Blog 3- Capital Structure

Coca-cola has been my favourite soft drinks since I was a kid, and it still is now. Imagine one sip of it went into your mouth, it just feels so great, sort of like an explosion in the mouth many thanks to the “secret recipe” of coca-cola. Another of my favourite drink, is of course the coffee! I can never go on a day without a cup of coffee in the morning, it sorts of like “a coffee a day, keep the sickness away” to me. So why are we talking about these two of my favourite drinks in this blog? It is because the main topic today is about one of the shocking acquisition happened in the late August this year, which is Coca-cola is buying the business of Costa from Whitbread.

Coca-cola has offered an £3.9 billion all cash for the business of Costa, the UK’s favourite coffee shop. Nevertheless, the area that we are focusing in this blog is the capital structure of Coca-cola funding the acquisition. In order to fund the acquisition solely through cash, Coca-cola would have to issue new debt, I mean, who would have carry so much cash in their pocket? Right? Debt financing has a lower cost than equity financing because it is tax deductible thus the company do not have to worry about paying large sum of taxes throughout the acquisition. By doing so, the weighted average cost of capital is actually lower if Coca-cola were to fund it through debt financing instead of issuance of new shares.

Consequently, the shareholders of the company would not face a dilution of their ownership without issuing new shares. In this case, the company can also maintain the earnings per shares which is actually beneficial to the shareholders. However, there is always a good side and a bad side in everything. The disadvantages for the company to finance through debt is that the credit rating might affected or downgraded due to the increasing debt and trigger a bad cycle such as the drop of share price or whatsoever.

In addition, the increasing debt level would also cause the interest rate to rise, and eventually pull up their cost of debt. In this case, it might offset the reduced in WACC that we discuss earlier. During the bad days, cash plays an important role for any company to settle their problem like the liquidity, hence there is a hidden risk for Coca-cola to turnover if there is any unwanted event happens. Overall, I personally think that this is a pretty good deal because Coca-cola get to involve in other business besides its core business as it could generate a decent continually revenue and contributes to its bottom line, not to mention the large market shares of Costa in the UK.

In short, this is a smart move by the company as coffee is considered as a necessity for all the coffee lovers. Exaggeratedly, I bet many of the coffee lovers couldn’t survive a day without a cup of coffee, even they were lucky to make it, they would be probably half-dead already.