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CORPORATES
ISSUER IN-DEPTH1 February 2018
RATINGS
JAB Holding Company S.a r.l.Long term issuer rating Baa1
Outlook Stable
JAB Holdings B.V.Backed SeniorUnsecured
Baa1
Outlook Stable
Source: Moody's Investors Service
KEY METRICS:
JAB Holding Company S.a r.l.
2016 2017 PF June '18 PF
Portfolio Assets MVLeverage
17% 16% (1) >18% (2)
(FFO + Interestexpense) / Interestexpense
1.9x 2.5x 3.5x (3)
(1) Pro-forma disposal of luxury assets
(2) Pro-forma Keurig Dr Pepper closing anddisposal of €1 billion of assets
(3) June 2018 (PF) interest cover includes theequivalent of 6 months of Dr Pepper dividend
Source: Moody's Investors Service; JAB Holdings
Contacts
Stanislas Duquesnoy +49.69.7073.0781VP-Sr Credit [email protected]
Matthias Hellstern +49.69.7073.0745MD-Corporate [email protected]
CLIENT SERVICES
Americas 1-212-553-1653
Asia Pacific 852-3551-3077
Japan 81-3-5408-4100
EMEA 44-20-7772-5454
JAB Holding Company S.a r.l.Merger of Keurig and Dr Pepper will strengthen JAB'sinvestment portfolio, despite increasing leverage
Summary
» The merger of JAB Holding Company S.a.r.l.'s (Baa1 stable) US coffee businessKeurig Green Mountain, Inc. (Ba2 stable) with US soft drink company Dr PepperSnapple Group Inc. (Baa1 stable) will strengthen JAB's investment portfolio. Itcreates an integrated beverage company with exposure to a wide range nonalcoholicpackaged beverage market categories and a broad distribution network. The new businesswill have a good split between low growth carbonated soft drinks and juices, where scaleis very important because growth is limited, and faster growing categories such as coffee,ready to drink tea and coffee, sport and energy drinks as well as still water. JAB and DrPepper expect $600 million of cost synergies as a result of the merger. However, thereare execution risks achieving large working capital improvements and cost synergies, andpotential business disruption as changes and cost cuts are implemented, although theproposed Keurig Dr Pepper management team has a strong track record in managingthese processes. Access to Dr Pepper's distribution system in the US market will improvethe distribution of JAB's consolidated coffee assets.
» The merger will increase JAB's market value leverage but interest cover willimprove. JAB's equity contribution to the transaction will be funded from cash onbalance sheet and additional debt. This will result in an increase in market value leverageto at least 18% pro forma the closing of the transaction, from estimated 16% as at 31December 2017, assuming JAB makes up to €1 billion from asset disposals. The increasein leverage will also depend on the share price development of Dr Pepper until thetransaction closes. At the same time, we expect JAB's interest cover to improve as a resultof a strong dividend stream from Dr Pepper. JAB also has a stated commitment to reducemarket value leverage to its 15% target during the next 12 to 18 months.
» JAB swaps a 43% stake in a Ba2 rated asset for a smaller stake in a higher rated,larger and more defensive Baa2 rated business, a longer term credit positive. Themerger will improve the liquidity of JAB's portfolio through a higher share of listed assetsin the portfolio. The contribution of the listed assets to the overall value of the portfoliowill increase pro forma the transaction, although the exact split will depend upon themarket's assessment of the value of the new Keurig Dr Pepper.
MOODY'S INVESTORS SERVICE CORPORATES
Keurig and Dr Pepper merger will strengthen JAB's investment portfolioOn 29 January, privately held investment holding company JAB Holding Company S.a.r.l. (Baa1 stable) announced that it will mergeits US-based coffee business Keurig Green Mountain, Inc. (Ba2 review for upgrade) with the US-based non alcoholic soft beveragecompany Dr Pepper Snapple Group Inc. (Baa1 review for downgrade).
Under the proposed transaction, JAB and other investors will pay Dr Pepper shareholders a dividend of around $103.75 a share, oraround $18.7 billion in cash. Keurig will then be merged into Dr Pepper to form Keurig Dr Pepper, or KDP, which will be listed on theNew York Stock Exchange. Existing Dr Pepper shareholders will retain a 13% stake in the new company, Mondelez approximately13%-14%, leaving around 73%-74% for JAB, JAB Consumer Fund and other investors. The proposed transaction will be funded with $12billion of new debt for the combined entity and about $9 billion of equity from JAB and other investors. The proposed merger remainssubject to regulatory and shareholder approval.
The merger of Keurig and Dr Pepper will create an integrated beverage company with exposure to a wide range of nonalcoholicpackaged beverage market categories and a broad distribution network. Dr Pepper brings a large scale, stable, profitable and cash flowgenerative portfolio of brands focused on carbonated soft drinks and juices. Keurig brings a single serve and ready to drink coffee andtea business with stronger growth prospects.
The new group will be the only global soft beverage company with exposure to all beverage categories apart from milk, but milk is lessprofitable than other categories. We consider this stronger horizontal integration a competitive advantage against larger peers TheCoca-Cola Company (Aa3 stable) and PepsiCo, Inc. (A1 stable) which are more focused on carbonated soft beverages, juices and waters.They have only recently started expanding their portfolios in the higher growth categories of ready to drink coffees and teas and awayfrom carbonates and juices, where growth is slowing. Nestle S.A. (Aa2 stable) is largely focused on tea, coffee and bottled water anddoes therefore not have the same depth of distribution network of its three competitors.
Exhibit 1
New KDP group will have a diverse range of beverage categories and a good mix of mature and growth categoriesNew company's portfolio of brands across beverage categories
Source: Dr Pepper Snapple Group
However, JAB is merging its growing coffee business Keurig into Dr Peppers' mature business which has little in the way of growthprospects. This leaves only the generation of cost synergies as a means to generate additional value from combining the twobusinesses, versus keeping Keurig as a stand alone company.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.
2 1 February 2018 JAB Holding Company S.a r.l.: Merger of Keurig and Dr Pepper will strengthen JAB's investment portfolio, despite increasing leverage
MOODY'S INVESTORS SERVICE CORPORATES
While JAB argues that the beverage market is a single market, we believe that there are distinct market dynamics in JAB's coffeebusinesses and the soft beverage market. The latter is more resilient because the US market is heavily consolidated, with Coke, Pepsiand Dr Pepper controlling more than 75% of the US market. The soft beverage market is also protected by very high barriers to entrybecause companies need a broad route to the market system to be able to compete successfully.
JAB portfolio companies' access to Dr Pepper's deep route to market system will benefit both the newly merged company and JAB. DrPepper will be able to distribute a large portfolio of JDE and JAB Beech Inc.'s retail coffee and tea brands. This will boost top line growthprospects of these brands, which include Peet's Coffee, Coffee Stumptown, Mighty Leaf and Tea Forte.
Both companies also expect the transaction to generate cost synergies, which they have estimated at $600 million. This accounts forabout 5.5% of the pro forma revenue of the new KDP group. About 80% of the cost synergies will be from cost of goods sold (COGS),selling, general and administrative expenses (SG&A) and distribution savings. JAB also has very ambitious working capital reductiontargets.
While there is sound strategic rationale for the transaction, there is execution risk in improving working capital and achieving costsynergies. We put Dr Pepper's rating under review for downgrade on 28 January, because we expect to downgrade its rating by onenotch to Baa2 with a negative outlook once the transaction has closed, if the deal is structured as it has been announced. A downgradewould reflect Dr Pepper's higher pro forma leverage after the merger, as well as the execution risk of achieving relatively large workingcapital improvements, synergies and cost reductions over the next few years, which are needed if Dr Pepper is to reduce leveragequickly. Our review will also consider the potential for business disruption as changes and cost cuts are implemented as part of itsreview process.
The proposed transaction will increase JAB's market value leverage but interest cover will improveWe expect JAB to fund its €1.5 billion-€2.0 billion equity contribution to pay for the dividend to Dr Pepper's existing shareholders andfor the increase in common equity of the new group through cash on balance sheet and drawings under the group's revolving creditfacility. JAB has also committed to asset disposals totaling up to €1.0 billion to reduce the net cash funding of its equity contributionto a maximum of €1.0 billion maintaining market value leverage, measured as the value of JAB's investment portfolio divided by thegroup's reported net debt, within JAB's financial policies.
As a result of the transaction, we expect JAB's market value leverage to increase to at least 18% pro forma the closing of thetransaction from estimated 16% as at 31 December 2017, pro forma the disposal of JAB's luxury businesses, announced in 2017.However, the increase in market value leverage will largely depend on the equity market's assessment of the value of the new Keurig DrPepper group. We would expect to gain more clarity over the next few weeks on the market's assessment of the value of JAB's stake inKeurig Dr Pepper.
An increase in market value leverage will be partly offset by improved interest cover because the increase in dividend from Dr Pepperwill more than compensate the marginal increase in JAB's net interest expense resulting from the modest increase in net debt. Weexpect JAB's interest cover to improve to around 3.5x in 2018 pro forma the transaction from around 2.5x in 2017. Interest cover willimprove further in 2019 as a result of the dividend flow from Dr Pepper.
JAB has also stated its commitment to bring down its market value leverage to around 15% within the next 12 to 18 months to supportits current rating. The ability of JAB to restore its market value leverage to 15% will also depend on the pro forma market value leverageat closing of the Keurig Dr Pepper transaction as the higher the market value leverage gets the more difficult it will become to bring itback to 15% in an acceptable time frame.
JAB will increase its net debt to approximately €4.5 billion (pro forma the Keurig Green Mountain transaction and including up to €1billion of asset disposals), from around €500 million in 2012, or around nine times since 2012, without a material deterioration ofmarket value leverage. This is because valuation multiples of both listed and private assets have increased materially, in line with theoverall market. However, the portfolio's underlying earning growth has been lower than the increase in net debt. Consequently webelieve that JAB is fairly exposed to a material correction in the equity stock markets — even if its portfolio of investments is resilientand earnings volatility remains relatively limited through the macroeconomic cycle.
3 1 February 2018 JAB Holding Company S.a r.l.: Merger of Keurig and Dr Pepper will strengthen JAB's investment portfolio, despite increasing leverage
MOODY'S INVESTORS SERVICE CORPORATES
Smaller stake in stronger business is a longer term credit positiveAs a result of the proposed merger, JAB will swap a stake in a Ba2 rated company — although one with a positive outlook prior to theannouncement of the transaction — for a higher rated asset albeit under review for downgrade following the announcement of thetransaction. The new group will account for a relatively material portion of the overall value of JAB's investment portfolio, providing asignificant lift to its overall creditworthiness.
The Baa2 credit rating of Keurig Dr Pepper will be supported by the group's large scale, earnings and cash flow resilience, strongprofitability and JAB's commitment to reduce leverage quickly after the transaction closes.
Beyond the positive impact on the overall credit worthiness of JAB's investment portfolio, the merger will also address JAB's otherrelative weaknesses.
The contribution of the listed assets to the overall value of the portfolio will increase pro-forma of the transaction although the finalshare of listed / unlisted assets will ultimately depend on the market’s assessment of the value of Keurig Dr Pepper. This will improvethe liquidity of JAB's investment portfolio because it is much easier to sell a stake in a listed asset than it is in a private asset. Thehigher share of listed assets will also improve the transparency of the valuation. Lastly the transaction will improve the breadth of JAB'sinvestment portfolio and diversify its sector exposure.
Second, the swap of a private asset for a listed asset will also improve the transparency of the investment's valuation.
4 1 February 2018 JAB Holding Company S.a r.l.: Merger of Keurig and Dr Pepper will strengthen JAB's investment portfolio, despite increasing leverage
MOODY'S INVESTORS SERVICE CORPORATES
Moody’s related publicationsMethodology:
» Investment Holding Companies and Conglomerates, 31 December 2015
Issuer Comments:
» JAB Holdings' Market Value Leverage Will Improve with Jimmy Choo Sale, 27 July 2017
» JAB's Acquisition of Panera Bread Will Substantially Increase Leverage, 10 April 2017
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of thisreport and that more recent reports may be available. All research may not be available to all clients.
5 1 February 2018 JAB Holding Company S.a r.l.: Merger of Keurig and Dr Pepper will strengthen JAB's investment portfolio, despite increasing leverage
MOODY'S INVESTORS SERVICE CORPORATES
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6 1 February 2018 JAB Holding Company S.a r.l.: Merger of Keurig and Dr Pepper will strengthen JAB's investment portfolio, despite increasing leverage
MOODY'S INVESTORS SERVICE CORPORATES
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Americas 1-212-553-1653
Asia Pacific 852-3551-3077
Japan 81-3-5408-4100
EMEA 44-20-7772-5454
7 1 February 2018 JAB Holding Company S.a r.l.: Merger of Keurig and Dr Pepper will strengthen JAB's investment portfolio, despite increasing leverage
