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Quaker rumors heat up
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November 3, 2000: 6:24 p.m. ET
Investor speculation over the next bidder for the food conglomerate heats up
By Staff Writer Tom Johnson
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NEW YORK (CNNfn) - Wall Street sizzled with speculation Friday about what company might next step up and bid for Quaker Oats, the cereal and sport drink producer that rejected a nearly $14 billion buyout offer from PepsiCo Inc. late Thursday.
Quaker Oats (OAT: Research, Estimates) shares climbed as high as $92 in afternoon trading Friday before closing the day at $89.62, up $7.37, or 9 percent. In after-hours trading Quaker Oats was at $88.41, down $1.22. Pepsi, meanwhile, lost $1.25 to $45.81.
The jump comes one day after Pepsi walked away from merger discussions with the Chicago-based company after Quaker Oats rejected Pepsi's all-stock acquisition offer that would have valued the company at $103.54 per share, a source familiar with the situation told CNNfn.
The rejection surprised most analysts, who believed the premium offered the maker of hot and cold cereals, Rice-A-Roni and Gatorade sport drinks was more than fair.
"It was a high premium on a high stock price," said John O'Neil, a food industry analyst with PaineWebber. "We think this was a reasonable and fair offer."
Opening the door to a bidding war
Still, the broken talks essentially have opened the door for a bidding war on the financially improved franchise coveted by several companies primarily for its Gatorade operation. Gatorade sales make up roughly 40 percent of Quaker Oats' business line, but offers tremendous growth opportunities for companies such as Pepsi, Coca-Cola Co. and Nestle S.A.
"The end game has started for [Quaker] now," said John McMillin, an analyst with Prudential Securities. "They are certainly in play here. There's only one Gatorade."
Clearly, by rejecting the offer, analysts said, Quaker Oats is taking a calculated gamble similar to that taken by Bestfoods Corp. earlier this year in its merger negotiations with Unilever PLC. In that transaction, Bestfoods threatened to walk away from the negotiations several times despite having no other strong suitors and ultimately garnered a much higher price tag.
 However, Quaker Oats finds itself in a slightly different situation, analysts said. While Bestfoods was struggling to improve its image on Wall Street, Quaker Oats has seen a dramatic turnaround since a 1998 restructuring effort designed to refocus the company on emerging markets.
The company ended up laying off roughly 10 percent of its work force in 1999, but ended up posting a nearly 21 percent growth in earnings. Gatorade helped lead the way, hitting $1.8 billion in sales worldwide despite a slight slowdown in European sales.
This came as the company's overall revenues slowed because of stagnant growth in the company's core food business -- a factor that analysts have long suggested would put Quaker Oats in play.
"Quaker is on a strong growth track and has strong earnings momentum," O'Neil said. "So they can afford to wait a little here."
"Quaker is out there because they have a very attractive brand that is near the top of the market," said Scott Wilkins, an analyst with Bank of America Montgomery Securities. "They are in a position to command a lot of money."
A Quaker Oats spokesman declined to comment.
Bidders ponder complications
For the company's potential suitors, however, the bidding now becomes a bit more complicated.
Pepsi's interest in the company revolves entirely around Gatorade, which dominates about 80 percent of the U.S. sports drink market. Analysts believe that dominance could actually climb even higher if the company gained the distribution might of a Pepsi or Coke.
Most analysts said acquiring Quaker Oats would dramatically improve the Purchase, N.Y.-based Pepsi's competitive position against its archrival Coke. Soft drink sales have grown stagnant in recent years, leaving both companies looking to expand their noncarbonated offerings.
Pepsi has made greater strides along that front recently. Earlier this week, the company beat out Coke in a heated bidding war for South Beach Beverage Co., a still small but fast-growing maker of fruit drinks and iced tea. Pepsi also owns the Gatorade competitor All Sport drinks line, but its sales have remained stagnant
 But analysts said Quaker Oats' rejection likely has left the No. 2 U.S. soft drink maker a bit flummoxed. Pepsi reportedly was offering 2.2 shares of its stock for each Quaker Oats share -- a price the company likely is unwilling to go much beyond because the deal would start to become dilutive to their earnings.
Indeed, the offer put on the table by Pepsi, which valued Quaker's food group at 10 times this year's EBIDTA (earnings before interest, depreciation, taxes and amortization) and Gatorade at 25 times this year's EBIDTA. By comparison, South Beverage and Snapple, a former Quaker Oats subsidiary that was sold at a massive loss a few year's ago before recently being acquired by Pepsi, both sold at about 12 times EBIDTA.
Also complicating the negotiations is what to do with Quaker's vast food-related holdings after any potential merger. Although Pepsi likely would hold on to certain brands that complement it own food line that already includes Frito Lay's chips, Tropicana Pure Premium orange juice and Rold Gold pretzels, most speculate they would try to sell most of the operation off, including Quaker's vast cereal line.
The trouble there, analysts said, is the market is not exactly rich with buyers at the moment. Kellogg Co. (K: Research, Estimates) and General Mills (GIS: Research, Estimates), the two most likely acquirers, will still be digesting major acquisitions of their own -- Kellogg a $3.4 billion deal for Keebler (KBL: Research, Estimates) and General Mills a $10.5 billion buy of Pillsbury.
"[Quaker's] food line is in a declining state and it doesn't appear to have much of an upside," said David Nelson, an analyst with CS First Boston. "All the cereal makers are busy with other acquisitions right now, so that wouldn't bode well for Pepsi."
Indeed, one reason analysts generally believe Pepsi might not take their price much higher is it would ultimately have to sell the food operations for a lower premium than what it's paying, diluting its earnings.
"The beverage portion of it is 40 percent of [Quaker's] business, so if they were to divest of all the other businesses, it could get messy," Wilkins said.
Still, analysts believed the company could come back with a similar premium, but offer more cash, perhaps alleviating fears Quaker Oats might have of a sudden downturn in Pepsi's stock.
Competitors line up
The other potential suitors listed by analysts are Coke, Nestle and Groupe Danone.
Coke (KO: Research, Estimates) is seen as perhaps the most unlikely potential acquirer because of antitrust problems the company has had in previous mergers, particularly in Europe. Coke also owns Powerade, the second-largest U.S. sports drink, albeit a distant competitor to Gatorade.
Still, the company has a higher stock price valuation than Pepsi and may still be smarting from losing out on the South Beverage acquisition. Coke shares shed $1.44 cents to $59.31 in midday trading.
Nestle, the world's No. 1 food group, is expected to be a serious bidder as well. The synergies between the two companies are less obvious -- Nestle's products range from coffee to ice cream -- but the Swiss company is it is sitting on a large war chest of cash, which may ultimately prove more attractive to Quaker Oats shareholders.
Still, Nestle has largely been left behind during the recent round of consolidation in the food industry while its two biggest competitors, Unilever and Philip Morris Cos. (MO: Research, Estimates) have made large acquisitions, and has shown no desire to jump into the game. Such a move could also upset General Mills, which operates a joint cereal venture with Nestle.
Danone's primary business line revolves around dairy products so it too possesses fewer synergies. But analysts noted the company has been looking to expand into the United States, particularly after losing to Philip Morris in the bidding war for Nabisco Group Holdings. 
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