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PepsiCo pays a high price for a gamble in Russian dairy

By Guy Montague-Jones , 08-Dec-2010
Last updated on 09-Dec-2010 at 18:22 GMT

PepsiCo pays a high price for a gamble in Russian dairy

When PepsiCo put up $5.4bn last week to acquire Wimm-Bill-Dann, it was seduced by the promise of high revenue growth but like any high-yield investment the Russian deal does not come without risks.

Almost twenty years since the end of the Cold War, there can hardly be any greater symbol of the demise of communism and the dominance of American capitalism than the sight of PepsiCo buying a key Russian asset.

The acquisition of Wimm-Bill-Dann is not only big news for PepsiCo and the food industry. It is also big news for American-Russian relations. This will be the biggest acquisition a US company has made in Russia.

And to make it happen, PepsiCo turned to its biggest guns including 89-year-old former CEO Don Kendall, the man who gave the ex-Soviet leader Nikita Khrushchev his first glass of Pepsi. Current CEO Indra Nooyi sent Kendall on a diplomatic mission to Moscow to obtain the seal of approval for the deal from Russian Prime Minister Vladimir Putin.

Seductive growth prospects

So what does PepsiCo expect to get out of the acquisition? The most immediate and obvious benefit is the prospect of high growth rates.

Since 2006 the Russian dairy market has grown at a compound rate of 22 per cent and PepsiCo said it expects low to mid double digit growth over the next few years. But there are other important strategic objectives that Wimm-Bill-Dann could help PepsiCo achieve.

The deal will take its annual global revenues from nutritious and functional foods from about $10bn to nearly $13bn, taking it a step closer to its $30bn target by 2020.

And the acquisition gives PepsiCo a good stake in the dairy snacks market. The company has already indicated that dairy is a direction it wanted to move in when it bought dairy and juice firm Almarai in the Gulf last year.

PepsiCo CEO Indra Nooyi put the point emphatically in a statement last week, saying that dairy, with its ability to straddle the bridge between snacks and beverages, offers “huge untapped potential”. Nooyi even went as far as calling it “the next frontier in food and beverage convenience.”

All this suggests that PepsiCo is onto a good thing with its acquisition of Wimm-Bill-Dann but not all indicators are good.

Dairy snacks: the next frontier?

Starting with the glowing words about the potential of dairy snacks, there is little doubt that this is a growing market. Zenith International published a timely report this week suggesting that the global market is heading for 6 per cent growth this year and is poised to continue in that vein as manufacturers seize on opportunities to market snacks for adults as well as children.

But dairy snacks are hardly the next frontier in food and beverage. It is a well-established category with some big brands like Dairylea and Babybel that PepsiCo will have to compete against. Russia may offer more virgin territory for dairy snacks but the market has some development to go before such products become big business.

And as for the growth potential that the Russian market offers, PepsiCo must remember that operating in Russia does not come without its risks and complications.

Political concerns

One particularly ominous concern is corruption. The WikiLeaks revelation last week that US diplomatic cables labelled Russia a virtual “mafia state” is hardly reassuring for international business. Transparency International gives an equally damming verdict, ranking Russia 154 out of 178 in the 2010 Corruption Perceptions Index.

On the plus side Wimm-Bill-Dann has been more open than most. When the company started trading on the New York Stock Exchange in 2002 it decided to reveal all.

It told potential investors about the nine years its largest shareholder, Gavril Yushvaev, had spent in a Soviet labour camp for unspecified violent crime and was open about links that shareholders and directors had to Trinity Group, a company rumoured to have had mafia connections. Wimm-Bill-Dann also revealed that it violated regulations on privatisation auctions during a prior acquisition of two dairies.

At the time these revelations did little to put off investors and this time around they have done little to put off PepsiCo.

But there is no doubt that the background of corruption in Russia in general and the hard hit the country took following the financial crisis last year means that operating in the country comes at a risk. Can PepsiCo really count on sustained high sales growth and healthy margins?

A high price?

There is enough uncertainty to suggest that the price PepsiCo is willing to pay is on the high side. When Danone sold its 18 per cent share in Wimm-Bill-Dann at the end of last year it got $470m. That would imply that the company is worth just over $2.6bn. Obviously we are not comparing like with like, but does this not indicate that the $5.4bn PepsiCo is putting on the table for Wimm-Bill-Dann is not just a little excessive?

Shareholders are undecided and have so far been muted in their reaction to the deal. The PepsiCo share price dipped slightly on the news while Wimm-Bill-Dann shareholders saw the price of their stock shoot up 25 per cent.

Time will tell whether Russians will lap up drinking yoghurt and became ardent fans of cheese sticks. If they do, the PepsiCo gamble may pay off but there is no guarantee that the venture into Russian dairy will not end on a sour note.

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