Early Returns Look Bad For This Merger

Our latest featured stock is a beverage giant formed via merger in 2018. We pulled this highlight from last week’s research of 659 10-K filings.

Analyst Cody Fincher found several unusual items in the footnotes of Keurig Dr. Pepper’s (KDP) 2018 10-K.

KDP was formed when privately held Keurig acquired Dr. Pepper Snapple in July of 2018, and the combined company began trading under the symbol KDP. As shown in Figure 1, Dr. Pepper Snapple earned consistently high returns on invested capital (ROIC), but the combined KDP earned an ROIC of 4% in 2018, which is below its weighted average cost of capital (WACC) of 4.5%.

Figure 1: ROIC vs. WACC for Dr. Pepper Snapple/KDP Since 2013

Sources: New Constructs, LLC and company filings.

In order to calculate the combined company’s ROIC, we made three significant adjustments related to the merger. Our two major income statement adjustments were:

  • The removal of $131 million (2% of revenue) in inventory step-up costs disclosed on page 81
  • The removal of $170 million (2% of revenue) in integration costs disclosed on page 113

KDP reported GAAP net income of $589 million in 2018, but our adjustments show that it earned net operating profit after tax (NOPAT) of $1.1 billion.

On the balance sheet side, we made a midyear acquisition adjustment to account for the fact that the merger closed in the middle of 2018. KDP had ~$46 billion in invested capital at the end of 2018 (96% of which consisted of goodwill and other intangibles), while Dr. Pepper Snapple started the year with ~$10 billion in invested capital. A simple average of these two numbers would yield $33 billion, but since the acquisition closed slightly more than halfway through the year we adjust and calculate the combined company’s average invested capital of ~$27 billion.

Our adjustments help strip out the accounting distortions surrounding the KDP merger and reveal that the combined company is failing to create value for shareholders. Executives will claim there are still “synergies” to be realized, but research shows that few acquisitions actually deliver the promised synergies. On the evidence we have so far, it appears that Keurig overpaid for Dr. Pepper Snapple.

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Disclosure: David Trainer, Cody Fincher, and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme.

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