BREAKINGVIEWS-For private capital, coffee's now as good as chips

By Sebastian Pellejero

NEW YORK, Oct 27 (Reuters Breakingviews) - Keurig Dr Pepper KDP.O is looking to win over public investors by turning to deep private pockets. Buyout and credit shops Apollo Global Management APO.N and KKR KKR.N will invest $7 billion across the company’s soon-to-split coffee and soda units, cutting borrowing costs and freeing cash as it pushes a giant merger over the line. As private capital funds hunt new balance sheets to bankroll, blue-chip financing will increasingly become a service sold by a few giants.

Investors initially balked at an $18 billion plan to buy fellow coffee-maker JDE Peet's before splitting off java into a separate business, sending Keurig’s shares down 18% after the deal’s announcement. The original financing leaned heavily on bank debt, which would have pushed leverage toward five times EBITDA, threatening the company's investment-grade standing.

Pressure further ramped up after rabble-rousing hedge fund Starboard Value built a stake in Keurig, as reported by the Financial Times. Though unable to block the deal, upheaval would have loomed over a soon-to-be-standalone coffee unit already facing a tough market.

To mend concerns, Keurig found equity-like capital without equity-style dilution. The $7 billion commitment includes preferred shares and a minority stake in a coffee manufacturing joint venture. The preferred carries a 4.75% dividend and converts to stock at a 37% premium to its closing price on October 24. The joint venture financing is expected to cost about 7.3% over ten years but, with the blessing of ratings agencies, won’t be treated as debt. On-paper leverage goes down to roughly four times EBITDA, within investment-grade range.

That takes a financing playbook once reserved for high tech into the beverage aisle. Hybrid structures of this scale have previously included Intel's INTC.O $4 billion chip manufacturing venture with Brookfield, or Blue Owl Capital’s $27 billion data center partnership with Meta Platforms META.O. Apollo did also strike a $2 billion deal with grocer Albertsons in 2020. The key is monetizing stable cash flows without ceding control. That the playbook can extend as far as a K-Cup concern suggests that it can stretch yet further.

The key advantage for Apollo and KKR is that giant check sizes and high complexity mean only the largest funds can secure these kinds of deals. That will ward off competition that has ground down returns in buyout lending. Both have capacity in captive insurers or on the balance sheet to hold risk long-term. For companies in a bind, like Keurig, it’s a tempting option.

The math is compelling: between the preferred’s dividend and potential upside from conversion, as well as manufacturing cashflows, returns could hit 8% annually, Breakingviews calculates. That's well above generic investment-grade returns, the key benchmark. If that spread can hold, alternative lenders will become steadily more entangled with the biggest U.S. balance sheets.

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CONTEXT NEWS

On October 27, Keurig Dr Pepper announced that KKR and Apollo Global Management will invest $3 billion toward its beverage division and $4 billion towards a coffee business partnership and joint venture for single-serving pod manufacturing.