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Coca Cola (NYSE: KO) adds Costa coffee to its vast empire, and with this agreement, retail stores, a vending machine company and a large capacity of hot drinks production.
In this Home of the industry segment, the team covers exactly what Coke gets from the transaction and how the move to coffee profits the company. They are also examining how the beverage giant can plug this product category into its existing portfolio.
A full transcript follows the video.
This video was recorded on September 4, 2018.
Vincent Shen: The last Consumer and Retail show, new fool Nick Sciple and I talked about the next Eventbrite IPO. We planned to follow up this discussion today with the coverage of one of its major competitors, Live Nation. We will put this episode on the ice until next week so that I can welcome Dan's Fool.com contributor Dan Kline into the studio. Always a pleasure when you are in town and you stop at the headquarters of fools, Dan!
Dan Kline: Hey, Vince! Thank you for having me!
Shen: Really great to see you! I know you have Coca-Cola in mind. They announced a big deal last week.
Kline: It was beautiful. It is very rare that we are surprised. Usually, we have a bunch of ideas drawn – if something by such. This one … while we knew that this coffee company, Costa, was for sale, we did not have Coca-Cola as buyer.
Shen: It's been about two years since I really look at Coca-Cola. Today, we are going to look into this $ 5 billion deal that they concluded for Costa Coffee. Then we will also examine how the business has changed in recent years. I will start things. To provide context to our listeners, Coca-Cola's expenses, along with the conversion, of $ 5.1 billion. This will push them to coffee, hot drinks, brick and mortar, which we will certainly be talking about, because this is a first for Coca-Cola. What does the agreement look like?
Kline: It's basically Coca-Cola, which says, "Which sectors of the soft drink market are not used? The coffee was a blatant hole. They would go to a business, let's call it a restaurant. And they would say at the restaurant: "We can serve you Coca-Cola products, we can serve you with energy drinks and we can serve you iced teas, and whatever your mix, we can satisfy it." And they were going, "Oh, awesome, what's your coffee platform?" And they said, "We do not have a coffee platform." This allows them to take a well-known brand in some parts of the world, and they can bring that brand to the United States, especially in situations where the brand is not the selling point. It's really able to meet the need. A restaurant can usually tell you that they are preparing Starbucks coffee, but this is not usually a sales pitch in a good steakhouse. It simply says that they have cappuccinos. This allows Coca-Cola to add this activity. This is a huge opportunity for the company as it already has relationships across retail and restaurants and all these other spaces.
Coca-Cola is also part of the retail business, as you mentioned. There are approximately 3,800 stores, about 60% of which are in England and the United Kingdom.
Shen: I stop you here, because we have a lot to discuss with this brick and mortar operation. I just want to add a little context. This is a very good point: they have this big opening with hot drinks, basically, that the company does not really attack that much, especially with regards to the coffee. We are looking at a category, particularly that of world coffee and tea. I think this category has had some of the highest growth rates, I think 6% last year. It's a $ 500 billion market at least.
Kline: And it's a hedge against the decline in soda sales. Coke did some interesting things to consolidate the Diet Coke business: thin cans, different flavors. But the long-term trend indicates that the market will likely continue to be smaller than healthier choices – coffee is a growing market. It's just logical.
Shen: Yeah. The addressable market for the company, in the presentation documents provided for this agreement, goes from about $ 800 billion to $ 1.5 trillion. It's huge. And I'll insist on the fact that right now, Coke only operates in the ready-to-drink segment in coffee. In this context, it only has about 15% of market share. If you look at the broad category, Coca-Cola is looking to go from a 2% market share to the additional opportunities we will be discussing with Costa Coffee.
The last thing I wanted to mention, in terms of the seller, an interesting company. His Whitbreadthey are an English company. They essentially separate themselves from this whole division to focus on their hotel and restaurant activities. What's crazy is that Coca-Cola is this historic venture, at least for the United States. Founded in 1892 or something like that. I saw that Whitbread was founded in 1742. She always puts things in perspective, being a much older company. This tends to be the case for many of these European companies.
There will be the standard shareholder and regulatory approvals that are required for a market like this. Coca-Cola and Whitbread, they expect that the transaction will be concluded in the first half of 2019. Coke will finance the transaction from the $ 20 billion of cash they have.
Before we look more closely at the strategy used by Coke to exploit the strengths and the brand, let's talk a little more specifically about what the company gets. Let's go into the brick and mortar appliance they've got.
Kline: There are really four pillars in the business. There is a huge area of vending machines. 8,200 Costa Express terminals. We joked about it in the United States, in the United States, the sale of coffee is like an old school, hot chocolate and coarse soup come out of the same beak. It's an advanced technology, as you'll see in a technology company. Like, to MicrosoftThere are coffee vending machines where you can compose exactly what you want.
Shen: A good analogy within Coca-Cola is these automatic freestyle vending machines, right? It's like the equivalent of coffee.
Kline: It's a coffee version of the freestyle machine, where you get the barista flavors. And you see them in some convenience stores. You can get the actual barista experience from a machine where you press the buttons. It's much more important in the rest of the world than in the United States. But it's a huge opportunity.
They also get the trade of coffee beans, which is literally the ability to go to a restaurant and sell them drinks that are not ready to drink. You buy the beans, you prepare them. Maybe you intentionally differentiate yourself from having Starbucks or one of the other brands. They also receive 3,800 retail stores in 32 countries. About half of them are franchisees and half of them belong to corporations.
They also get a huge loyalty program, which is actually something that Coke does not really have experience with. In general, you do not buy Coca-Cola from Coke. There is no program where, if I drink a pack of 12 each day, I get a free stuffed teddy bear or whatever.
Shen: They sometimes have these competitions where, you would look under the cap –
Kline: They usually have to do these things with their partners. Now, they can not only have a direct relationship with a certain percentage of consumers. They also have 3,800 stores where they can test products or promote or see if people want different things. It's a really different affair for them.
They take about 16,000 employees. They only get into something that they have not done, that they have everything in place to sell.
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