Days after Keurig Green Mountain Inc. unveiled plans to buy Dr Pepper Snapple Group Inc., Wells Fargo analyst Bonnie Herzog was left with one major question.
"What is the strategic rationale of combining these businesses?" Herzog wrote in a research note published Jan. 29, the day both companies announced the deal. While the companies did not disclose the total value of the transaction, Herzog estimated that the deal could be worth about $33 billion.
Executives from both companies described the deal in more detail during a call Jan. 29, saying that the new corporation will have a broad distribution network and more ability to develop new products.
The company "will have even greater ability to reach nearly all consumers at virtually every point of sale," Keurig CEO Robert Gamgort told analysts during the call. Gamgort will be the top executive at the combined entity, Keurig Dr Pepper.
But analysts, including Herzog, remain divided about what is driving Keurig to make a bid for the Plano, Texas-based company.
One option, according to Herzog, is that the new Keurig Dr Pepper could use its publicly traded status to issue equity, raising money for more acquisitions. Currently, the maker of K-Cup coffee pods is privately held, with Europe-based firm JAB Holding Co. and other private shareholders set to control about 87% of the new company.
Annual sales at the combined company will total about $11 billion, the companies said Jan. 29. That estimate would put Keurig Dr Pepper behind both PepsiCo Inc., which reported $63.41 billion in revenue for its 2016 fiscal year, and Coca Cola Co., which posted sales of $41.85 billion for 2016, according to S&P Capital IQ.
Keurig "now appears ready to accelerate its transformation efforts and likely sees public equity as a useful tool in its kit," Barclays analyst Lauren Lieberman wrote in a Jan. 29 note. Dr Pepper Snapple shareholders and federal antitrust regulators have yet to sign off on the deal.
For Dr Pepper Snapple, the acquisition could signal a change in focus. The company has built a distribution network that spans a variety of retail outlets, from Dollar General Corp. to Costco Wholesale Corp., but could use the Keurig purchase to expand its new-product development abilities, Lieberman said.
In recent years, Dr Pepper Snapple has experimented with new products by distributing beverages from companies it does not own. Such arrangements between the beverage giant and these labels, which the company calls "allied brands," allow Dr Pepper Snapple to sell products ranging from Bai waters and soft drinks to Hawaiian Punch.
The companies' decision to put Keurig's Gamgort in charge of Keurig Dr Pepper could be consequential for innovation at the combined company. Gamgort's "strong reputation as a more traditional [consumer packaged goods] brand-builder should be complimentary to [Dr Pepper Snapple's] existing small-outlet distribution capabilities," Lieberman wrote.
Under his leadership, the post-deal company could pursue more acquisitions than Dr Pepper Snapple has, though many small beverage labels in the U.S. are "richly valued," she added.
Both Keurig and Dr Pepper Snapple did not respond to requests for comment from S&P Global Market Intelligence.
Consumers turn away from soda, toward water

Whether by acquisition or partnership, the Keurig Dr Pepper operation would be able to compete in a wide variety of beverage categories. The combined company's portfolio would include traditional soda labels, such as 7-Up and A&W. Even though U.S. consumption of those sugary beverages, along with other carbonated soft drinks, has fallen in recent years, soda is still likely to remain a central part of the beverage industry's revenue, according to data from the Beverage Marketing Corporation, or BMC, an industry group. Sales of carbonated soft drinks are expected to clock in at about $72.66 billion for 2017, about 1.2% below their 2016 total.
At the same time, consumers have taken an interest in multiple types of bottled water, including flat, sparkling and flavored varieties. The Dr Pepper Snapple-owned Bai brand would fit into this category. Consumption of so-called value-added water — a category that includes water with fruit or other flavors — rose 12.3% in 2016, the fastest of the eight categories that BMC tracks. Sales of value-added water are projected to total about $4.17 billion in 2017, according to BMC.
Ready-to-drink coffee products also constitute a high-growth category, with the total volume consumed in the U.S. increasing 11% in 2016.
Broadly, consumers have become more health-conscious in their drinking habits in recent years, Gary Hemphill, managing director of research at BMC, said in an interview.
"Generally speaking, consumers are moving to products that they perceive as being better for them," he said.
That consumer demand has led major beverage makers to change their strategies and debut new products. During the Jan. 29 call to explain its deal to analysts, Dr Pepper Snapple executives pointed to sales of "premium, better-for-you and authentic" drinks, such as sparkling water products it distributes under the Bai label. Sales of those drinks are growing at about 40% annually, Keurig CEO Gamgort said.
Within the soft drink category, a future Keurig Dr Pepper will have to fight to grow market share: Dr Pepper was the fourth-most consumed U.S. beverage trademark in 2016 and Dr Pepper Snapple's only product in the top 10 that year, according to BMC. Consumption of Dr Pepper was less than one-third that of Coca Cola Co.'s eponymous soda and behind Pepsi and Mountain Dew, two drinks manufactured PepsiCo Inc.

Soda's dominance at the beverage industry's major players, including a combined Keurig Dr Pepper, is likely to provide financial stability for the competitors as they look to expand new brands such as Bai, said David VanAmburg, managing director at the American Customer Satisfaction Index, which tracks consumer perceptions of major companies and brands. The biggest brands in the combined portfolio, especially Dr Pepper, have a loyal following among consumers, providing a reliable source of revenue as the company experiments with new brands.
"It's kind of hard to see how that would be anything other than good for consumers and for Keurig itself," he said in an interview.
