Says management credibility to create shareholder value is low based on Trian’s recent meetings with fellow shareholders; urges PepsiCo Board to meet shareholders without management
NEW YORK, March 13, 2014 – Trian Fund Management, L.P. (“Trian”), whose investment funds beneficially own approximately $1.3 billion of PepsiCo, Inc. (NYSE: PEP) common shares, today sent a letter to PepsiCo’s Board of Directors calling on it to provide shareholders with analytical support for
PepsiCo’s continued reliance on the “Power of One” strategy and its rejection of Trian’s recommendation to separate global snacks and beverages into two independent public companies.
Trian’s letter to the PepsiCo Board is below.
March 13, 2014
Board of Directors
700 Anderson Hill Road
Purchase, NY 10577
Dear Members of the Board:
We were extremely disappointed by Mr. Cook’s February 27th response to our white paper. The dismissive tone of his letter suggests that you do not appreciate the degree to which PepsiCo’s shareholders, the owners of the company, are frustrated. Given the company’s prolonged underperformance, we believe the Board and management are obligated to provide shareholders substance and analytics – not just platitudes and rhetoric – to defend the alleged benefits of the “Power of One.”
We call on you to back up your assertion that “much of Trian’s data is selective and, in many instances, misused.”i Please identify the specific data you are referring to. Our white paper is based on more than a year of exhaustive due diligence as well as decades of experience in the beverage industry as a former supplier and competitor. Our sources include publicly available information filed by the company, industry data and conversations with analysts, industry participants, customers, other knowledgeable sources and competitors from around the world. Among the sources we spoke with are some of the most respected people in the consumer products industry. We stand by our work product and insist that you furnish shareholders with information and transparency addressing the following “Trian data”:
- Excessive overhead costs. Provide the amount and detail behind PepsiCo’s unallocated and, mostimportantly, allocated corporate expense.
- Advertising declines. Show direct consumer advertising as a percentage of sales for snacks andbeverage by year since 2005 (the year before Indra Nooyi became CEO).
- Volume share losses. Provide volume growth and market share data for all beverage categories inNorth America in recent years and also show shareholders that PepsiCo is not losing significant volume share to Coke. If PepsiCo’s beverage volumes continue to decline by hundreds of basis
points per year, the bottling system will lose its relevance and PepsiCo’s beverage business risks being permanently impaired.
– Provide data that shows robust growth for Pepsi Max (and all diet brands under the Pepsi umbrella) versus Coke Zero and other no-calorie Coke brands.
– Describe how Nielsen data is mistaken when it shows Coke’s regular calorie colas delivered solid volume performance in 2013 despite challenging carbonated soft drink market conditions, while Pepsi’s competing colas continued to erode.
– Provide data that shows Tropicana has not ceded significant market share to Simply Orange, a brand that did not exist in 2000 (especially in the most profitable, “premium” category).ii
– Explain what happened to Gatorade’s market share since the re-branding campaign.
– Explain what happened to SoBe, once a strong competitor in the fast-growth non-carbonated segment.
- Inferior return on investment. Show the returns on major investments since Indra Nooyi became
CEO. We estimate that PepsiCo has spent $46bn (37% of the current market capitalization) since 2006 on capital-intensive acquisitions, capex and restructurings, net of divestitures and asset sales.iii This includes $21bn (enterprise value) spent acquiring the bottlers ($17bn excluding the equity
PepsiCo previously owned) and $5bn spent acquiring Wimm-Bill-Dann for a whopping 17.5x LTM EBITDA.iv We note that the company’s return on invested capital (ROIC; defined as net operating profit divided by average debt and shareholders’ equity) has declined from 25% in 2006 to 14%
today while earnings per share (EPS) growth has materially trailed peers and management’s own targets.v If we are wrong, and these acquisitions have in fact generated strong returns, show your shareholders the actual numbers.
- Buying the bottlers a mistake? Explain your strategic vision for bottling in North America. It hasbeen four years since the $21bn acquisitions of Pepsi Bottling Group and PepsiAmericas. Last fall,
management told us that the acquisitions were “a mistake” and the bottling system was “in disarray” when the bottlers were acquired, yet we believe the system is operating far less efficiently today.vi
Coke has committed to significantly reduce North American bottling exposure by 2020 through refranchising, thereby improving ROIC.vii Does PepsiCo plan to refranchise? Will refranchising require fresh capital, as we suspect, given the makeup of PepsiCo’s remaining bottling network? What precisely is management’s plan or should shareholders assume low-ROIC bottling, which PepsiCo has shown limited ability to manage, will be a fixture of the beverage business in the future?
- Years behind on alternative packaging. Tell us we are wrong and that PepsiCo is not three yearsbehind Coke in North America when it comes to alternative package sizes (7.5 oz and 16 oz). Please note that in a recent phone conversation, CEO Indra Nooyi acknowledged that PepsiCo is indeed behind Coke in alternative package sizes but argued that catching up would require significant capital investment.
- Costly headquarters renovation. Explain why management and the Board believe it is better to
spend $240mm of shareholder money renovating the Purchase corporate headquarters as opposed to upgrading the company’s bottling capacity and investing in additional alternative package sizes.viii
- “Power of One”: international synergy myth. Explain why,if “Power of One” is so powerful,
PepsiCo continues to have low beverage market share (single or low double-digit) in five of its largest international snacks markets: Mexico, UK, Brazil, Spain and Australia.ix Provide market share data in each of those countries and show how those shares have meaningfully changed over time.
- “Power of One”: domestic synergy myth. Explain why, if “Power of One” is so powerful,
beverages lost significant domestic market share in recent years while snacks was pushed to over-earn, culminating in slowing volume trends and the 2012 EPS re-set to fund reinvestment.x
- “Power of One”: foodservice myth. Explain why,if “Power of One” is so powerful, PepsiColostthe Subway beverage contract to Coke despite Subway being one of Frito-Lay’s largest foodservice
accounts.xi Since management cites the Buffalo Wild Wings fountain contract to justify the “Power of One,” quantify the size of that contract relative to the Subway beverage contract loss.xii Explain why, 17 years after the YUM! Brands spin-off, Taco Bell, Pizza Hut and KFC remain three of Pepsi’s largest foodservice accounts. And tell shareholders how many foodservice accounts have
Pepsi’s equivalent of the Coke Freestyle machine.
Trian is looking for improved operating performance, not “financial engineering.”
Another of your assertions is that the “financial engineering [we] propose erodes value for shareholders rather than creates value.”xiii We take exception to you characterizing our proposal as “financial engineering.” This appears to be yet another example of PepsiCo’s use of rhetoric and catch phrases to serve management and the Board’s public relations agenda. Moreover, we find it ironic that you criticized us for “financial engineering” shortly after the company announced increased share repurchase and dividend programs simultaneously with disappointing fourth quarter earnings results and weak 2014 guidance.xiv Obfuscating poor operating performance with increased capital returns is, in our view, a classic example of “financial engineering.” We also believe including one-time Vietnam refranchising gains in core EPS, as PepsiCo management did in 2013, qualifies as “financial engineering.” xv
The heart of the argument in our white paper is that centralization of costs and power within corporate has eroded PepsiCo’s culture and impaired the competitiveness of its businesses. We would like to see a separation of global snacks and beverages to empower focused management while eliminating the holding company structure and the excessive bureaucratic costs that go with it. We would close the Purchase and Chicago facilities (Quaker Oats to be run out of Frito-Lay and Tropicana to be run out of North American Beverage), thereby eliminating significant unnecessary corporate costs by having two headquarters (Plano for snacks and Somers for beverages) instead of four. Separating the businesses and closing Purchase and Chicago will be the catalyst to further and significantly reduce what we believe are billions of dollars ($1.1 billion of publicly disclosed “unallocated” corporate costs plus what Trian believes is a multiple of that amount which is undisclosed and “allocated” to the divisions) presently being spent on a centralized corporate bureaucracy.xviAs stated above, we call on management toprovide transparency on corporate costs and thereby publicly disclose how much is allocated to the divisions. We expect those savings will be reinvested in the brands and/or passed along to shareholders. Either way, we believe – at any reasonable multiple of earnings – there will be tens of billions of dollars of shareholder value created by the increased profitability.
Frito-Lay can be a standalone snacks powerhouse.
PepsiCo has an amazing snacks business that has performed consistently well over many years. But we believe Frito-Lay could perform even better if standalone management were allowed to market, invest and make strategic decisions with no interference from corporate. Too often in recent years, the snacks business has served as a “piggy bank” for PepsiCo management. Tapping into the bank has come in the form of aggressive Frito-Lay pricing and advertising cuts. Frito-Lay still grew during these periods of underinvestment but, too often in our view, it grew slower than the market and underperformed its potential.
It is our understanding that advertising for snacks declined to approximately 3% of sales at one point in the recent past – a very low number for a leading branded food business. By way of example, we would note that in 2006, advertising at Hershey had declined to 2.2% of sales. That year, Hershey’s organic growth slowed to 2.6% and the company traded at only 20x forward earnings. Fast forward to today and, under new leadership, Hershey is spending 8.1% of sales on advertising, the company grew 7.9% organically last year and it now trades at 26x forward earnings.xvii The implication is obvious – Frito-Lay could accomplish great things if it were no longer forced to subsidize an underperforming beverage
Full pep white paper and press release below in pdf