Last Friday brought us the news that Coca-Cola had bought the Costa coffee chain for £3.9bn which – as the headline writers gleefully reported – is a latte money. We see Costa coffee shops and vending machines everywhere we go. We have all grown up with Coke. But why has the Coca-Cola Company decided to buy a chain of coffee shops? Who has got the best of the deal? And what does it mean for the UK’s high streets?
There are two parties involved in this deal. Whitbread – the owner of Costa – and the Coca-Cola company, headquartered in Atlanta, Georgia and with operating revenues in 2017 of $35bn (£27bn).
Originally intended as a patented medicine, Coca-Cola – I will just call it Coke from now on – was invented in the late 19th Century by John Pemberton. The company was later bought out by businessman Asa Griggs Candler, whose marketing skills led to Coke’s dominance of the world’s soft drinks market in the 20th Century.
We are all familiar with the many different varieties of Coke now on sale – although I am still trying to recover from accidentally buying Peach Coke – and the Coca-Cola Company now has a huge range of soft drinks products sold across the world. What it does not have is a significant coffee brand.
Whitbread and Costa
In the old days when life was simple Whitbread made beer. The business dates back to 1742 when Samuel Whitbread formed a partnership with two others and acquired a small brewery in London and started to brew ‘pale and amber beers.’ Today the company operates around the world, has 50,000 employees and its most notable brands are Premier Inn, Brewers Fayre and Costa.
The first Costa shop was opened in 1971 by two Italian brothers: in 1995 they sold the chain to Whitbread for a reported £23m. There are now 2,755 Costa shops in the UK – with some big shopping centres having two or three branches – compared to around 2,400 Starbucks and 755 Café Nero.
There are around 6,000 Costa coffee machines and approximately 1,350 shops around the world, including 10 in – where else? – Kazakhstan.
Costa was up for sale
To take the valuation of Costa from £23m to £3.9bn is a remarkable achievement by Whitbread – but the last sales figures for the coffee chain had been disappointing.
Back in June, we reported that Costa’s sales had fallen by 2% in the first three months of the year, with the company placing the blame squarely on the declining number of people in the high street – or, as Whitbread put it, “from footfall weakness in traditional shopping locations.”
However, Costa’s sales growth was up by an overall 5.2%, thanks to new stores being opened and more and more coffee machines going into petrol stations and convenience stores. The stores said Whitbread CEO Alison Brittain, “Remain highly profitable and deliver an excellent return on capital.”
Despite this, Whitbread confirmed its determination to spin off Costa from the company’s other business interests to ‘maximise value for shareholders.’ Presumably, that would have seen the chain floated on the stock market with Whitbread retaining a proportion of the shares. But now they have gone for an outright sale: Coke get Costa, Whitbread get the money and – according to Alison Brittain – will use it to expand the Premier Inns chain, return some cash to the company’s shareholders, pay off debt and boost the company pension fund.
Is it a good deal for Coca-Cola?
In the UK, maybe. Maybe not. We have written consistently about the downturn in UK retail and commented on more bad news in Friday’s Economic Round-Up for August. Costa’s last set of results saw sales down as fewer people visited the high street and those that did increasingly decided to drink their coffee in independent shops or shops belonging to smaller chains.
So at first glance it easy to be sceptical about the deal. This represents a very big bet on physical stores at a time when the high street is in decline – in the US as well as the UK. So why spend so much money on Costa: for the Coca-Cola Company, there are four good reasons.
Why Coke bought Costa
First and foremost Coca-Cola does not have a coffee brand, and soft drinks are increasingly seen as unhealthy, so like many soft drinks manufacturers, they are trying to diversify their core product range
Secondly, the US. The biggest coffee chain in the US – by far – is Starbucks, followed at a respectable distance by Dunkin’ Donuts. After that there is a huge gap to the smaller chains, with Tim Hortons – I have to admit I have never heard of it – in third place. That means there is a significant gap which Costa will undoubtedly be looking to fill.
Coffee is a booming business. You may think that we are long past ‘peak coffee’ in the UK but apparently not. The market is forecast to continue growing, hitting nearly £3.5bn this year. But what Coca-Cola really wants is growth around the world and with Nestle having acquired a licence to produce Starbucks branded products, it undoubtedly felt it needed to act quickly.
Analysts say that the Costa deal will allow Coca-Cola to challenge the Nestle/Starbuck link up in “one of the fastest growing beverage categories in the world.” Importantly, this does not just mean sitting in coffee shops: Coca-Cola will look to promote the Costa brand in ground and instant coffee – and people with a Nespresso machine can expect to see Costa pods prominently displayed on the supermarket shelves.
Lastly, there are cost savings. Analysts had previously valued the Costa chain at around £2.7bn, so Coca-Cola could be accused of paying over the odds. But they will expect to make significant cost savings, with Coca Cola’s global distribution, sourcing and logistics network expected to bring big savings to Costa. And it is buying ‘coffee expertise:’ given that it was determined to expand into the coffee market, it does not have to recruit people to source and market its coffee. Buy Costa, get the expertise free…
Is it good news for the UK high street?
In the long run, I suspect the deal will make very little difference. I think the trend towards the smaller, independent coffee shops will continue and the high street’s problems will not be solved by a change of ownership at Costa. One thing is certain though: wherever you go in the world, you will not be able to escape Costa coffee…