The Coca-Cola Company, one of the largest and most iconic food and beverage manufacturers, bought out British coffee chain Costa Coffee in September in a deal valued at $5.1 billion. According to details of the transaction released, Coke bought out Costa from its parent company Whitbread PLC in a cash, debt-free deal, which is being viewed with great interest by industry watchers around the world.

Much energy is being expended in debating whether the current financial performance of Costa justified a $5.1 billion valuation and what Whitbread and Coke would get as a result of this transaction. On the face of it, things are bullish at Costa. The company is the third largest coffee franchise chain around the world (albeit distantly, trailing both Starbucks and McDonald’s). It does, however, have an extremely strong presence in 37 countries, including its two largest markets (the UK and China), both of which figure heavily in Coke’s growth plans. Around the world, Costa has 4,000 retail outlets, as well as distribution deals to sell its coffee at a host of locations like cinemas, driven-ins and grocery stores.

Furthermore, the company has an 8,000 strong footprint of coffee dispensing self-service machines, called Costa Express, along with bottled, ready-to-drink coffees sold at retailers. During FYI 2017-18, Costa grew with revenues of $1.7 billion and EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) of $312 million.

Coke however as a global F&B powerhouse, dwarfs this significantly. The Coca-Cola Company has a massive stable of 500 plus brands, which include two bottled ready-to- drink (RTD) coffee brands. These are Gold Peak in the US and Georgia (popularly dubbed Jojia) in Japan. During 2017, Coke reported revenues of $35.4 billion with an operating income of $9.7 billion.

So it came as no surprise that Whitbread PLC’s board unanimously supported the buyout from Coke when it was proposed. The Coca-Cola Company hopes to finalise the takeover in the first half of 2019 and has big plans to further energise what is a very promising brand.

However, the two questions that are piquing the interest of industry watchers are, firstly, has Coke paid a huge premium for Costa? And secondly and more importantly, what do both companies (Whitbread and Coke) get out of the deal in the long-term?

The Costa Valuation

According to industry analysts, Coke has paid a significant premium for Costa. Credit Suisse, commenting on the deal, went as far as to state that the deal should have been closed, perhaps at half the value of what it did. Citi called the deal a cash windfall for Whitbread and others termed Coke’s acquisition ‘an undeniably rich valuation for Costa’. Others opined that Coke had valued Costa’s earning potential at a higher price than even Starbucks – the rival that Costa most likes to emulate and significantly trails globally. While everyone agrees that buying Costa fills in a Death Star sized hole in Coke’s portfolio, the question is what Coke intends to do with the brand that could justify the generous valuation. So what does Coke have up its sleeve? Read on...

What Whitbread stands to gain

Whitbread was under considerable pressure for the past two years from shareholders to disinvest of Costa or spin it off into an independent business. The idea was that both companies would be worth more independently than clubbed together. That bet seems to have paid off. By selling Costa, Whitbread has earned considerable return on an investment of only $26 million, which is what they paid for Costa, which was a niche chain with only 39 outlets 20 years ago. Plus the cost of being in the coffee space in the UK (Whitbread’s flagship market) is expected to increase as regulators increase focus on how caffeine-related businesses operate. This cash windfall, as it is being dubbed, will be used by Whitbread to focus on areas where a cash infusion is needed. These include commitments to its pension fund as well as fuelling growth in its hospitality business, primarily revolving around the Premier Inn brand in the UK and Europe.

From a portfolio standpoint, acquiring Costa makes perfect sense for Coke. The company’s core soda business is set to shrink (as high as 15% in some markets). Conversely, the global coffee business (ready-to-drink and retail served) is expected to grow upwards of six percent annually. Coke at present only has RTD and cold coffees in its stable and getting Costa would fill a major gap and give them a recognisable brand along with expertise and new capabilities in the hot beverages category to build the required scale.

The Future Belongs to Coke

Coke is betting big on Costa becoming yet another sheet anchor of its growth around the world. Costa has a recognisable presence in East Asia and the Middle East, both of which are markets that Coke has big plans to expand into. In the last five years, the company has made major expansions into markets like Myanmar, Iraq and is making a bigger push in China. The pivot of Coke’s strategy is to take Costa’s brand recognition and mate it to its super strong distribution and sales network. The idea in the words of Coke’s management is to take Costa to more people in more places than ever before. From a portfolio standpoint, acquiring Costa makes perfect sense for Coke. The company’s core soda business is set to shrink (as high as 15% in some markets). Conversely, the global coffee business (ready-to-drink and retail served) is expected to grow upwards of six percent annually. Coke at present only has RTD and cold coffees in its stable and getting Costa would fill a major gap and give them a recognisable brand along with expertise and new capabilities in the hot beverages category to build the required scale. The brand also fits well with other natural drink acquisitions by Coke which includes milk, flavoured water, sports drinks and even sparkling water in these last few years. Many point out that the coffee space is extremely hot (no pun intended) at this point, recently Nestlé paid Starbucks a reported $7 billion for rights to sell its coffee at retail locations. Seen in this context, it looks like Coke has made a correct bet with Costa. How successful will Coke be in getting Costa up from third place to becoming a more recognised coffee destination around the world, only time will tell. However, on the face it seems that Coke is working hard to brew the right mix with a great product, strong distribution, farsighted strategy, promising brand and assertive marketing.

Tariq Ziad Khan is a US-based marketer and a former member of Aurora’s editorial team. tzk999@yahoo.com