Coca-Cola Isn't Done Adding Fizz to Keurig Green Mountain's Shares

U.S. stocks finished roughly flat on Tuesday, with the benchmark S&P 500 up 0.04% and the narrower Dow Jones Industrial Average gaining 0.12%. Nevertheless, that was enough for both indexes to set new record highs. Investors ought to note, however, that the technology-heavy Nasdaq Composite Index and the small-cap Russell 2000 Index were not onboard with that trend, losing 0.33% and 1.10%, respectively.

This morning, I wrote about the possible acquisition by AT&T of DirecTV as an example of this year's vibrant mergers-and-acquisitions market; in a move that could well foreshadow another large acquisition by a market leader hungry for growth, Coca-Cola announced today that it will increase its stake in Keurig Green Mountain from 10% to 16%. Investors showed their appreciation for Coca-Cola's vote of confidence, pushing Keurig's stock up nearly 8% today.

In February, when Coca-Cola announced it had taken a 10% stake in Keurig Green Mountain, the agreement already gave Coca-Cola option to increase its stake to 16% within three years via open market purchases. The fact that Coca-Cola waited little more than three months to exercise that option suggests that the Atlanta soft-drinks giant has been very impressed with Keurig and the quality of their collaboration thus far. My guess is that we won't have to wait three years before Coca-Cola acquires the company outright.

Coca-Cola is struggling to sell increasing volumes of soft drinks, particularly in the U.S., as consumers become more aware of the harmful effects of excessive sugar consumption. That shift in attitudes is momentous and should not be underestimated; I believe it could ultimately be comparable to the impact that public safety awareness concerning the effects of nicotine has had on tobacco companies.

In that context, Coca-Cola is rightly looking to diversify away from sugary drinks as well as exploring different ways to sell their existing range of beverages to consumers. The agreement it signed with Keurig in February will make its entire drink portfolio -- including its namesake cola -- available through the KeurigCold system, which Keurig plans to introduce in its fiscal 2015. As such, Coca-Cola has moved more boldly than arch-rival PepsiCo in this area. PepsiCo has taken a minority stake in Bevyz, which is set to sell home carbonation machines in the U.S. this year, but it has not committed to selling its drinks via that channel.

Investors are right to salute Coca-Cola's expanded stake with a share-price pop for Keurig (incidentally, Coca-Cola shares outperformed the market today, too, rising 0.7%). Coca-Cola has a better view of Keurig Green Mountain's operations than any outside investor; today's news is a vote of confidence by an informed party that home carbonation systems are not a fad and that Keurig's growth prospects are sound. At a forward price-to-earnings ratio of nearly 26 (according to Morningstar), Keurig's shares don't look cheap per se; however, I'll predict that Coca-Cola will make an offer to acquire the company within the next three years at a significant premium to today's closing price.

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Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, Keurig Green Mountain, and PepsiCo; owns shares of PepsiCo; and has options on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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