FORTYFOURYEAR OLD financier Ted Forstmann slipped into the back seat of his Mercedes, oblivious to the promise of the Indian summer day. As his car jockeyed into the Park Avenue traffic, he sat back with a cup of coffee and unfolded The Wall Street Journal. One item jumped out and grabbed him by his pinstriped lapels: Dr Pepper, the No. 4 force in soft drinks, was on the block.
The article betrayed a process that had been secretly going on for some three months. At the request of Dr Pepper, New York investment bankers Lazard-Freres were shopping for corporations that might help the soft drink firm compete in an increasingly competitive field. Forstmann Little-a trio of Ivy Leaguers highly respected for their leveraged buyouts (mergers heavily financed by debt)-was not on the list.
It wasn’t long before Forstmann, intrigued with the idea of acquiring Dr Pepper, picked up the phone and called Lazard. It was a call that would set in motion what may be the most misunderstood merger in business today.
The cat fight that followed kept Pepperwatchers on their feet from last September to early this year. It pitted suitor Forstmann Little against a second bidder, Hawaii-based food conglomerate Castle & Cooke, with Dr Pepper straddled awkwardly in the middle. It featured several renowned business rivals, one of whom was shadowed ghostlike in the wings. It became a war of words, waged through lawsuits and the press.
To understand the most misunderstood merger, you must turn back the famous 10- 2 and 4 clock. How Dr Pepper evolved-from what it was to what it became to what it is-is at the very heart of the controversy that now rages around it. The story begins in a sleepy soda fountain and ends in a Manhattan skyscraper. It has many characters and one enduring star: a Southern-born supersalesman named Woodrow Wilson Clements.
The contemporary history of Dr Pepper dates to 1969, when W.W. “Foots” (so named because “his feet grew up before he did”) Clements was named president. But the company’s history stretches much further than that. In 1985, in fact, the firm will celebrate its centennial anniversary. Dr Pepper was born in 1885 to a druggist in Waco who concocted his own fountain brew and named it for the man he hoped would become his father-in-law. The fruity, fizzy flavor was a hit, and its inventor began bottling the drink as “Dr. Pepper’s phos-ferrates.”
The small company moved its headquarters to Dallas in 1923-about the time Clements was working his way through the back country of Alabama to what would eventually be his first job: a route salesman for Dr Pepper. Legend has it that Clements’ success was virtually assured by his immediate and steadfast enthusiasm for the product. Today, Clements drinks up to 12 Dr Peppers a day-more, they say, if he’s thirsty.
Foots Clements is, and always has been, a salesman. His corporate climb has landed him a series of marketing jobs that led, in 1967, to the post of executive vice president. At the same time, he made another milestone move to a cushy seat on the company’s board of directors-a toehold that he has never let go.
In the Sixties, Dr Pepper was somewhat the darling of the soft drink industry-a maverick with a certain Cabbage Patch homeliness but a peculiar spunk as well. The drink began to be looked upon as a growth product of humble origins, with nowhere to go but up. Then, in 1963, DP pulled off a legal coup that gave it the necessary leg up: It argued effectively in a U.S. District Court that Dr Pepper was not a cola. That seemingly innocuous distinction gave the company the freedom to do what it had to do: make the product national.
Dr Pepper had been slow to expand because of the way its distribution network was set up. Most soft drink territories in the United States are controlled by independent bottlers who own franchises for a given brand-Coke, Pepsi, 7-Up, Dr Pepper, RC. The parent company makes an agreement with the bottler to provide marketing assistance, but its primary role is to ship the syrup. The bottler then adds carbonated water and sweetener, packages the drink and sells it as far and wide as its territorial franchise will allow. Before Dr Pepper officially became an “uncola,” certain Coke and Pepsi distributors were prohibited from carrying competing brands. The court decision allowed Dr Pepper to add independent franchisers at will, and the wooing of bottlers began in earnest.
Insiders and industry analysts credit Clements with building Dr Pepper’s bottler base through personal hand-holding and perseverance. Says one ex-Pepper who asked not to be identified, “Foots is the grand ol’ man among the soft drink bottlers. He has always bent over backwards to see that they are treated well. I remember watching him work at a bottlers’ convention in Hawaii one year. He knew 60 percent of the bottlers’ names, their wives’ names-even the names of their kids.”
Surveys that measure bottlers’ opinions of the parent companies tend to bear that out. Beverage World, a trade journal, tested reactions to Dr Pepper and found high marks for “attendance to bottler needs” and even higher grades for accessibility to management. Said one bottler who does only 5 percent of his business with Dr Pepper, “I’ve always been able to talk to anyone-from Foots on down.”
Unfortunately, Foots did some talking of his own during those heady years, and it got him in trouble. The notion that Dr Pepper could be distributed along lines already established by Coke and Pepsi became news a little too big for him to keep quiet. “Clements made a huge tactical error,” reports beverage analyst Joseph Frazzano. “Once he realized he could piggyback cola, he started to brag. He was quoted as saying that Dr Pepper would become No. 1 by following Coke’s lead. Once Coke heard that, Dr Pepper was dead.”
The infamous cola wars have been raging in one form or another for years, but it was during the Seventies that competition really got rough. Coke began to put the squeeze on bottlers who carried both Coke and Dr Pepper. If DP offered $50,000 for promotion, Coke would up the ante to $250,000. Or pressure would flow in reverse: Coke might suddenly become a little stingy with its marketing advice or a little slow to answer the phone.
But the syrup really hit the fan when Coke came out with Mr. Pibb-a soft drink that tastes remarkably like Dr Pepper. Although Coke has consistently disavowed any intent to battle Dr Pepper head to head with Mr. Pibb, it’s a poignant coincidence that the Atlanta-based firm chose to test-market its product in Waco.
“The company developed rapidly during the early Seventies, doubling its volume and leading the industry in growth,” the former insider says. “The existing business was increasing somewhat, but the real numbers came incrementally-from new business. Despite the expansion, the company was never terribly sophisticated. Market research was negligible, and the field force got by on little more than a handshake and a smile. Our guys didn’t even understand the Nielson Reports [a supermarket auditing source], and you had Pepsi salesmen coming in with computers! They blew our field force away.”
Former executive vice president Rick Avery, now president of Anderson-Clayton Foods, agrees: “When I took over sales and marketing in 1975,I cleaned up the structure, added discipline and marketing plans. At the time, Y&R [Young & Rubicam advertising agency] was pretty much outlining marketing strategy. They desperately wanted Dr Pepper to take a more active role.”
The contribution to growth made by Young & Rubicam can’t be overstated. From the time Clements hired the then-fledgling firm in 1969, they fleshed out an identity for Dr Pepper that may be its most formidable asset. Y&R’s high-powered, bizarre “Misunderstood” theme in 1970 and “The Most Original Soft Drink” campaign in 1974 introduced the notion that Dr Pepper is uniquely desirable. Says one former employee, “That’s when Dr Pepper really started to fly.”
Another bench mark of the Seventies was the company’s foray into international markets-a move that has never resulted in resounding success. The biggest move was made on Japan with the 1973 formation of a joint venture company with the Tokyo Coca-Cola Bottling Co. Clements has gone on record admitting that the Japan operation has yet to turn a profit, but he’s determined that the organization there will be valuable one day. Others are not so optimistic, nor so kind. Says one: “Japan was and continues to be an ongoing disaster.”
As domestic expansion clipped along, the company began to buy or build its own bottling plants in strategic Sun Belt sites, mostly in Texas and Southern California. The bottling operations proved to be immensely profitable, accounting for, by some estimates, up to 60 percent of Dr Pepper sales. According to a report prepared by analyst Frazzano for Oppenheimer & Co., “A bottler makes [per case of soda sold] two and a half times the profit the parent makes by selling a like amount of concentrate.” But while the potential is there, it doesn’t come cheap: Dr Pepper paid $21 million to build a production facility in Irving in 1977 and then spent the same amount two years later in Houston to build a plant half its size.
By the mid- to late-Seventies, Dr Pepper’s glamour growth had begun to level off. The industry as a whole was maturing, as baby-boomers grew up to show taste preferences for beverages other than soft drinks. And with the completion of its countrywide distribution network, the natural development of the Dr Pepper brands was complete. The battle for business shifted from the bottling franchisers to supermarkets-where salesmen jockey endlessly for more and better shelf space.
IT SHOULDN’T GO unsaid that Dr Pepper’s push to become the No. 3-selling soft drink was nothing short of Herculean. Clements was at the top, and credit for spearheading the effort must go to him. But there were others close behind: namely, Rick Avery and Joe K. Hughes. Avery had been hired in 1970 to head plant operations; Hughes was in charge of sales and marketing. In 1975, the two switched jobs-not an uncommon corporate maneuver and one that suggests a two-man footrace to the top.
If Clements had that in mind, he didn’t say so. What he did say, around the middle of 1978, was that the board of directors was pressuring him to name a successor. For some four years, Clements had held the titles of chairman, president and chief executive officer. He was 64 years old. The board wanted some assurance that he had a successor in mind and formed an executive committee to conduct an outside search.
“There’s a classic checkpoint in a company’s development when it must move from an entrepreneurial stance to a professionally managed firm,” an insider says. “By 1979 and 1980, Dr Pepper had run out of steam. The easy pickings were over. The business had gone beyond the incumbent group. Either Foots couldn’t or wouldn’t choose between Avery or Hughes.”
After an 18-month search, the committee came up with a 20-year veteran of Proctor & Gamble: Charles L. “Chuck” Jarvie. Avery, Hughes and another VP, John Albers (now president of a reorganized Dr Pepper USA), were interviewed, but rather perfunctorily.
In February 1980, Jarvie moved to Dallas to become president of Dr Pepper. According to several accounts, he came in with both guns blazing. Remembers one member of his team, “He carried a note pad with him everywhere, asking questions, challenging assumptions, going head to head with people. He came to the conclusion that Dr Pepper had no strategy for the future at all.”
Jarvie’s tenure was relatively brief. In November 1982, he was shoved out the door by a chairman and a board who saw his flaws as outweighing his attributes. But a great deal was accomplished in less than two years, including some important acquisitions that figure prominently in the Dr Pepper picture today.
Where Jarvie failed was in bruising the only real foot in the door that Dr Pepper ever had: personal relationships with bottlers. “For 20 years at P&G, Jarvie had never had to play up to a middleman,” says Avery. “There, you blitz the consumer with advertising, and buyer demand forces the retailer to fall in line. That’s just not the way the soft drink business is run-especially in Dr Pepper’s case. We always got more out of the bottler than we rightfully had reason to expect. The bottler is very, very important.”
If Jarvie failed to court the bottlers in the manner in which they were accustomed, he had no trouble wooing firms that would broaden the Dr Pepper product line. Soon after his arrival, Jarvie and Clements were in pursuit of Canada-based Crush International. The bidding was intense; in the end, Jarvie’s alma mater, Proctor & Gamble, won. But eventually, Jarvie had his way with an even more desirable plum when he convinced Norton Simon to sell Canada Dry.
By most accounts, Canada Dry was a strategic acquisition, even with a $143 million price tag. For one thing, the company has fabulous international distribution-an area in which Dr Pepper lagged behind. For another, it’s strong in sections of the United States where Dr Pepper is weak (the Northeast, for example). Canada Dry increased Dr Pepper’s market share and added to its earnings in 1982 and 1983. But it also put the company up to its bottle caps in debt-some $120 million worth. It soon became apparent that with industry competition, Dr Pepper desperately needed heavy infusions of cash to compete. Some say that Jarvie saw the need to sell sooner than Clements did, and that was the fatal dividing line. The official corporate explanation cited “obvious differences in philosophy.”
Whether Jarvie was an arrogant “P&G man” who refused to listen and learn or a superb marketing exec faced with an egotist who shunned modern management is answered pro or con depending on whose side you’re on. Unquestionably, he made mistakes-maybe even unforgivable ones. But he probably got a raw deal, too. Jarvie has consistently refused to comment on his time at Dr Pepper, except to say in response to open criticism from Clements, “Was Foots in Afghanistan the whole time I was making decisions in Dallas?”
Jarvie was on the way out in the fall of 1982 when Dr Pepper had been edged into fourth place by 7-Up. The firm was about to declare its first quarterly loss in 27 years. Of the former inside contenders, two had left: Albers to private investments, and Avery to Anderson-Clayton Foods. If Hughes was still being considered, it wasn’t made known. In November, a new president was named: Richard Q. Armstrong, former president of Canada Dry.
With a new president and heavy losses behind them, 1983 looked brighter. But there were still some tough issues to resolve-and one was how to get the bottlers back. The new team of Clements and Armstrong decided to mount the splashiest show of shows that the bottlers had ever seen. The 1,700 franchisers who came to Los Angeles in October 1983 saw a management team seemingly committed to mending the fences Jarvie had damaged. Clements even went so far as to say in a speech, “About two years ago, we made [a] choice. And I guess we’ll all wonder about that choice for a long time to come, and we have already learned from it. The choice was this: We chose to stray from the heart of the Dr Pepper tradition. We strayed from the time-tested success formula for marketing Dr Pepper, and we strayed from the spirit of our partnership.”
The event marked other changes in the corporation’s course as well. The popular but unproductive “Be a Pepper” campaign had failed to bring converts on a national scale. National media-placement strategies were largely being replaced by the old method of local buys. Radical new commercials moved away from “Me too” Peppers dancing in the streets and toward the old philosophy of “Love me because I’m different.” A jazzy new logo was unveiled, and a new slogan trumpeted, “Hold out for the out of the ordinary.”
The extravaganza had to be good, since a month before, the firm had dropped the biggest bomb in its 100-year history: Dr Pepper might be for sale.
The Wall Street Journal article that ran in September-the one that caught Ted Forst-mann’s eye-quoted Clements as confirming that Dr Pepper had retained an adviser to “explore investment alternatives.” But, the fact that Dr Pepper was in dire need of money and therefore was shopping for some solution shouldn’t be attributed solely to its cumbersome debt. Pepsi and Coke raise the stakes required to play in the soft drink game practically by the hour. Intense competition between the two cola giants has led to costly new product entries, big-bucks advertising campaigns and a discounting war that has all but squeezed the little guys off the shelf. That expensive situation, combined with DP’s considerable debt, left it with limited options: restructure debt, sell some assets or be acquired by a cash-rich firm.
When this became painfully acute in June 1983, Clements and Armstrong turned to an expert: New York investment advisers and bankers Lazard-Freres. In strict secrecy, Lazard prepared an extensive selling document and began contacting 20 or so obvious buyers around the world. After the story was leaked to The Will Street Journal, the press had a heyday speculating who those suitors might be: R.J. Reynolds, Anheuser Busch, Proctor & Gamble, Royal Crown, Southland. But according to Phillip Keevil at Lazard-Freres, none of those companies were biting. And for several reasons: First, Clements had made it known that the bidding would start in the low to mid-$20s. At the time, DP stock was selling for between $12.50 and $17 a share. Yet earnings for the year would be under $1 per share at best. “When you take that type of enormous price/earning multiple, even a large corporation would find it a relatively dilutive transaction,” says Keevil. “And on top of that, they were all very concerned about the competitive situation between Pepsi and Coke.”
Lurking as an ominous precedent was Philip Morris’ high-priced purchase of 7-Up. Says Keevil, “They all looked at Philip Morris and saw that they had not been able to move 7-Up much, and it scared them off.” Prudential-Bache securities analyst George Thompson agrees: “I know that RJR looked very closely and that Busch test-marketed root beer and didn’t like the soft drink business. P&G has owned Crush for some time and hasn’t done anything with it. Those are strong consumer products companies, and they simply chose not to get involved.”
But there was one firm that was interested, and not because of extensive experience in consumer brands. Forstmann Little had another idea for Dr Pepper-a leveraged buyout. Simply put, a leveraged buyout is a purchase transaction in which most of the money used for payment is in the form of debt. It usually requires a continuation of the target firm’s management, and often-but not always-is instigated by them. What an LBO is not is a venture capital deal, says Ted Forstmann. “[Venture capitalists] look for businesses that are nothing [now] but one day may be great. We look for businesses that already are strong.”
“When we were approached by Forstmann Little,” recalls Keevil, “We didn’t really see how you could do an LBO at this price/earnings multiple. But in spite of that, they persevered.” DP management apparently reacted with similar reluctance. Keevil says, “It took several days for us to agree to send them the confidential memorandum.”
It was Forstmann Little’s reputation and its considerable financial resources that eventually got it to the door. In the leveraged buyout field-a young but suddenly hot specialty-this partnership of well-heeled, well-connected men is considered No. 2. In the six years they’ve been in business, Ted Forstmann, his younger brother, Nick, and their partner, Brian Little, have made seven acquisitions-all of which appear to be going strong. One of their private companies was taken public this year, and Forstmann Little came out with almost 12 times what it invested. Another sale netted a whopping 16 times their investment. Says Forstmann, “We look for a company with good management, a solid niche business, predictable cash flow and a strong balance sheet. Great growth potential is not essential, but you do need enough to keep pace with inflation.”
By all insider accounts, the Dr Pepper team hadn’t considered a leveraged buyout as an option. Historically in an LBO, a company is streamlined into maximum profitability. With acquisitions in 1980 to 1982, Dr Pepper had reached out in a more expansive competitive stance. Speculation is that Clements was slow to relinquish that plan.
The price offered by Forstmann Little was $22 a share. That’s three times the stock’s book value and approximately 20 times earnings. (The industry standard is 15 to 17 times earnings.) Yet almost the minute the offer was announced, disgruntled shareholders ran to file lawsuits that cried “thief!” One factor may have been another of Clements’ ill-timed remarks. At the time of the Wall Street Journal article, a reporter asked Clements what his reaction would be to an offer of $24 a share. His answer: “I’d tell them to get lost.” Now, if you’re a shareholder and you hear that Dr Pepper later accepts $22 a share, you begin to wonder. Then, if you learn that Clements makes $3 1/2 million on the deal, plus keeps his job and gets a stake in the new business, you begin to get concerned.
Even so, the fracas might have been confined to a few nuisance court cases if it hadn’t been for the sudden emergence of the Misunderstood Merger, Part II: the entrance of a second bidder-Castle & Cooke.
Castle & Cooke is a food, real estate and manufacturing conglomerate run by Ian Wilson, who once headed Pacific operations for Coke. According to the proxy mailed to Dr Pepper shareholders in early February, Wilson first broached the subject of buying Dr Pepper to Clements in early November. Wilson’s plan was to enlarge the range of C&C products to include a soft drink line.
Despite the fact that DP management was not overwhelmingly receptive to Wilson, C&C formed a partnership with two New York financial firms: Drexel Burnham Lambert investment bankers and Citicorp Venture Capital Ltd. An offer was somewhat delayed in coming, and there were numerous conversations back and forth, but finally, on December 5, the DPCC Acquisition Corp. came out with a bid of $560 million or roughly $50 million more than Forstmann Little. Later, DPCC upped the offer to come out at exactly $24 a share. Although Wilson said his offer was firm, he requested more information from Dr Pepper to negotiate definitive loan agreements. And this was when the war of words really got nasty.
The DPCC side complained that Dr Pepper was not cooperating in its efforts to review their books. They hinted that Lazard was more interested in its $2 1/2 million fee than in procuring the best deal for Dr Pepper shareholders. And that was just the part that made it into print. Privately, there was talk that Clements would never allow Wilson -a 20-year veteran of Coke-to run Dr Pepper. Forstmann was quietly bemoaning the fact that his money was sitting in the bank while Wilson’s purchase price was little more than an inflated balloon. Writers atThe New York Times and The wall Street Journal probed to see if DPCC’s bank commitment letters were as highly conditional as Clements had alleged. Both papers drew hazy conclusions that they probably were.
There was more. Rampant rumors suggested that the No. 1 persona non grata at Dr Pepper, Chuck Jarvie, was somehow behind the DPCC bid, a notion that a spokesman at Drexel Burnham categorically denies. There was talk that Ian Wilson had made a mess at Coke and that the huge Pepper bottler in New York would dump the brand if Ian Wilson came on board. Innuendoes were drawn to infer that Clements had been given a “sweetheart deal” by Forst-mann Little that he wasn’t about to give up. Continuously stoking the fire were the press and Wall Street arbitragers (brokers who buy up stock before an impending merger hoping to make a killing on the spread).
The end was anticlimactic. After meeting with Dr Pepper and getting less information than it was happy with, DPCC backed down. With only one bidder, the process played itself out. On February 28, DP shareholders voted to sell out to Forstmann Little.
The aftermath of the merger raises some fascinating questions. First: Was $22 a share a fair price? Most analysts agree that it was. Says Dr. Nikhil Varaiya, finance professor at SMU and a specialist in mergers and acquisitions, “It’s the classic case of a bird in hand. The alternative is to wait for a higher offer. With the industry what it is, if I were a stockholder, I’d take my money and run.”
A second question: Did the stockholders who sued have a legitimate case? (The cases were settled out of court in late February-with Dr Pepper paying legal fees.) Wall Street analyst Frazzano says that shareholders never win that type of “garbage suits.” “Many suits are filed on the hope that the company will pay them $50,000 to go away.” Forstmann says that he’s been sued over every public deal he’s done: “Not three hours after the offer is out, the suit lands on my desk. We fight every one, and we’ve never paid one red cent.”
Much of the distrust about leveraged buyouts is born out of ignorance on the part of the public, the analysts and the press. Says Keevil, “Most who have even a vague notion of LBOs think they mean management comes up with the idea, ’Let’s take the company private, and we’ll all get rich.’ The trend is for guys with pools of capital-like Forstmann Little-to approach a company first. But they never do it without strong management support. It won’t work.”
If an LBO isn’t inherently evil then, is it right for Dr Pepper? Why would a company heavily in debt want to heap more leverage on top of it?
The answer is that it will only work if assets are sold, debts repaid and operations streamlined to provide maximum cash flow. The party line is that Dr Pepper will become a “singly focused company” again. Said Clements at a press conference immediately following the shareholders’ approval of the merger, “We’re going back to what we do best-selling Dr Pepper.”
In fact, selling seems to be the key strategy of the new DP. And first on the agenda is the selling of Canada Dry. It has been estimated by the new owners that the Canada Dry business will go for at least $160 million. (Dr Pepper paid approximately $140 million two years ago.) Ironically, Castle & Cooke is said to be interested. Dr Pepper’s Jim Ball says even more than that: “All they ever wanted was Canada Dry.” Again, Lazard-Freres will be brokering the sale.
The man from Canada Dry who stepped into Jarvie’s presidential shoes-Richard Armstrong-has already opted out. Soon after the Forstmann Little merger agreement was finalized, it was announced that Armstrong would leave the company in early ’84. There were complaints all along that he showed little allegiance to either Dr Pepper or Dallas. “Armstrong is going back to New York, which he never left in spirit or body,” said Clements. “He just never really got the Dr Pepper religion we require.”
While Canada Dry is shopped around, efforts will be made to sell other Dr Pepper assets-namely bottling plants and other “real property.” One option is the sale of the real estate around Dr Pepper operations, which the company could then lease back. “My question is,” says Prudential’s Thompson, “Who is going to buy the bottling plants? Even if somebody will, is it smart to give up the only distribution area you can control?”
Analysts aren’t the only ones questioning Dr Pepper’s new divestiture strategy. Practically everyone reacts emotionally to watching a local institution stripped to its bare bones. Texans don’t take kindly to the thought of New Yorkers coming in and selling the very land that Dr Pepper’s landmark headquarters is on. Those who have spent a portion of their lives working to take Dr Pepper to the top (and those who have simply applauded in the wings) can’t bear to see the firm reduced to what it was 10 to 15 years ago. The key to Dr Pepper’s future-at least the short-term-may be found in what it was in the past: small, private, regional and profitable-with W.W. Clements in control.