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JAMES FLANIGAN

As Investment, Coke Decides It Prefers Coke

July 22, 1987|JAMES FLANIGAN

What does it tell you that Coca-Cola Co. is going to buy up 40 million of its own shares in the next three years at a cost, based on today's prices, of $1.8 billion?

One thing it tells you is that Coca-Cola stock has a strong buyer behind it for the next couple of years. That doesn't necessarily mean the stock will go up, but it could put a cushion under any fall.

Also, it gives you some idea of what a great business soft drinks are. Coke Chairman Roberto C. Goizueta calls the buyback a "good use for our excess cash flow." So profitable is the business that the Atlanta company expects cash flow--that is, after-tax profits plus depreciation on past investments--to total $1 billion this year and even more in the next few years. And that is more than Coke can easily reinvest in its $8.7-billion (sales) business.

But the fact that Coke is prepared to spend more than half its cash flow buying its own stock tells you other things as well.

First it says there are no bargains in the stock market. Coke, said Goizueta, would consider diversifying through acquisitions of other companies if it could see a long-term return. Obviously, at today's prices, he doesn't see anything.

In Coke's case, that means specifically in the entertainment business--where Coke spent $820 million to acquire Columbia Pictures in 1982 and has invested heavily since then--or in the food business, where for all its dominance of the supermarket's soft drink shelves, Coke has never done particularly well and isn't winning any prizes today.

Big Investors Impatient

Secondly, there's what you might call the Allegis factor. The fact that Coke stock shot up $2 to $47 a share when the buyback was announced (it has since slipped to $45.75) tells you that Goizueta was wise to cool it on the acquisition trail. Because the stock market's institutional investors are impatient with big companies using their "excess cash flow" to enrich shareholders of other companies through ambitious acquisitions.

It was pressure from big institutional investors that ultimately forced the dismantling of United Airlines' attempt to grow into a travel conglomerate called Allegis. And they might have sold off Coke stock, too, if Goizueta had reached for a big acquisition at this time.

In fact, though, there's not much fear of that. The company's Atlanta brain trust is normally cautious in acquiring other companies and might even be a little disillusioned with diversification these days.

Five years ago, when Coke acquired Columbia, Goizueta--a Yale graduate in chemical engineering who has been with Coke 33 years and has run it since 1981--explained enthusiastically that just as in Roman times folks enjoyed bread and circuses, so today Coke and movies were a natural fit. Thus inspired, Coke followed up the Columbia acquisition with investments in Tri-Star Pictures and television's Merv Griffin Enterprises.

Can't Transfer Skills

But for all Goizueta's enthusiasm, Coke didn't leap last year when from all reports it might have acquired a major position in CBS. Had it bought CBS, Coke would be an entertainment giant, with ample future uses for its cash flow. As it is, Coke's entertainment division is posting operating losses, thanks to the poor showing of the $40-million movie "Ishtar," and Atlanta management doesn't talk much about the relationship between Coke and movies.

In food, a seemingly natural fit has never emerged. The paradox is that one of the world's great marketing companies, with what may be the world's best-known brand name, hasn't been able to transfer its skills to other items in the supermarket. Its best-known food product is Minute Maid orange juice, which is no slouch, of course. But the orange juice business is under pressure from Procter & Gamble, which is muscling in with Citrus Hill. Coke is fighting an uphill competitive battle against P&G, and the Atlanta management can be excused for not venturing further in food.

So Coke, in a sense, is thrown back on soft drinks. But, as analyst Emanuel Goldman of Montgomery Securities points out, that's one of the world's best businesses. The company makes an 80% operating profit on the Coca-Cola concentrate it supplies for every can and bottle of Coke. And even with movies and food holding it back, Coca-Cola makes almost a 30% return on investment. Moreover, the soft drink business continues to grow--4% a year in the United States, and 8% to 10% a year overseas.

What effect will buying in 10% of the shares have on such a company? Analyst Joseph Doyle of Smith Barney, Harris Upham says: "We figure a 1% addition to the earnings (per-share) growth rate," as total profit is divided by fewer shares. "So where we were predicting 13% growth, now go 14%." Faced with the market's alternatives, it's small wonder that the management thinks Coke is a bargain.

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