Collection: Mohnish Pabrai - #110 'Buffett's Investment In Coca-Cola, Part 2 Numbers'



[Transcript]

MOHNISH PABRAI 00:00

You know, there’s a lot more model they went through, but in all the model that I’ve gone through with you, we haven’t talked about any numbers. You see, so I went through all this stuff about it being great investment we haven’t talked about numbers really.


And so now I’ll just go through some numbers, but none of these numbers need a spreadsheet, there’re kind of – very simplistic number.


So, the way of Coke model works is the Coca-Cola Company produces concentrated syrup. So, let’s go back to the point, where there is just one product which is Coca-Cola, we won’t go through the hundred brands they have right now.


But let’s say there is only one product, Coca-Cola, they product concentrated syrup, the syrup gets sold to bottlers around the world and the bottlers then produce the Coke cans and bottle that you see in supermarket and everywhere else.


And the Coke company also sells the syrup to various fountain operators, so like Burger King and McDonald’s and so on where you can buy fountain drinks. So, there are two models right, there’s the bottling model and the fountain model. And the – or let say restaurant and such.


So, the way of bottling model works is, the Coca-Cola Company does not set the price of a bottle of Coke. It lets the bottler do that. So they can pretty much set whatever price they want. What it does do is it sets the price for the syrup and what it does do just like Warren did on January 1st to See’s Candies, it’s on January 1st they pumped the price of the syrup, non-stop. And been doing for a hundred years.


And so the simple economics is that if you have a can of Coke on sale at Costco or wherever, you might get it for about $0.25 cent, you know 12 Oz (ounce) can. The $0.25 cent the Coca-Cola Company gets around $0.06 cents, $0.06 or $0.07 cent of that comes to the Coca-Cola Company for the syrup.


And the rest of the – let’s say, $0.18 cent or so is shared between the retail outlet that sells it and the bottling operation that produces it. And the, so the bottler is where a large amount of CAPEX (capital expenditure) is happening, right, because they got all these bottling plants, they got all these trucks, they got drivers, they got all the distribution going on.


The Coca-Cola Company just need a few plants around the world to produce syrup. So, and the number of people they need to do that, so when Warren and Charlie want to make the investment, the Coca-Cola Company has 17,000 employees, all the bottlers had half a million.


So, the CAPEX is on the bottlers and the – so this is a See’s Candies on stereo, because you don’t have any retail.


You know, it’s kind of like reminded me one time I was visiting Microsoft, I think this is like probably 15 years ago. And the – you know, they used to sell their operating system to, for example, Dell. So, Dell would install Windows on all the machines.


So, I was talking to one of the Microsoft engineers, so I said, “So do you guys like sell – send the CDs to Dell and then they, you know, when you buy the computer, you get the CDs and such.”


They said “No”, or the floppy disks, they said “No". They said "We gave them one copy and then everything else is their cost." Okay, so Microsoft wasn’t even willing to spend the money on the disk or even that they dumped on the PC makers, right?


So that was the – it was even better than the syrup business at least Coke has to provide syrup, in the case of Microsoft they just provide the BITS once and then they charged you on the BITS which is why it’s such a beautiful model and Mr. Gates is the wealthiest person on the planet.


And so it’s very funny like he said – he looked at me like I was dumb as a doorknob – he said what do you mean I’m gonna send them CDs, no, I’m not gonna send them CDs, I’m going to give them 1 copy and then he told me that once it got to streaming, we didn’t even send them copy, we just streamed it to them. You know – (Laughs) – Not going to send them a single copy, right.


And so, in the case of Coke is not quite Microsoft, they still have to sell the syrup but what they did is they came out with one more enhancement where they got to concentrate, so the syrup had sugar in it, so what they did is – and it had water and what’s the point of, you know, shipping these heavy thing.


So they actually improve the model to just giving concentrate and telling the bottler add so much sugar and add so much water and now you got the concentrate – you got the syrup. So they even took it down one level further.


So, you take the $0.25 cent can, the Coca-Cola Company get about $0.07 cents, the costs on that is basically next to nothing, it’s sugared water. They’re not even paying for the sugar.


And the bulk of their – you know, they spend about 10% of that on advertising and approximately about 25 or 30% of that number is a pre-tax profit. You know, so that’s basically their model, that’s on the bottling side.


Now, when you get to the fountain side, things get even more exciting. So, when you go to a restaurant and you ask for a Coke, you know they don’t charge you $0.25 cents. What do they charge you Alex? Couple of bucks?


Yeah, so you know that 8 or 12 oz serving is now 12 bucks. The Coca-Cola Company is giving it to the restaurant at probably, I don’t know, $0.15 cents or something, and they are very benevolent, and they let the restaurants make a lot of money on the Coke.


And so what happens in that format is the restaurant loves Coke, you know, is a highest volume – highest margin product of anything, they're going to sell, right? And people want it and people ask for the brand name, etc.


Like, you know, the ones that don’t offer Coke and they have Pepsi, they have to ask you, you know, would you like a Pepsi instead and you know, you kind of say okay, you know, it’s fine. I’ll take the Pepsi, take a bullet for the team.


And so, the fountain sales model, if you think of the ecosystem, everyone makes money. You know, the restaurant makes a lot of money, the restaurant very happy. The bottler that converts the concentrate to syrup makes money, they’re very happy because they deliver it and they do the last mile stuff. And the Coca-Cola Company is obviously very happy, so both these models worked really well.


And you know, just to give you kind of a sense of the CAPEX differential, you know, before they made the investment, these numbers have gone up quite a bit since then, but in scale, they’re correct.


So the – all the bottlers were spending in the mid-80s about $1.3 billion in CAPEX every year and the Coca-Cola Company is spending $160 million, you know, approximately like 12% of the bottlers were spending. So, most of the volume – most of the benefit of all of this went to the Coca-Cola Company.


And then you know, you look at, you know, Warren has obsessed over the fact that there was – you know, Branson had started Virgin Cola and then there was Sam’s Choice, and they were all these kind of private label type Colas and they studied that. And bottom line is that none of those ever got any traction. So why didn’t they get traction?


Well, number one, you know the person space, the mouth. You know, you’re not quite sure what Sam’s Choice even though you like Sam Walton. And the second is the economics, they can’t really undercut.


So, if you think about the $0.25 cent can. Well, the reason it set $0.25 cent to because of global scale, you know, this is a global company selling at a huge volume. I mean they’re buying aluminium at a huge volume all those things right?


So, you try being – even Walmart with whatever volumes Walmart has and then you try to get customers to not buy Coke and buy Sam’s Choice, how much can you undercut Coke by? They have got about $0.02 cent that they’re making on that $0.25 cent as profit. And the bottler is probably making another couple of cents, so you got about $0.04 cents.


So, once you go to – if you had the exact same cost as the Coca-Cola Company, if you were at $0.21 cents, and Coke was charging $0.25 cents, you’ll make no money, right? And if you didn’t discount versus Coke, who would buy Sam’s Choice?


How many of you consume Sam’s Choice? Does it even exist anymore, does it exist anymore? I haven’t been to Walmart lately. Does Sam’s Choice exist? Alex, you haven’t kept up? No?


Alright so, but in Costco, I don’t remember, maybe you guys know because I don’t fit. Does Costco have a generic Cola, they sell? No, I don’t think so, right? Do they have?


So, that’s the – is that the store brand?


Yeah, so they got some private labels, but they got the big containers.


Okay, who drinks Refreshe? Is it cheaper? And is it – do they have a Cola?


(Laugh) Okay.


Alright, so you see that – So what they found is that if a competitor tried to come in and the store try to do a private label or whatever else, they really couldn’t undercut them because the economics just weren’t allowed. So, this is what they understood about Coke – some of the things they understood about the Coke when they read those annual reports.


(Source: https://youtu.be/jfxOvdiac94)

 

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