Nelson Peltz: No Fritos with My Pepsi.

Trian Fund Management, LP wrote a letter to Pepsi's board saying that as an owner of $1.2 billion in PEP shares and with experience in the food business, Pepsi should spin off its snack business to shareholders and leave the beverage business as a stand-alone company.

Trian spins its arguments specifically for the seven year period of current CEO Indra Nooyi's tenure, and this seems to coincide with the data points about Pepsi's under performance. Here are the really salient points in their argument:

"As a distant number two competitor in beverages, PepsiCo never had the luxury of following the same strategies as those deployed by industry leader Coke. But PepsiCo nevertheless competed extremely effectively The company did so, from its earliest days through the 1990s, and was known for being faster on its feet, quicker to introduce new products, more willing to take risks and more willing to occasionally fail by doing so. Pepsi not only survived in this role of “industry disruptor,” it thrived. 

Meanwhile, Frito-Lay was known historically for having one of the best corporate cultures in America. Its culture was separate and distinct from Pepsi, which made sense given different category and competitive dynamics – snacks versus beverages, push versus pull marketing, Frito-Lay as #1 in an industry with regional competitors versus Pepsi as #2 in an industry with one large competitor. Frito-Lay’s strong culture, combined with a dominant market share in an attractive category, created a force to be reckoned with in the food industry.

         On the corporate front, PepsiCo was known for running with low overheads, even after the company            moved to Purchase in 1970."

All of these points are on the money.  Pepsi has become the Microsoft of its snack foods and beverages business: a duopolist in colas and dominant in snack foods, but unable to innovate and  really leverage its assets into earnings growth.  Agility, culture and costs should be the bread and butter charters of the board and management and clearly these have to be addressed.

But, to go from here to a spinoff seems to hang on some pretty weak arguments, such as "We've seen Kraft and others do this, so ipso facto, it must be the best thing to do right away."  The board should address how costs are going to be cut visibly and faster, and the right people should be put into the right slots to make the businesses perform better with the assets they have.  Innovation is not as easy, but it's not rocket science either, because this isn't drug discovery, after all.

In recent quarters, Pepsi appears to have actually pulled a few earnings surprises.  It has also given its longer-term projections as being a low single digit revenue growth business with mid to high single-digit revenue growth, with cash flows for dividend growth. This is about all this business can be in the medium term.

Distribution channels in the food business are everything. Frito Lay was the best in breed, and I presume that it still is, abstracting from any overhead allocation issues. Pepsi owns 11 out of the top 15 snack food brands direct delivered to retail, and Fritos are at the top.  Buying its bottlers has been criticized, with Trian quoting the CEO as admitting it was a "mistake."  The argument for doing so was, in addition to competing better with Coke, to give the company flexibility in pushing new and niche volume products through the distribution chain as sugared colas are clearly a declining unit volume business. Independent bottlers wouldn't want to take on a line of new organic juices instead of the larger volume carbonated drinks, the argument would go,

The answers to these questions are nowhere near as clear as Trian's letter makes out. In the emerging markets, much is made of losing share in India: that has more to do with the dynamics of Indian distribution than it does with Pepsi's execution.  Pepsi, unlike Coke, is said to be gaining share in China.

Should Pepsi become leaner, more agile and more efficient?  Absolutely, no doubt, and in a hurry.  Is the holding company structure the best for Pepsi?  It should be, but it isn't because of the above failures of management. Is a structure of two independent companies the best?  Unclear.

I'll take that Diet Pepsi now, please.