Why Pepsi Should Consider Selling Quaker Oats (or Part of It)

NEW YORK (The Deal) -- When PepsiCo (PEP) acquired Quaker Oats in 2000 for around $14 billion in stock and debt, the Gatorade sports-drink business was the real prize.

After the deal closed, Pepsi considered selling the non-beverage portion of the Quaker unit. According to one industry banker, the potential sale was complicated by the need to de-lever the Quaker brand related to the parts Pepsi did not want -- namely the cereal business -- from the parts it wanted to keep, such as the granola-bar unit. That's because the Quaker brand name was used across a wide range of products.

Pepsi CEO Indra Nooyi, who was chief financial officer at the time, liked having Quaker as part of Pepsi because it offered a patina of supposedly healthier offerings. Nooyi continued to hold that view when she became CEO. Quaker's more wholesome image offset the parent's reputation for hocking foods high in sugar and fat, particularly with a group of customers that might include school districts and universities, not to mention food critics in general. In addition, health and wellness was -- and is still -- seen as an area of growth.

But Quaker's sales growth remains sluggish, and its cereal business badly trails its competitors, a group that includes General Mills (GIS), Kellogg (K) and Post Holdings (POST). For the fiscal year ended Dec. 27, Quaker had revenue of close to $2.57 billion, compared with about $2.61 billion for the same period a year prior, and also down from revenue of almost $2.64 billion in 2012, according to regulatory filings.

Likewise, profit at Quaker has continued to deteriorate. For its most recent fiscal year, Quaker posted $621 million in operating profit, a slight increase from the $617 million for the same period a year prior, but a decline from $695 million in 2012, according to regulatory filings.

The most recent quarter also did not dazzle. For the first quarter ended March 21, Quaker's revenue was up only slightly year-over-year to $639 million from $634 million, while operating profit fell to $99 million from $160 million. Operating profit was affected by an asset-impairment charge on a dairy joint venture operated through the Quaker division.

Given those numbers, the best course for Pepsi may be to focus on the parts of its business where it has deep penetration and to sell off the lagging food businesses. It should be noted that Quaker does not make just oatmeal and granola bars. It also is a producer of Quaker-branded products such as grits, rice cakes, granola and oat squares. And it produces non-Quaker brands such as Aunt Jemima mixes and syrups, Rice-A-Roni side dishes and Cap'n Crunch cereal and Life cereals. None of those brands really helps PepsiCo's image.

The Quaker division, furthermore, generates 4% of PepsiCo's revenue, according to regulatory filings, not meaningful in scale compared with the other parts of the food and beverage group's major divisions.

Pepsi would be better off selling Quaker and using the proceeds to bolster the parts of the business where it does have scale and can have a more meaningful impact on the company's financials. Specifically, the company should get back into the acquisitions game. It's Atlanta-based arch-rival Coca-Cola (KO) has pulled ahead of Pepsi in such investments, grabbing stakes in Keurig Green Mountain (GMCR) and Monster Beverage (MNST).

In addition, Coke has launched a new milk beverage, Fairlife, which has more protein and less sugar than regular milk, putting Coke in position for growth in key categories. Pepsi could have its own line of milk and plant-based beverages if it were to acquire WhiteWave Foods (WWAV), parent of Horizon organic milk brand and Silk plant-based beverage brand. That would put PepsiCo in the rapidly growing areas of natural and organic foods, as well as plant-based beverages including almond milk.

In lieu of a sale of the entire Quaker division, Pepsi could at the minimum sell Aunt Jemima and Rice-A-Roni. It could then find partner -- Post, perhaps -- giving it the license to sell Quaker-branded cereals and the Life and Cap'n Crunch brands.

Moves like that would simplify Pepsi's structure, giving it greater focus on beverage and snacks as the battle for market share with Coke and other rivals intensifies.

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