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PepsiCo, Inc. (PEP) and Mondelez International Inc (MDLZ)? Yes Please.

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PepsiCo, Inc. (NYSE:PEP)What if PepsiCo, Inc. (NYSE:PEP), the world’s second largest beverage maker, stopped selling its namesake drink? The idea may sound absurd, but it’s what activist investor Nelson Peltz wants.

If you’ve been reading the Wall Street Journal, you’ve seen the commotion. Peltz – of Trion Fund Management – is pushing a merger between PepsiCo, Inc. (NYSE:PEP) and fellow snack maker Mondelez International Inc (NASDAQ:MDLZ), followed by a spinoff of PepsiCo, Inc. (NYSE:PEP)’s weaker beverage business.

Here is why I think the plan has potential, and how it could be better.

Snacks drive profits

PepsiCo, Inc. (NYSE:PEP) markets more than just beverages. In fact, only half of Pepsi’s $65 billion revenue in 2012 came from drinks. The rest came from its snack division. In 1965 Pepsi merged with Frito-Lay, giving it one of the largest snack brand portfolios in the world. Do you like Doritos, Lays, Cheetos, or Sunchips? Each of those snacks is made under Pepsi’s roof, plus many more.

In the second quarter, Pepsi reported earnings of $1.28 per share, up 36% from $0.94 a year ago and beating Wall Street expectations of $1.19. According to Pepsi CFO Hugh Johnston, its variety of products helped the firm remain strong despite the unusually chilly quarter that saw rival The Coca-Cola Company (NYSE:KO)’s earnings go backward.

The Coca-Cola Company (NYSE:KO), which gets 100% of its revenue from beverage sales, saw earnings decrease by 4% to $0.59 per share in its second quarter. Coca-Cola blamed the slide on cold weather lessening consumers’ taste for cold soda. Specifically, North American soda sales fell by 4%, continuing an eight-year downward trend of soda consumption in the region. Pepsi however, was able to rely on its snacks to power through the cold quarter.

Why Mondelez?

A merger between Pepsi and Mondelez International Inc (NASDAQ:MDLZ) would create a snack giant with quarterly revenue upwards of $21 billion. Such a company would be unmatched in size and market share in the global snack industry. Furthermore, the merger would enable Pepsi to further distance itself from Coca-Cola’s woes in U.S. beverage sales.

In the first quarter of this year, Mondelez International Inc (NASDAQ:MDLZ)’ grew revenue by .9% to 8.7 billion, which included 9.3% revenue growth in emerging markets. In addition, Mondelez posted gross profits of $3.2 billion up by 1.5% from the year before. This means snack consumption isn’t decreasing with soda consumption. Consumers appear happy to enjoy chips and cookies while skipping a cold soda.

I’ve heard concerns that by acquiring Mondelez International Inc (NASDAQ:MDLZ), Pepsi would be competing with itself. However, that would not be the case as Mondelez’ lineup consists heavily of cookies (Oreos and Chips Ahoy! for example) and other candies and sweets. Mondelez International Inc (NASDAQ:MDLZ) does make some snacks (mainly Nabisco products) but the firm would complement Pepsi more than cannibalize it.

Keep the drinks

Should PepsiCo, Inc. (NYSE:PEP) get rid of beverages? I say no. Pepsi should compromise, by buying Mondelez International Inc (NASDAQ:MDLZ) while still keeping the beverage unit. Yes, the America’s Beverage unit is underperforming, but the segment represents almost a third of Pepsi’s revenue.

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