes.

Cokes biggest brand acquisition until now was its $4.1 billion purchase in 2007 of Glaceau, the company behind the vitaminwater and smartwater brands. The company has struck smaller deals since Mr. Quincey took over, including buying Mexican seltzer maker Topo Chico and taking a stake in BodyArmor, a Gatorade rival.

Coca-Cola shares fell 38 cents Friday to $44.57. The stock has slipped 2% over the past year, missing out on a broad stock-market rally that has lifted the S&P 500 Index more than 17% to record highs.

Questions

1. Identify and briefly outline THREE (3) factors that would contribute to Cokes decision to acquire a different line of product other than in the carbonated beverage product line. 6 points

2. Briefly explain TWO (2) possible reasons why Coke would enter the crowded world of physical retail, where it has no experience. 4 points

3. Briefly explain ONE advantage and ONE disadvantage to Coke having a distribution strategy as opposed to a retail strategy 4 points

4. Identify and briefly explain THREE (3) benefits that the acquisition of Costa by Coke would have on the Costa coffee brand. 6 points

5. Identify TWO (2) concerns that you have regarding Cokes acquisition of Costa and propose ONE (1) recommendation on how Coke may address EACH concern.