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Coke mulling Quaker bid
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November 20, 2000: 6:02 p.m. ET
World's No. 1 soft drink company takes aim at cereal and sports drink producer
By Staff Writer Tom Johnson
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NEW YORK (CNNfn) - Looking to quell growing investor concern about a possible overbid, Coca-Cola Co. confirmed Monday that it has entered merger discussions with cereal and sports drink producer Quaker Oats Co., but said it would only pursue a transaction that enhanced shareholder value.
In a short statement released just minutes before the closing bell on Wall Street, Coke said it had entered negotiations with Quaker Oats (OAT: Research, Estimates), but emphasized that there could be "no assurance that such discussions will result in a transaction."
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The world's No. 1 soft drink producer went on to say that any transaction would be consistent with its strategy of building out a complete, non-alcoholic beverage company.
"Any agreement must be consistent with our strategic program and enhance our ability to increase value to our shareholders and our other constituents, as well as deliver value to consumers," said Douglas Daft, Coke's chairman and chief executive, in a prepared statement.
A Quaker Oats spokeswoman declined to comment on the release, saying it was company policy not to comment on merger and acquisition activity.
Coke's comments came as its stock was getting hammered on Wall Street in response to published reports Sunday evening indicating it was offering between $15 billion and $16 billion for the maker of Rice-A-Roni, Captain Crunch cereal and Gatorade sports drinks.
Coke (KO: Research, Estimates) closed Monday off $4.88, a decline of nearly 8 percent, to $56.56. Analysts attributed the decline to a number of factors, including fears that Coke was paying too much for a company that still derives a majority of its revenue from several slow-growth food categories.
Though the exact structure of Coke's offer could not be learned, the Wall Street Journal reported Monday the Atlanta-based company was offering to swap 1.9 of its shares for each Quaker Oats' share, valuing the company at approximately $116 per share.
Analysts said an acquisition at that price, while rich, would likely add to Coke's earnings in the first year. Still, there remained questions on taking on such a weighty acquisition as the Atlanta-based company undertakes a massive internal restructuring project designed to cut costs.
 The company was also stung by a downgrade of its stock to "outperform" by Salomon Smith Barney beverage analyst Jennifer Solomon, who said while the deal at current prices would not be dilutive to the company's earnings, it did signal a level of "anxiousness" on the part of Coke's management.
"The added complexity of being in the food business suggests that [Coke] may be less confident about the long-term prospects of [its] existing portfolio," she wrote.
John McMillin, a food analyst with Prudential Securities, said the decline in Coke's stock was likely raising some doubts in Coke's boardroom, which not only features a relatively new chief executive in Douglas Daft, but also the value investor Warren Buffett, who reportedly has expressed reservations about the potential deal.
"I think Coke's shareholders are trying to send a message to their new CEO," said John McMillin, a food analyst with Prudential Securities, who kept his "accumulate" rating on Quaker Monday but raised his price target to $105 per share from $100. "But he may be very interested in providing a new domestic growth engine for the company. They need a domestic jolt."
Tasting a Gatorade buy
The negotiations come just two weeks after Pepsi (PEP: Research, Estimates), the world's No. 2 soft drink company, walked away from merger discussions with Quaker Oats, leaving a $14 billion stock-swap offer on the table.
Based on closing prices Monday, the Coke stock-swap offer would value the Chicago-based company at $107.46 per share with a total enterprise value of $14.1 billion, while the Pepsi offer, which reportedly remains on the table, would value Quaker Oats at $99 per share, or $13 billion.
Pepsi reportedly walked away from its discussions with the company after Quaker Oats executives insisted on a "collar," or price protection mechanism meant to guard against sudden downward swings in the acquiring company's stock price. Analysts said investor reaction to Coke's stock Monday would likely prompt Quaker to seek the same protection, or more of a cash and stock mix.
Coke's entrance into the bidding war came as little surprise to analysts, who noted the company could ill-afford to lose Quaker Oats' crown jewel, Gatorade, at a time when non-carbonated drink sales are far outpacing those of soft drinks.
Check out food analyst's Ann Gurkin's reaction to the Coke/Quaker talks
The Atlanta-based company is also still smarting from losing a bidding war for South Atlantic Beverage Co. to Pepsi, further increasing shareholder pressure to increase its stake in the non-soft drink beverage category.
Still, there are several complications surrounding a Coke bid for Quaker Oats. Since Coke would likely structure the transaction as a pooling of interests to ease tax concerns, it would be required to operate the company's slower-growth food business, an area where it has little experience, for at least two years.
"The idea of keeping it out of Pepsi's hands has to be outweighing the idea of being in the food business," said Bill Pecoriello, a beverage analyst with Sanford Bernstein. "After losing SOBE, you can understand why Coke is looking at this pretty hard."
Indeed, analysts agree that combined with Coke's massive worldwide distribution system, Gatorade's growth prospects could nearly double during the next 10 years.
Gatorade already dominates 73 percent of the sports drink market in the United States, according to Beverage Digest. Coke's Powerade is a distant second at 15 percent, while Pepsi's AllSport is third at 6 percent.
The assumption is Coke would be forced to sell its Powerade stake to alleviate federal antitrust concerns, but analysts struggled to predict who, other than Pepsi, would be interested in buying it. Having just two major players in the sports drink market could leave antitrust regulators uneasy, a factor that also hurt Coke's stock Monday.
Pepsi remains on sideline
Analysts did not rule out Pepsi re-entering the process with a higher bid, but most considered it unlikely because company executives have repeatedly stressed that they would not pursue an acquisition that hurt Pepsi's bottom line.
"They would take huge flack from shareholders if they did," said Caroline Levy, a beverage analyst with UBS Warburg.
Coke's higher stock-price valuation gives it the financial flexibility to complete a deal at a higher price without hurting its earnings, analysts said. French food conglomerate Group Danone (DA: Research, Estimates) has also reportedly explored a possible acquisition of Quaker Oats, but the company's relatively low American depositary receipts valuation diminishes its chances, analysts said.
"The issue here is Coke's intent," said John O'Neil, a food industry analyst with UBS Warburg. "If they want Quaker Oats' businesses, they have the financial muscle to get it done."
Quaker Oats shares climbed as high as $100 Monday before falling back, finishing the day up $4.69 to $95. Meanwhile, Pepsi shares gained $1.06 to close at $45. Danone ADRs shed 28 cents to $27.87. 
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