A New Future for Cadbury Schweppes

Separating the candy and drinks divisions is supposed to allow them to sharpen their focus on rivals such as Coke and Wrigley, but big challenges await

The moment was almost a year in the making. On Apr. 11, shareholders of Cadbury Schweppes (CSG), the world's largest candymaker and one of the top sellers of beverages, finally voted to spin off the company's U.S. drinks division. Separating candy from drinks theoretically will boost shareholder value and allow the two halves of the company to sharpen their competitive focus on rivals such as Coca-Cola (KO), Pepsi (PEP), Nestlé (NESN.BE), Hershey's (HSY), and Mars.

But despite an upbeat tone set by Chief Executive Todd Stitzer, both new companies face big challenges. Lacking the diversified product ranges of its competitors, the newly independent chocolate, candy, and gum business—to be listed on the London Stock Exchange on May 2—could become a takeover target (BusinessWeek.com, 10/19/07) for a deep-pocketed rival such as Kraft Foods (KFT). Some British shareholders worry about another iconic brand falling into foreign hands.

Meanwhile, the new U.S. drinks business—which will be named Dr. Pepper Snapple Group (DPSG) and is set to be listed on the New York Stock Exchange on May 7 (BusinessWeek.com, 3/12/08)—could face even tougher odds. Competing against giants Coca-Cola and Pepsi, DPSG must find new ways to exploit its noncarbonated brands, including Snapple and Mott's, to take advantage of consumer movement away from soda pop to healthier, fruit-based beverages.

Candy and Gum Sales Up

"The jury is still out on whether the demerger of the U.S. drinks business will solve Cadbury's problems," says Jeremy Batstone-Carr, director of private client research at stock brokerage Charles Stanley (CAY.L) in London, who has a reduce rating on the stock. "The U.S. [beverage] market is moving in their direction, but both sides of the company face an uphill battle." Shareholders voiced their doubts on Apr. 11 by driving Cadbury Schweppes shares down 2.6% in London and 3.2% in New York.

From the company's first-quarter interim report, released Apr. 11, it was clear why Stitzer would rather be in the confectionery business. First-quarter candy and gum sales climbed 7% over the same period last year (the company doesn't disclose specific revenue figures), due primarily to growth in emerging markets. Analysts figure sales for the group will hit $11.3 billion in 2008, up 9.5%.

By comparison, the Americas Beverages division turned in growth of just 1%, mainly due to weakness in its carbonated drinks, which include 7Up, Dr. Pepper, A&W, Canada Dry, and Schweppes tonic. The company expects revenues for the group to grow 3% to 5% for 2008 as a whole, to around $6 billion.

Foreign Expansion

So what happens now? Though chocolate in Britain—especially the iconic purple-wrapped Dairy Milk bar—is still Cadbury's core, the new confectionery company is staking its hopes on chewing gum and emerging markets. Cadbury paid $4.2 billion in 2003 to buy Adams from Pfizer (PFE) and since then has grown its share of the North American gum market by nine percentage points, to 35%.

Much of the gain has come at the expense of Wrigley (WWY), whose own market share has fallen six points, to 60%, over the same period. Cadbury now aims to extend its big brands, including Trident, Dentyne, and Bubblicious, into Europe and Asia, where revenue growth for its gum divisions has been in double digits in recent years.

Emerging markets already provide one-third of the company's confectionery revenues—and represent its main source of growth. In the first quarter, for instance, sales in the Asia Pacific region grew 7% year-over-year, vs. just 3% in Britain. To boost its foreign stake, Cadbury is splashing out on acquisitions. In 2007, it spent $450 million to buy Turkey's Intergum and $111 million for Japan's Sansei Foods.

Analysts say more acquisitions may be needed to go after bigger opportunities. Cadbury "hasn't found much traction [in China and Russia]," says Graham Jones, director of equities research at brokerage Panmure Gordon (PMR.L) in Liverpool. "The best approach would be to find acquisitions and focus on the countries' biggest cities."

Will Kraft Want a Bite?

Another risk remains the possibility of an unsolicited takeover bid. Market-watchers believe the most likely contender would be Northfield (Ill.)-based Kraft Foods, which bought Danone's (DANO.PA) biscuit and cereal business in 2007 for $7.2 billion and has expressed interest in further international expansion. Panmure Gordon's Jones says Cadbury would help Kraft increase its presence in Europe and Asia, though any deal likely would have to wait until the company has finished digesting the Danone division.

Prospects for Dr. Pepper Snapple Group are decidedly less clear, in part because many of its brands have troubled histories. Dr. Pepper, for instance, was a pioneer in cherry-flavored cola, but now faces stiff competition from Cherry Coke, while Coca-Cola's Sprite long ago vanquished 7Up despite the latter's head start in the lemon-lime category. Then there's Snapple, which has been tossed from one corporate parent to another, but has never quite lived up to its lofty valuation.

The drinks business originally was going to be sold off to private equity investors last year (BusinessWeek.com, 7/27/07), but the freeze in credit markets killed the deal. Now, as a standalone public company, it must contend with a change in customer tastes toward healthier fruit drinks. According to Citigroup (C), fruit-based drinks account for about one-fifth of DPSG's revenues and posted growth of 5% last year. By contrast, the much larger carbonated drinks group grew just 1.3%.

"DPSG will have to invest aggressively in its drinks business to push its existing [fruit] brands forward," says analyst Batstone-Carr of brokerage Charles Stanley. "The company isn't well-placed financially to acquire other companies, so it will have to focus on organic growth."

Caught Between Coke and Pepsi

In the fiercely competitive $106 billion U.S. beverages market, future expansion for DPSG is no sure bet. Market leaders Coca-Cola and Pepsi also have targeted fruit-based drinks—and enjoy larger distribution networks and deeper pockets. DPSG brands such as Nantucket Nectars and Hawaiian Punch already are feeling the squeeze, and analysts are skeptical that the business can hit its 3% to 5% annual sales growth targets.

"You can't ignore the competition from Coke and Pepsi," says Panmure Gordon's Jones. "DPSG is half their size and it could get caught in the crossfire when these bigger companies ramp up their [healthier drink] offerings."

In its nearly 40 years as a unified company, Cadbury Schweppes had ample time to prove that soda pop and candy are natural bedmates. But the marriage has ended in separation. Shareholders of the new spin-offs can only hope that the two halves of Cadbury Schweppes can find better fortunes on their own.

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