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Time to Invest in the Dr.

Pepper Spin
Current
Price
Shares Outstanding
Market Cap
Dividend
Dividend Yield
Location

$20.45
253.69 MM
$5,187.87 MM
None
0.0%
Plano, TX

Dr. Pepper Snapple Group (Dr. Pepper, ticker: DPS) stands out from other spin-offs due to its
well-known brand names, discounted valuation to comparables, and added selling pressure due
to its listing in a the US from a parent with a UK shareholder base. Dr Pepper officially became
an independent company after the demerger from its parent company, Cadbury Schweppes
(who is also trading under a new ticker symbol CBY), was completed on May 7th, 2008.
Dr. Pepper is in the great business of selling sugar water. They, of course, have very wellknown brand names, which include: Dr Pepper, Snapple, 7UP, Motts, A&W, Canada Dry,
Hawaiian Punch, Schweppes, IBC, Sunkist, Nantucket Nectars and Yoo-hoo. The branded
beverage business has been a great business for decades. Recently, there have been some
concerns about the growth rates of carbonated beverages.
Dr. Pepper looks cheap. According to unaudited supplemental financial information released on
June 27th (prepared on a carve out basis from Cadbury Schweppes historical financial data),
Dr. Pepper is currently selling at a P/E multiple just under 10x.
Dr. Pepper is also attractive because it has had additional selling pressure due to being listed in
the US when its parent company, Cadbury, is traded on the London Exchange. After being
spun-off, Dr. Pepper began trading on the NYSE, causing many UK institutions to sell the stock
right away, creating a steep decline in the stock price.
Dr. Pepper began regular-way trade back in May around $25. The stock has fallen during first
three months of trading to the $21 level. During this same time period, Pepsico has been flat
and Coke has only had half the decline of Dr. Pepper.
Dr. Pepper will issue second quarter 2008 financial results on Wednesday, August 13, before
the market opens. Following this release, an earnings conference call will take place at 11 AM
ET.

Industry Analysis
The beverage industry is a highly competitive industry with Dr. Pepper competing against
multinational corporations with significant financial resources and brand name awareness,

including Coca-Cola and PepsiCo. In addition, smaller regional corporations have the ability to
glean some of the market due to their ability to exploit niche markets and quicker turnaround in
product innovation. Therefore, in order to compete, Dr. Pepper must utilize advertising and
marketing effectively while also using pricing measures to gain a competitive advantage.
Currently the beverage industry is being hit by escalating commodity costs and a slowing U.S.
economy, which has created 2008 as an especially challenging year for the beverage industry
as a whole. Year to date, the soft drink index has had a 14.83 percent decline while the DJ U.S.
Total Market Index has only declined 13.38 percent.
Specific to Dr. Pepper, volume in bottler case sales (BCS), which is determined by sales of
finished beverages, in equivalent 288oz cases, sold by Dr. Pepper and bottling partners to
retailers and independent distributors, declined by 3 percent this quarter versus 2007 first
quarter. Carbonated soft drinks (CSDs) declined 2 percent and non-carbonated beverages
(NCBs) declined 8 percent.
The 2 percent decline in CSDs can be summarized by: (1) Dr. Pepper volume declining 2
percent due primarily to mid-single-digit declines in fountain/foodservice and (2) Core 4
(7UP, Sunkist, A&W, and Canada Dry) volume declining 5 percent due primarily to decreases in
promotional activities for 7UP this quarter as compared to 2007 first quarter.
The 8 percent decline in NCBs can be summarized by: (1) Double-digit volume declines in
Hawaiian Punch due primarily to price increases taken in April of 2007 and (2) the loss of a
distribution agreement between Glacau products, reducing NCB growth by 4 percentage points
in the quarter. These declines completely offset volume growth increases of 3 percent and 6
percent, respectively, for Snapple and Motts.
North America BCS declined 4 percent while Mexico and the Caribbean BCS grew 3 percent
due primarily to single-digit growth in the product Squirt.
Overall, sales volume decreased this quarter by 4 percent from the 2007 first quarter results.
This is due, in combination, to BCS declines and a change in the timing of concentrate price
increases from April in 2007 to February in 2008.
Net sales, however, still increased by 3 percent, as sales volume decreases were offset by
increased pricing. Though, the question is raised whether this growth can be sustained by
raising prices again in order to further offset rising commodity prices and potential reoccurring
volume decreases. Specifically, Dr Pepper has issued 2008 full-year guidance indicating they
expect rising commodity costs to increase their COGS by approximately 6 percent. The ability
to recover these increased costs through higher pricing may become more and more limited by
the competitiveness of the beverage marketplace. As a result, certain hedging strategies were
used in the past to offset these risks and must continually be used effectively in the future so
that these increased costs to not effect Dr. Pepper more so than their competitors.

Business Overview
Business Lines
Dr. Pepper is an integrated brand owner, bottler, and distributor of non-alcoholic beverages in
the United States, Canada, and Mexico. Dr. Peppers non-alcoholic beverages include a
diverse assortment of flavored (non-cola) carbonated soft drinks (CSD) and non-carbonated
beverages (NCB), which include ready-to-mix teas, juices, juice drinks, and mixers.
Gator Capital Management

August 4, 2008

As a brand owner, bottler, and distributor, Dr. Pepper operates and reports through four
business segments: (1) Beverage Concentrate, (2) Finished Goods, (3) Bottling Group, and (4)
Mexico and the Caribbean.
Distribution
Dr. Peppers operations are more integrated than Coke and Pepsis because Dr Pepper owns a
higher percentage of its bottling operations. This arguable because Coke has a large stake in
Coca-Cola Enterprises and Pepsi has a stake in Pepsi Bottling Group. It is also debatable
whether owning bottling operations is a good ROIC business. Certainly, owning bottling
operations reduces the natural friction between the concentrate company and the bottler.
However
Brands
Dr. Peppers brand portfolio has some of the most well-recognized beverage brands in North
America, which include: (1) popular CSDs such as Dr. Pepper, 7UP, Sunkist, A&W, Canada
Dry, Schweppes, and Squirt and (2) NCBs such as Snapple, Motts, Hawaiian Punch, Clamato,
Mr & Mrs T, Margaritaville, and Roses.

Managements background
Larry D. YoungPresident, CEO and Director
Young was elected to the position in October 2007 and he remains subsequent to the company
going public. Young worked his way up after servings as President and COO of the Bottling
Group segment and Head of Supply Chain in 2006 after the acquisition of Dr. Pepper/Seven Up
Bottling Group, where he had been President and CEO since May 2005. Before join the
company, Young served as President and CEOO of Pepsi-Cola General Bottlers, Inc. and
Executive VP of Corporate Affairs at PepsiAmericas, Inc.

Hidden values from the spin


Integration
Dr. Peppers boasts its business model as being a competitive advantage to other competitors.
They claim their integrated business model strengthens the route-to-market, provides
opportunities for net sales and profit growth through the alignment of the economic interests of
their brand ownership, bottling, and distribution businesses, which enables them to be more
flexible and responsive to the changing needs of large retail customers. This could be the case
as soon as the benefits from the separation start to truly take effect. However, as mentioned
before, operating margins are still on the lower end compared to its competitors. This could
change as the separation will allow Dr. Pepper to further pursue new acquisitions through the
use of shares of common stock as consideration.
Acquisition of SeaBev
Dr. Pepper acquired the Jacksonville, Florida-based Southeast-Atlantic Beverage Corp.
(SeaBev) on July 11, 2007 for $53 million. SeaBev is the second largest independent bottling
and distribution company in the United States with 2 manufacturing facilities and 16 warehouses
and distribution centers located from Miami to Atlanta. This will provide Dr. Pepper with gained
distribution and geographic coverage in the Florida market. Due to this acquisition, SeaBev
accounted for an increase of net sales growth by 2 percentage points and added an incremental
$39 million to Dr. Peppers net sales for the three months ended March 31, 2008.
Gator Capital Management

August 4, 2008

Restructuring
Prior to the spin, in October 2007, Dr. Pepper announced a restructuring of the organization
that was intended to increase efficiency. Specifically, the company cut 470 employees in their
corporate, sales, and supply chain functions. In addition, the restructuring will include the
closure of two manufacturing facilities in Denver, CO (closed in December 2007) and Waterloo,
NY (closed March 2008). The employee reductions were expected to be completed in June
2008.
As a result of the restructuring Dr. Pepper said they recognized a charge of approximately $32
million in 2007 and they expect to recognize a charge of approximately $21 million in 2008.
They expect to generate annual cost savings of approximately $68 million due to the
restructuring, of which most is expected to be realized in 2008 and the full benefits realized from
2009 onwards.

Balance sheet
Debt Structure
Dr. Pepper settled all receivable and loan balances in relation to Cadbury Schweppes upon the
completed separation from Cadbury Schweppes on May 7, 2008. The net balance was paid
using new unsecured senior credit totaling $3.9 billion. The new capital structure has a blended
interest rate of 6.3%, based on current LIBOR and including 50 basis points related to the
amortization of certain fee and expenses associated with establishing new facilities.
Dr. Pepper entered into arrangements on March 10, 2008 with a group of lenders to receive an
aggregate of $4.4 billion in senior financing, which included a term loan A facility, a revolving
credit facility, and a bridge loan facility. As of March 31, 2008, no amounts of these facilities
were outstanding.
However, on April 11, 2008, the previous March 10, 2008 arrangements were amended and
restated to consist of a $2.7 billion senior unsecured credit agreement that provides $2.2 billion
term loan A facility and a $500 million revolving credit facility (collectively, the senior unsecured
credit facility) and a 364-day bridge credit agreement that provided a $1.7 billion bridge loan
facility. The bridge loan was replaced by a $1.7 public debt issue at the end of April.

Debt Ratios
Long-Term Debt to Equity
Long-Term Debt to Equity vs. Industry
Long-Term Debt to Total Capital
Long-Term Debt to Assets
Total Debt to Equity
Total Debt to Total Capital
Total Debt to Assets
Total Debt (in millions)

0.48
130.73%
0.30
0.23
0.60
0.38
0.29
$3,900.00

Capital Management Going Forward


Dr. Pepper plans to manage capital to the liquidity needs of the business with any excess
cash to be used in order to pay down debt.
Gator Capital Management

August 4, 2008

Valuation

Dr.
Pepper
CocaCola
Pepsi

Price

Enterprise
Value

2007
EBITDA

Absolute
EV/EBITDA

3-year
growth*

Absolute
PE

Relative
PE*

20.45

8,087.28

1100

7.35

25%

9.79

50.89%

51.86

125,169.5

7,252

17.26

11%

20.69

107.62%

67.40

110,904.3

7,228

15.34

10.5%

18.71

*3-year growth for sales


from 2005-2007

97.31%
*P/E vs. Industry

Dr. Pepper has exhibited a much larger 3-year growth in earnings and its price has not followed
this figure proportionally since the company going public with a P/E ratio of only 9.79 and a
relative P/E ratio to the soft drink industry of 50.89%. If the company can increase operating
margins to rival its competitors and keep growth in earnings relative to where they are, Dr.
Pepper seems like a very good bet in the long-run.
Summary
Dr. Pepper is a well-branded, popular soft drink business that could very well exhibit the benefits
of a spin-off after a huge sell-off from Cadbury stockholders. In addition, Dr. Pepper looks like a
great value buy with its current valuations and growth prospects. Moreover, with the separation
complete, management can now focus more on growing the business and using capital more
efficiently.
I recommend following Dr. Pepper in the upcoming days and weeks in order to determine if a
bottom in its initial spin-off decline has been found and whether a breakout could occur for this
well-branded, competitive company. However, I also advise treading with caution, as the
general market trend is poor at the moment and any investment may still be premature, even
with Dr. Peppers cheap position.

Gator Capital Management

August 4, 2008