The Inevitability of Coca-Cola’s Monster Energy Buyout

Marty Whitman, the successful investor and author of “The Aggressive Conservative Investor”, recommended investing in companies that were profitably growing in their own right but also had the high probability of being acquired by a larger firm in the industry.

The attractiveness of this philosophy is that you can have a few holdings in your portfolio that stand to gain from a one-time bump of 37% in addition to receiving returns fueled by the earnings growth in the interim.

The awareness of this type of flavor to one’s investing strategy is generally most actionable when you are considering businesses that you would independently own in their own right even if not accompanied by the promise of an eventual buyout.

I imagine some form of this strategy animates at least a portion of the shareholder base for Monster Beverages stock, most famous for selling drinks under the same name (although its brands include lemonades, cocktails, and bottled juices as well).

This is a business that has a strong record of double-digit growth dating back to Hubert Hanson’s founding of the California juice firm in the 1930s, making anyone who invested a few thousand dollars in the then known as “Hansen Foods” a millionaire within their lifetime. Then, it struck gold with its energy drink brands and the 8-10% growth transformed into 21% annual growth (see Monster’s growth changes since 2005).

When you buy Monster Beverages stock, you are getting: (1) a business with a nearly centuries long track record of operational success; (2) a business that relies on heavy amounts of caffeine, which has a “stickiness” in the form of lifelong customers that form habits and cannot imagine life during caffeine withdrawal; (3) a business with no debt and over a billion in cash in the bank; (4) a business that has grown earnings per share by 21% annually since 2005.

In addition to all those things, you also obtain a high likelihood that Coca-Cola will either pay you a substantial premium, perhaps something in the vicinity of $90-$105 per share, to purchase buy out the business.

We can categorize the likelihood as “highly probable” because Coca-Cola owns 100 million shares of the 560 million that are outstanding, and now services distribution of Monster Energy products on its platform. The acquisition is about as readily apparent as any you will ever see in the publicly traded markets. When the price is right, it will happen.

For someone who owns Monster stock (MNST), the terms are highly favorable while you wait. You get to own something with a strong balance sheet that is fast-growing, and you will either get a one-time cash payout premium or you will receive a premium to convert your shares to Coca-Cola (since any acquisition would likely cost Coca-Cola somewhere in the neighborhood of $45 billion, future shares of KO would almost be guaranteed to be a part of the transaction.

This leads to the obvious question: If the prospect of an eventual buyout is so evident, why doesn’t everyone buy the stock and do the strategy? Well, the answer is two-fold: (1) the time horizon of when this will happen is uncertain, it could be days or decades away; and (2) to some extent, everyone has adopted this strategy.

Monster is valued at around $30 billion but earns $1 billion in profits, for a P/E of 30. That is lofty. In a severe recession, it would not be unusual to see the price fall into the $20s. During the last recession, the price fell from a high of $11 per share in 2007 to $4 per share in 2009. The risk is that a recession occurs, the price falls, and Coca-Cola makes its move to buy out the company at the depressed valuation.

Picture this: You buy the stock at $55, events transpire such that the stock trades at $20, and Coca-Cola makes a buyout at $35 per share. That transaction is fine and well for the shareholders that buy the stock in the $20s, and it could even be a fair approximation of value at the lowered price. But that would have the effect of locking in a loss for the investors in Monster that buy the stock before a recession that would give Coca-Cola a chance to buy out the remaining 400+ million shares at a price that is not elevated compared to today’s valuation.

Personally, I think the long-term shareholders of Monster energy are going to be very happy with the long-term results of the stock. I would wager to say that, if someone under the age of 40 buys $25,000 worth of Monster stock today, he will end up with over $1 million in Coca-Cola stock within his lifetime.