A dispute between Monster Beverage Corp. and Coca-Cola Co. over the latter’s plan to launch energy-like drinks will weigh on Monster’s shares for the foreseeable future, analysts said Thursday.
Monster revealed on its earnings call late Wednesday that the drinks giant has delayed the launch of two planned drinks to April of 2019 and sent the matter to arbitration. The two companies have a strategic partnership, which restricts Coke from encroaching on Monster’s core product line.
Chief Executive Rodney Cyril Sacks said the contract between the two companies
that was struck in 2015 restricts Coca-Cola from competing in the energy drink category with certain exceptions. Coke, which owns a 16.7% stake in Monster, has developed two energy products that it believes qualify as exceptions, he said.
“We believe that the exception does not apply,” Sacks told analysts, according to a FactSet transcript. Monster is expecting the issue to be resolved and emphasized that talks remained civil.
Stifel analysts said they were surprised by the news as they do not rate Coke’s changes of gaining traction in the space.
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“Brand Coke is unlikely to resonate with energy drink consumers who prefer edgier products,” they wrote in a note. “We also think the value proposition is likely to be an impediment, assuming the Coke offerings are line-priced to energy products, particularly in the U.S., the world’s largest energy drink market.”
The analysts are further surprised that Coca-Cola is willing to risk its investment in Monster, which they calculate as being worth about $6 billion, and endanger its relationship with management, over “what is likely at best to be a niche product.”
Until the dispute is resolved, however, they agree it will weigh on Monster’s shares. Stifel rates the stock a buy with a $66 price target.
The shares, which had initially gained after the release of third-quarter earnings late Wednesday, fell sharply in after-hours trade as analysts peppered management with questions about the dispute. The stock was down about 4% in midday trade Thursday.
Sacks said their agreement allows Coca-Cola to make certain changes to its products, such as adding vitamins or increasing the caffeine in its drinks.
“But where the brand transcends into a product that we see positioned as an energy drink, that’s where we have a difference of view on the exception under the Coke brand,” he said. “That is really where we are.”
JPMorgan analysts said they spoke to investor relations at Coca-Cola after the call and learned that the exception to the agreement includes energy drinks under the Coca-Cola or Vitamin Water trademarks.
Coca-Cola is planning to launch two products next year independent of the arbitration process as a way to promote growth in the sparkling category, they wrote in a note. The drinks company is hoping to attract a different consumer to Monster’s that would boost growth in the category without cannibalizing Monster’s customer base. But the news is a clear negative for Monster, they said.
“Even though KO (and other large CPG (consumer packaged goods) players for that matter) has historically not been particularly successful in gaining traction in the energy drink category, it does increase competition for broader shelf space (which is already increasing from smaller competitors like Bang energy) in the category and within the company’s global distribution network,” they wrote in a note.
Coca-Cola has been clear that it prefers having an equity investment in Monster over outright ownership, but Monster’s shares have still been trading with a takeover premium, they said.
“While investors may argue why would KO enter the category unless it plans to increase ownership stake in Monster down the road, we believe a move into the category with their flagship brand makes a takeover less likely at this stage.”
Wells Fargo analyst Bonnie Herzog agreed, but Guggenheim took the opposite tack.
“While details of the new Coke product are unclear, it highlights to us that Coca-Cola likely wants to be more relevant in the high-growth energy category,” they wrote in a note. “Ultimately, we think this adds credence to our thesis that Coca-Cola will eventually acquire Monster Beverage, although not likely before the end of 2019.”
Guggenheim rates Monster a buy with a stock price target of $72, or 45% below its current trading level. Wells Fargo has a market perform rating on the stock, while JPMorgan rates it as neutral.
Analysts agreed that earnings—a sales and profit beat—were strong and expect margins to improve in the fourth quarter. The company beat EPS estimates by 6% and revenue estimates by about 3%.
Shares are down about 17% in 2018, while the S&P 500
has gained 5% and the Dow Jones Industrial Average
has gained 6%.