Keurig-Dr Pepper: Why Coffee and Soda Might Just Mix

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DPS 22.39%

Keurig Green Mountain is buying a drinks company—and, just as importantly, a currency to keep the deals flowing.

The unusual deal announced Monday involves Keurig paying Dr Pepper shareholders not just $103.75 a share, or $18.7 billion—8.5% more than last Friday’s market value—but also a share in the combined company, Keurig Dr Pepper. Exactly what that share will be worth is the key question for investors in the short term. Dr Pepper Snapple shares jumped 25% to $120 in early-afternoon trading.

Keurig management, which is taking the key positions at Keurig Dr Pepper, says the two companies together would have generated earnings per share of $1.27 last year with the new company’s projected capital structure. Assuming a constant earnings multiple, that implies a share price of roughly $30—well above where Dr Pepper Snapple shares now change hands, adjusting for the $103.75 dividend.

However, the $1.27 figure includes an estimated $600 million of annual cost savings that aren’t expected to be realized in full until 2021 (and excludes the $750 million one-off cost of realizing them). Pablo Zuanic at brokerage SIG estimates 2018 earnings per share of $1.07, which implies a share price closer to $20. Investors can expect volatility over the coming days as this valuation debate plays out, but on the face of it the shares have bounced to a sensible level.

Once the deal completes, the shares will become a leveraged play on the management and deal-making prowess of JAB Holding, the private German investment group that bought Keurig in 2016 and will now, alongside its investment partners, become Keurig Dr Pepper’s controlling shareholder.

JAB, one of whose key managers is on the board of Budweiser-brewer Anheuser Busch InBev, has a reputation for tight budgeting. That will be necessary to pay down the $16.6 billion of net debt the company is taking on. There may also be growth opportunities in plugging Keurig or JAB brands like Peet’s Coffee, which makes bottled iced coffee, into the Dr Pepper distribution machine.

Previously JAB has taken companies private—Krispy Kreme and Panera Bread as well as Keurig in the past two years. This deal is different because JAB wants Keurig Dr Pepper’s listed stock as a currency for further deals. The investment group seems to have similarly aggressive ambitions for the unfashionable sugary-drinks industry as Kraft Heinz does for the packaged-food industry, albeit on a more modest scale. It is only a matter of time before the market starts wondering which company JAB has in its sights next.

Write to Stephen Wilmot at stephen.wilmot@wsj.com

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