LDN - Business

Coca-Cola takes plunge into coffee with $5.1 billion Costa deal

[August 31, 2018] By Kate Holton and Martinne Geller

(Reuters) - Coca-Cola Co <KO.N> has agreed to buy coffee chain Costa for $5.1 billion to extend its push into healthier drinks and take on the likes of Starbucks and Nestle in the booming global coffee market.

The purchase from Britain's Whitbread <WTB.L> of Costa's almost 4,000 outlets thrusts the world's biggest soda company into one of the few bright spots in the sluggish packaged food and drinks sector.

Paying about 1 billion pounds ($1.3 billion) more than some analysts had expected, Coke will use its distribution network to supercharge Costa's expansion as it chases current coffee chain market leader Starbucks <SBUX.O> and its almost 29,000 stores across 77 markets.

Beyond coffee shops, Coca-Cola CEO James Quincey, himself a Briton familiar with the UK brand, said Costa would provide an important growth platform ranging from beans to bottled drinks in what is one of the world's fastest-growing drink categories, growing around 6 percent a year. Coke sells Georgia coffee in Japan, but wanted a bigger platform.

"Coca-Cola doesn't have a broad, global portfolio in this growing category," Quincey said in a blog post https://www.coca-colacompany.com/stories/james-quincey-on-costa, highlighting Costa's retail footprint, roastery, supply chain and Costa Express vending system, which the company plans to expand.

But Coca-Cola will face a fight, as rivals are also bulking up in a fragmented market, keen to attract young people prepared to pay out for barista-made drinks and developing tastes for ever more exotic coffees.

Nestle <NESN.S>, the market leader in packaged coffee, for example, has sealed a $7 billion licensing deal for Starbucks' retail business, while Europe's billionaire Reimann clan has built the JAB empire spanning coffee brands such as Kenco, Douwe Egberts and soft-drink maker Dr Pepper Snapple.

Operating a retail chain marks a new challenge for 132-year-old Atlanta-based Coca-Cola, which mostly sells soft drink concentrates to a network of franchised bottlers.

Other packaged goods firms with restaurant footprints include Nestle, with its stake in upscale coffee chain Blue Bottle, and Unilever <UNc.AS> with gelato chain Grom.

In the key U.S. market, an expansion of Costa shops into the country would be a threat for Starbucks, McDonalds <MCD.N> and JAB, which owns a string of chains including Peet's and Caribou.

Meanwhile, a roll-out of canned or bottled coffee drinks through Coke's bottling system could upset the dominance of a joint venture between Starbucks and PepsiCo <PEP.O>.

The purchase of the biggest coffee chain behind Starbucks adds to Coca-Cola's drive to diversify away from fizzy drinks and expand its options for increasingly health-conscious consumers, after countries started introducing sugar taxes.

CAFFEINE HIGH

Whitbread shares leapt as much as 19 percent to a 2-1/2 year high of 48 pounds on news of the deal, which analysts said was priced at a punchy 16.4 times Costa's latest annual earnings. Coke shares were up more than 1 percent in pre-market trading.

"Coca-Cola are one of the few companies in the world that could justify the valuation," said Nicholas Hyett, equity analyst at Hargreaves Lansdown.

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Cappuccinos sit on a table in Costa Coffee in Loughborough, Britain April 25, 2018. REUTERS/Darren Staples

"Its global reach should turbo-charge growth in the years to come, and hot drinks are one of the few areas of the wider beverages sector where the soft drinks giant doesn’t have a killer brand. Costa will get lots of care and attention."

Whitbread had been in the process of demerging Costa from its hotel group Premier Inn, and the sale marks the latest transformation in a business that was established in 1742 as a brewer and which has also owned sports clubs and restaurants.

Whitbread bought Costa, founded in 1971 in London by Italian brothers Sergio and Bruno Costa, for 19 million pounds. It only had 39 shops then, but now its maroon shop front is one of the most ubiquitous sights on British high streets, with 2,422 outlets in the UK and a further 1,399 in international markets, operated as franchises, joint ventures and wholesale outlets.

Whitbread Chief Executive Alison Brittain said the price tag represented "a substantial premium" to what would have been created through a demerger.

"We were not interested in a sale other than to somebody who had a strategic rationale and therefore would be able to create significantly more value than Costa could create on its own."

Some of the proceeds will go toward reducing Whitbread's pension deficit and financial debt to ease expansion of the Premier Inn hotel chain in the UK and Germany, but Brittain said a "significant majority" of the cash would go to shareholders.

Brittain also denied Whitbread had been pressured to accelerate the sale by activist investor Elliott and other hedge funds. "I would imagine they would be as delighted and surprised as anybody else this morning," she told reporters.

CAFE CULTURE

The global market for packaged coffee and drinks was worth about $83 billion in 2017, a fraction of the $513 billion market for soft drinks, according to Euromonitor International, but it is growing faster. What is more, sales at coffee shops like Starbucks and Costa are growing even faster, as people increasingly indulge their habit on the go, rather than at home.

Costa recently expanded into China to try to offset an increasingly saturated market in Britain, where chains such as Starbucks and Caffe Nero vie with thousands of independents.

A burgeoning cafe culture in China provides an encouraging backdrop, but Costa faces intensifying competition there as well. Starbucks, which has 3,400 stores in China, is planning to almost double that by 2022, while partnering with Chinese tech giant Alibaba <BABA.N> to start delivery services.

Local rival Luckin is also planning to more than double its Chinese store count to 2,000 by the end of 2018.

Rothschild advised Coke on the deal while Goldman Sachs, Morgan Stanley and Deutsche Bank advised Whitbread.

($1 = 0.7679 pounds)

(Additional reporting by Sangameswaran S and Shashwat Awasthi in Bengaluru, Ben Martin in London and Miyoung Kim in Seoul; Editing Mark Potter)

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