The Coca-Cola Co (KO) announced its plans to acquire Costa Group Holdings Ltd, which means Coke is getting serious about coffee as well as China.
Costa's is the third biggest coffee brand in China, signaling the soda giant will soon go head to head with other U.S. multinationals in a fight for the hearts and wallets of Chinese coffee consumers.
The transaction is all about international expansion for Coke.
"Coke plans to expand the Costa brand internationally across Europe and Asia Pacific (particularly China)," says Dara Mohsenian, equity analyst at Morgan Stanley Research in a note on Friday. "The Costa acquisition fits into Coke's 'total beverage company' strategy under James Quincey and allows the company to enter into global hot coffee/tea beverages in a significant manner."
The deal, which his expected to close in in the first half of 2019, will mean a major boost to Coke's existing coffee and tea segment. The $5.1 billion tag makes up 2.7% of the Coke's market capitalization.
'Bigger than One Brand'
The move into the hot beverages segment is reflective of the CEO James Quincey's vision for Coke.
Back in February 2017, then still serving as Chief Operating Office, he laid out his mission for the company to be a "total beverage company."
"The brand Coca-Cola will always be the heart and soul of The Coca-Cola Company, but the company has outgrown its core brand," Quincey said at the time. "The company needs to be bigger than our core brand."
The timing of Coke's foray into coffee business and expansion into China via a partnership with Alibaba and an ongoing trade standoff between the two countries.
Transformation into a well-rounded beverage company of the future, a company that is environmentally friendly and is attuned to the consumers' changing tastes, will take time.
Carbonated Soft Drinks segment still makes up about 70% of Coke's global volumes, Morgan Stanley points out.
In China, Starbucks dominates the market with a 59% share, so growth there is not going to be an easy feat.
This is a big strategic move and will general nice headlines for Coke, but some analysts are concerned about the retail coffee business's profit margins.
"Although we think investors will appreciate the impressive top-line growth of Costa and the continued diversification away from Carbonated Soft Drinks, we do think investors will have questions surrounding the retail component of the business and lower operating profit margin vs. legacy KO,' Mohsenia noted.
Contrast the operating margin of 13.1% for the fiscal year of 2017 with Coke's 2018 estimate of 31.2%. There is also that backdrop of Trade War and the high-level political standoff between the two nations to worry about.
Meeting Consumers' Demand
Costa is the latest addition to Coke's growing coffee and tea segment.
The company already owns Honest Tea, Gold Peak tea and coffee and Ayataka green tea.
Coke is also already competing with Starbucks in its domestic market via its partnership and distribution of Dunkin' Donuts iced products. Most recently, Dunkin' Donuts® bottled Iced Coffee beverages introduced Pumpkin Spice Iced Coffee, which takes on Starbucks Pumpkin Spice Latte, which has its own following and Twitter account.
In China, Starbucks has 3,400 stores and plans to almost double the number of its locations there. Costa only has 459 stores in China, which is still its biggest market outside the U.K.
As Starbucks and other multinationals are expanding aggressively into China in response to burgeoning demand, Coke is making the right strategic move if it wants to take advantage of this growth and boost its overall product offering.