PepsiCo Inc.'s (PEP) decision this week to take full control of its two main bottlers could push other U.S. beverage companies, like Coca-Cola Co. (KO) and Dr Pepper Snapple Group Inc. (DPS), to seek out similar acquisition strategies.

By acquiring companies that bottle its beverages, PepsiCo gains greater flexibility, control and a faster reaction time when it comes to introducing and revamping new and existing products.

However, the deal has negative implications for both its small and large rivals. Case in point is Dr Pepper Snapple Group, which has been tapping Pepsi Bottling Group's (PBG) infrastructure to drive growth of its products such as Crush soda.

The agreement between Dr Pepper and Pepsi Bottling, which was struck in August 2008, instantly doubled Crush's market penetration while increasing competition for Pepsi's own fruity drink offerings. But this arrangement could be at risk now that PepsiCo is acquiring the bottler, and that could prompt Dr Pepper to look for alternative sources of distribution in the markets served by Pepsi Bottling. Now that PepsiCo can directly control who has access to its distribution infrastructure, it also gains added negotiating leverage when it comes to future acquisitions of smaller rivals.

The trend to control distribution via acquisition of bottlers was started by Dr Pepper with its 2006 acquisition of Dr Pepper/Seven Up Bottling Group. Following that deal, Dr Pepper acquired several other bottling assets that gave it direct distribution control of more than half of its U.S. volume.

PepsiCo is likely to gain similar control by acquiring its top two bottlers, since the two, along with smaller rival Pepsi Bottling Ventures Group, account for more than 60% of PepsiCo's North American volume. That would leave Coca-Cola as the only remaining beverage giant not in direct control of its distribution, putting it at a potential disadvantage versus its competitors.

PepsiCo's bid represents a marked departure from an earlier strategy by PepsiCo and Coca-Cola when the soft-drink makers spun off their bottling plants to become asset-light and focus solely on selling their high-margin concentrates.

Since then, however, the non-alcoholic beverage market has experienced a shift in consumer preferences from carbonated to newer, alternative beverages, like energy drinks. The success of smaller, nimbler companies such as Red Bull and Hansen Natural Corp. (HANS), maker of Monster-brand drinks, in introducing these new products has also served to increase the strategic importance of controlling distribution assets. Gone are the days when carbonated products from Pepsi and Coke dominated consumer mind-sets and, hence, marginalized the roles of the distributors.

Given the enhanced strategic importance of these assets, the market may bid up the share prices of bottling companies.

Shares of both Pepsi Bottling Group and PepsiAmericas Inc. (PAS) are trading slightly above the prices offered by PepsiCo, implying investors are hopeful of higher bids. Shares of Coca-Cola Enterprises Inc. (CCE) jumped nearly 3% Monday on speculation that Coca-Cola may have to react.

Coca-Cola has subsequently said it likes the current franchise model with respect to its bottling system; however, if PepsiCo is able to increase its market share with its new bottling strategy, Coke may have to reassess its position.

The acquisitions could also be a first step by PepsiCo in acquiring additional bottling distributors. PepsiCo's current master bottling agreement forbids its largest bottlers from acquiring other independent PepsiCo bottlers outside of their territories, potentially to avoid making any of the bottlers too powerful.

However, following these acquisitions, PepsiCo's new bottling arm could make further strategic acquisitions. PepsiCo currently has 110 independent bottlers in the U.S., some of which could be acquired as part of a strategy to improve performance as well as to restrict competitors' access to certain markets.

While it does make strategic sense for the beverage companies to acquire bottlers on an individual company basis, these transactions will probably take the fizz out of the returns for the beverage industry as a whole by tacking capital-intensive bottling assets onto an otherwise extremely profitable business of selling concentrates.

Consider PepsiCo's 2008 return on assets, or ROA, of 13.2% versus Pepsi Bottling's and PepsiAmericas's 2008 ROA of 5.5% and 6.0%, respectively (not taking into account the premium PepsiCo will pay or the potential deal synergies). The deal also slightly increases the volatility of PepsiCo's earnings by exposing it to commodities such as aluminum and plastic, the major raw materials for its bottlers.

(Sameer Bhatia is a columnist with Dow Jones Newswires. He can be reached at 201-938-5863 or by email at sameer.bhatia@dowjones.com. Dow Jones Newswires is enhancing its news, commentary and analysis for the investment banking community, and is providing it on this service temporarily. Stay tuned for information on continued access to the best of Dow Jones news and opinion on companies, sectors and deals for bankers and research analysts.)

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