Fizzy math

Peltz, Pepsi break-up arguments both a bit flat

Nelson Peltz and the Pepsi management are both falling a bit flat in their opposing arguments about the merits of breaking up the company. The soda maker has long argued that losing up to $1 billion in synergies between the drinks and food divisions would offset gains from a split. That's not quite true. But only a rapid uptick in profitability afterwards would justify the drastic surgery Peltz proposes.

The activist investor thinks severing the connection between snacks and soda would allow both units to operate more efficiently. Pepsi's total returns have lagged those of other big snack and beverage peers since 2006, when Indra Nooyi was appointed chief executive.

He's assuming Pepsi snacks, anchored by Doritos-maker Frito Lay, might eventually warrant the same multiple as US confectioner Hershey. Its shares currently trade at 25 times this year's forecast earnings. On that basis, just cleaving Pepsi in two might add some 21 per cent to its current market value - or $26 billion.

That looks aggressive. A more conservative analysis would value snacks in line with Mondelez at 20 times earnings. Keeping beverages at Pepsi's current 17.6 times earnings multiple would then leave shareholders roughly $2 billion better off than they are now, even after accounting for the lost synergies.

By itself, that's nowhere near enough to justify a split. It would require both newly independent companies to up their game on profitability. Peltz certainly has a case that being on their own could inspire better management focus, stronger innovation and less top-level bureaucracy.

Assume, for example, that aggregate operating margins were to improve from the current 15 per cent to 18 per cent in, say, five years' time. Using the more conservative valuation method, investors still owning both companies would be 36 per cent better off than they are now.

The trouble is, that's a long time to wait and requires a good deal of faith in executives who have sat on a bloated cost structure for years. Peltz might be better off arguing for a change of management than a break-up.