DBRS Places the Ratings of PepsiCo, Inc. Under Review with Negative Implications

DBRS has today placed the AA (low) and R-1 (middle) ratings of PepsiCo, Inc. (PepsiCo or the Company) Under Review with Negative Implications following today’s announcement that the Company has offered to buy all remaining un-owned shares of its two largest bottlers – The Pepsi Bottling Group, Inc. (PBG) and PepsiAmericas, Inc. (PAS) – for total consideration of approximately $6.0 billion.

PBG, which has been concurrently placed Under Review in view of today’s announcement (see related press release), has annual sales and operating earnings (before non-recurring items) of $13.8 billion and $1.1 billion, respectively, and is PepsiCo’s largest bottler. PepsiCo currently owns 33% of PBG’s outstanding shares. PAS (not rated by DBRS) has annual sales and operating earnings of $4.9 billion and $496 million, respectively, and is PepsiCo’s second largest bottler. PepsiCo currently owns 43% of PAS’s outstanding shares.

The consolidation of PBG and PAS will provide PepsiCo with a fully-integrated supply chain and control of 80% of its North American beverage volume distribution. PepsiCo hopes that this will create a more agile business, capable of greater innovation, faster decision-making and more efficient execution, especially in the non-carbonated soft drink segment. PepsiCo estimates that pre-tax synergies will be approximately $200 million per annum and the transaction will be accretive to earnings.

While DBRS views the transaction positively from a business profile perspective, we note that it will result in considerable deterioration of the Company’s financial profile, notwithstanding the Company’s large cash balances, free cash flow-generating capacity and the prospect of improving EBITDA growth.

PepsiCo’s proposal is based on 50% cash and 50% stock, which will require a total cash outlay of approximately $3.0 billion based on the terms proposed, to be financed via debt (note: PepsiCo’s existing debt at Q1 2009 was $9.5 billion). In addition, the transaction would result in the consolidation of PBG and PAS’s indebtedness, which at year-end stood at approximately $6.2 billion and $2.2 billion, respectively. DBRS notes that PepsiCo’s ratings already take into account $2.3 billion of PBG debt that is guaranteed by PepsiCo. On a pro-forma basis, DBRS forecasts that PepsiCo’s consolidated gross debt will be slightly over $20 billion, resulting in debt-to-EBITDA approaching 2.0 times, a level DBRS considers more in line with an A (high) rating.

DBRS’s review will focus on several factors, including, but not limited to: the potential operational benefits of the bottler consolidation; the impact on PepsiCo’s longer-term strategy; the Company’s intentions with respect to capital expenditures; and share repurchases, acquisitions and debt reduction. Following our review, should the Company indicate the desire to continue using free cash flow for share buybacks versus debt reduction or continue with debt-financed M&A, it is likely that the ratings will be downgraded. DBRS notes that commercial paper ratings are mapped to the long-term ratings and would also be lowered in the event of a downgrade of PepsiCo’s Senior Unsecured Debt.

That said, DBRS acknowledges that PepsiCo does remain a market leader within its business segment, possesses strong brands and improving geographic diversification, all of which continue to lend support to its ratings. Therefore, DBRS believes that there is a possibility the rating could be confirmed at AA (low) following our review, should the Company clearly outline plans to return metrics to a level more commensurate with the current ratings within the next 12 to 18 months.

Notes:
All figures are in U.S. dollars unless otherwise noted.

PepsiCo Canada ULC’s Commercial Paper is guaranteed by PepsiCo, Inc.

The applicable methodology is Rating Consumer Products, which can be found on our website under Methodologies.

This is a Corporate rating.