Coca Cola bottle caps
Critics say the deal will dilute existing shareholders

Company lore has it that the two Chattanooga businessmen who took Coca-Cola from soda fountains in drugstores to lumberjacks on the banks of the Mississippi paid just $1 for the rights to do so in 1899. From that move sprang a global $70bn-plus bottling empire that sells nearly 2bn servings every day.

The Coca-Cola model splits ownership of the brand and concentrate from capital-intensive bottling and logistics, by far the bulk of which is handled by independent franchises. The system is a product of history but endures “because it works”, says Steve Powers, analyst at Bernstein Research. It works for Coca-Cola by handing it the superior margins that come with an asset-lite model, while giving it control over the bottlers.

Now the two sides of the so-called Coca-Cola system are tightening their bonds, through greater co-ordination and consolidation of the sprawling bottling empire.

Muhtar Kent, himself from a bottling background, began his reign at the helm of Coca-Cola by touring the bottlers and launching a medium-term plan that targets a doubling of revenues for the overall system to $200bn by 2020.

But it is a delicate balancing act. Bottlers revolted in the 1990s, when the prices charged by Coca-Cola eroded their profitability and returns. Ian Shackleton, analyst at Nomura, estimates that returns on invested capital subsequently doubled to about 10-11 per cent now.

Scale would further improve financial metrics, prompting Coca-Cola to help orchestrate the merger of eight Spanish and Portuguese bottlers – and of four in Japan, three in Brazil, and the sale of a controlling stake of the Philippines bottler. Together, these deals represent revenues of some $15bn, according to calculations by Nomura, and more consolidation is expected to follow.

According to one banker, there is “zero chance” of the current landscape in Western Europe – dominated by four big bottlers, including the Spanish operation, Coca-Cola Enterprises in France and the UK, and Coca-Cola Hellenic, which operates in Eastern and Southern Europe – looking the same in 10 years’ time.

“Fewer but bigger anchor bottlers are more efficient and can afford to pay more for their concentrate,” he says. “At the end of the day, it’s all about how the company can make money, and they think cost-effective bottlers can afford to pay them more.”

Equally, splitting off the bulk of its bottling makes life “pretty good” for Coca-Cola, says Mr Powers: “They keep all the fixed assets off their books, so when it’s working well it delivers great margins and returns on invested capital.”

He calculates that operating margins on the pure Coca-Cola concentrate and branding business exceed 40 per cent. However, the company also owns Bottling Investments Group, dubbed “the hospital ward” by outsiders, who describe it as the place where ailing bottlers are spruced up before being sold on again.

Highlighting that role, BIG margins last year were below 2 per cent, compared with approaching 60 per cent for Coca-Cola’s Latin American and European businesses, which have minimal bottling operations. That brought Coca-Cola’s overall company margins down to 22.5 per cent.

The odds remain skewed at system level, with bottlers providing the majority of revenues but garnering a smaller slice of the profit pool.

Observers are divided on the extent to which that will change as Coca-Cola tightens its bonds with bottlers and moves to consolidate its 275-strong bottling empire into fewer but bigger operators.

The recent mergers, and more modest portfolio tweaks at rival PepsiCo in China “signal a new wave of refranchising . . . as both companies look to shift bottling assets to strong franchise partners,” according to Rabobank analyst Ross Colbert.

Mr Colbert sees this shift as enabling the beverage companies to focus efforts on brand-building and marketing, especially in areas other than carbonated soft drinks, which are slowing.

Dimitris Lois, chief executive of Coca-Cola Hellenic, the second-biggest independent bottler, says Europe’s economic woes are driving change. He says his own company’s relationship with Coca-Cola has been evolving since 2007 to be “far closer”.

“I believe the external environment, especially in the territories we have been involved with, [including Greece, Italy and Ireland] facilitate getting more together. The consumer environment was far more friendly then; after 2008 that changed quite a bit as disposable income fell and unemployment rose,” he says.

“So this new environment helped us and [Coca-Cola] move to the next step: a far more evident collaborative approach. We are 100 per cent in the collaborative era.”

Coke’s franchise system, with roots going back to the 19th century, is in no danger of being consigned to history. As Mr Kent told investors last month: “It is a beautiful system when you can get it to work, as we have.”

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