Today Pepsi is one of the strongest brands in the world with a capitalization of nearly $125 billion. But this wasn’t always the case. It may be hard to believe, but Pepsi was on the verge of bankruptcy during its first forty years of business. In fact, Pepsi-Cola’s financial situation was so bad that three times between 1922 and 1934, Pepsi-Cola approached Coca-Cola and offered to sell out to their competitor. All three times Coca-Cola rejected their offer. Coca-Cola’s rejections could be among three of the biggest marketing snafus in history, while Pepsi’s “12 ounce” jingle campaign turned out to be one of the most successful marketing efforts of all time. Not only did the campaign prove a success for Pepsi, but it revolutionized the soda industry as a whole. This case study is an interesting one indeed and shows how perseverance in the marketplace and promotional advertising can be worth billions.

A Secret Recipe: Pepsin and Kola Nuts

First introduced in North Carolina as “Brad’s Drink” in 1893 by Caleb Bradham, the name was changed to Pepsi-Cola in 1898 mainly because of Pepsi’s secret ingredients. Digestive enzymes named pepsin and kola nuts were used in the creation of this special drink. However, when Bradham unsuccessfully speculated on wildly fluctuating sugar prices (shown below), the company faced bankruptcy. Charles Guth wanted to cut costs at his soda fountains, so he tried to get Coca-Cola to lower the cost of their syrup. Coke refused, so Charles Guth turned to Pepsi-Cola. Guth bought an 80% controlling stake in Pepsi-Co. in September 1938, and had Loft’s chemists reformulate the Pepsi-Cola syrup. Guth then quit Loft, Inc. as President to run Pepsi-Cola Co. and sold the syrup to Loft, Inc., his former employer, at a profit. At the same time, Loft, Inc. was sliding into bankruptcy. The chart below shows how the price of Loft, Inc. sank to new lows in the 1930s: The company’s Happiness Candy Stores were consistent money losers and Loft, Inc. lost money on its candy for five years in a row. The Depression was so bad, not even candy could cheer people up! The chart below shows the desperate situation the company’s shareholders were facing in the late 1930s:

Losses and Loft Suits

Next, Le Roy proposed that Loft, Inc. and Pepsi-Cola, Co. merge into a single company. With 95% of Pepsi-Cola Co. shareholders approving and 75% of Loft, Inc. shareholders approving, the merger was given the go ahead and on June 30, 1941, Pepsi-Cola Co. shareholders received 8.43 shares Loft, Inc. common stock for their old stock. Loft, Inc. changed its name to Pepsi-Cola Co. in a reverse acquisition. You have to admire how Le Roy Jr. handled the situation, getting rid of the loss-making candy business, the loss-making candy stores, settling several lawsuits with shareholders over mismanagement in a favorable manner, winning the lawsuit against the company’s former President for failing in his fiduciary responsibility, and organizing a reverse acquisition which turned a company that suffered losses year-after-year into a profitable company that has become a global brand recognized throughout the world. Giving away an extra six ounces for free was a stroke of genius on Guff’s part. Pepsi’s little jingle produced a hundred-fold increase in its stock price, rising from $3.25 in June 1937 to $350 in April 1940. Since Loft, Inc. changed its name to Pepsi-Cola Co. in June 1941, on a nominal basis, the stock has increased in price 130-fold. On a total return basis, $1 invested in Pepsi-Cola, co. on June 30, 1941 would be worth $10,000 today. The chart below, on a log scale, shows how PepsiCo stock rose after the acquisition of a controlling stake in Pepsi in 1938. As for Loft Candy Stores, Inc. where all of the assets of the Loft Candy and retail stores were placed and spun off, its stock traded at $0.50 on June 30, 1941, rising to $8 by 1946, subsequently falling to $3 by 1951, rising again to $14 in 1968, and settling at $0.25 in 1972 after the company changed its name to Briarcliff Candy Corp. The company was dissolved in 1981. Below is a chart of Loft Candy Stores stock after the company was spun off:

    Yields on United States 10-year bonds rose above 3% at the beginning of January. The yield on the 10-year had reached its lowest point in history in July 2012 at 1.43% as a result of the Fed’s policy of Quantitative Easing. Since then yields have doubled as markets have incorporated the impact of the Fed tapering their purchase of U.S. Government securities. This raises the question, how high could interest rates go from here? Could interest rates move up to 3% per quarter? U.S. interest rates were that high back in 1981 when the yield on US 10-year Treasuries hit 15.84% and 30-year mortgage rates hit 18.63%. What about 3% per month? That works out to 42% per annum compounded. Although interest rates have never been that high in the United States, they have been that high in other countries. The yields on 3-year bonds in Mexico were over 50% back in the 1990s. Other countries, mainly in the developing world where inflation was more common in the 1970s to the 1990s also experienced double or triple digit interest rates.  

The Impact of Hyperinflation

Interest rates at that level can only occur because of inflation. The problem is that as inflation rates rise, they become more unstable and unpredictable. Consequently, the maturity of debt instruments shrinks as the uncertainty increases. Annual interest rates become meaningless, and the maturity shrinks to months or days. What about 3% per week? At this level, the compounding of interest rates takes over. An interest rate of 3% per week works out to 365% per annum. Interest rates rose significantly beyond even this level during the German hyperinflation of 1923. The interest rate charged at the Berlin Stock Exchange in October 1923 hit a high of 7950%, the equivalent of 9% per week. Although this interest rate is high enough to even make a Payday Loan store blanch, it didn’t even come close to compensating for the inflation that occurred in October 1923. The monthly inflation rate in Germany during October 1923 was 24,380%, which far exceeded the 45% monthly interest rate implied by the 7950% interest rate the Berlin Stock Exchange charged. During that month, the US Dollar exchange rate went from 242 million Marks to the USD on October 1, 1923 to 100 billion Marks by November 1, 1923.  

Investors and Speculators Get Wiped Out

At these levels of hyperinflation, interest rates become meaningless. When prices are rising at the rate of 30% per day, as occurred during Germany in October 1923, fixed-income assets are completely wiped out by the inflation, and no one will deposit or lend cash that will become worthless in a few days. During hyperinflations, the future ceases to exist and cash becomes the only medium of exchange as the value of assets with a maturity over a few days is completely wiped out. Interestingly enough, government bonds rose in price along with inflation during 1923 in Germany. The German 3% bond paying 3 marks in interest actually traded for 37 million Marks in September 1923, right before the inflation came to an end. This provided a yield on the bond of less than one-ten millionth of a percent (i.e. 0.0000001%). The price on the bond had risen from 475,000 Marks just one month before, and a chart of the stock is illustrated below. The government, however, had a different point of view. What is the point of having a hyperinflation if you don’t at least wipe out your government debt? By October 1923, the German government was issuing 100 Billion Mark (100,000,000,000) banknotes (equal to 100 Trillion Marks by US measurement), and when the government finally did convert the currency from old Marks into Rentenmark, it took 1 trillion old marks to get a new Rentenmark. What about government bonds? What happened to them? Did the speculators reap a windfall from the revaluation of the currency? Of course not. This proves two things. First, markets are efficient. The net price in Berlin after the inflation and in London after the devaluation ended up the same. Second, don’t try to outsmart the government who deals the deck of cards. You will lose.

  So far in 2014, emerging markets have significantly underperformed Developed Markets. Turkey has been forced to raise their interest rates dramatically to defend the Lira while Argentina saw a collapse in its own currency. The Fed is expected to continue to taper in 2014, reducing the flow of funds to Emerging Markets and causing them to further weaken relative to Developed Markets. The MSCI Emerging Markets Index has failed to break above its 2011 highs and could soon break critical support right below 900. How long can this continue? The chart below shows the long-term relative performance of Emerging markets relative to Developed Markets. Global Financial Data has extended the MSCI Developed and MSCI Emerging Markets back to the 1920s so their long-term interaction can be analyzed. How far can Emerging Markets fall relative to Developed Markets? If the trend follows the pattern of the past, quite a lot. Whether it continues down to the levels of 1985 or of 2000, or even 1968, remains to be seen, but this chart does not bode well for Emerging Markets over the rest of the decade. This technical analysis is backed up by the fundamentals. The end of tapering, and eventually the end of Zero Interest Rate Policy will attract more money to Developed Markets. Assuming the worst of the Eurocrisis is over, growth may soon return to Europe. Many Emerging Markets will have to see their exchange rates decline in order to make their labor markets more competitive. In the coastal areas of China, wage rates have risen substantially over the past decade, reducing the future gains from trade. Countries like India struggle with providing the infrastructure necessary for economic growth. Commodities made a huge move over the past decade, and they are unlikely to continue their relative appreciation, reversing the improvement in the terms of trade that some Emerging Markets had enjoyed. In short, the chart and the fundamentals say that you should not see the current weakness in Emerging Markets as a buying opportunity. Instead, it probably foreshadows continued weakness for several years to come. Don’t try to catch a falling knife because you are likely to get hurt.

  Global Financial Data is proud to announce the addition of almost 40,000 files that our subscribers can now access. The source of the data is the World Bank, which has made their data archives available to all users. These files cover every country in the world, and a wealth of topics from the environment to the economy. All the data files are annual with some providing data back to 1960. Global Financial Data has gone through these series and chosen the ones that would be most useful to our subscribers. The focus has been on choosing series that provide long-term data and supplement the 20,000 series in the original GFDatabase and the 45,000 series we provide from Eurostat. Between these three databases, subscribers now have access to over 100,000 data series that cover the world. Included in the series GFD has chosen are new series providing data on Gross Domestic Product, Exports and Imports, Debt, Education, Technology, the Environment, Health Care, Trade Barriers, Infrastructure, Defense and Income Distribution. In addition to these areas, we have expanded coverage of topics traditionally covered by the GFDatabase including Interest Rates, Price Indices, the Stock Market, Monetary Aggregates, Population, and Exchange Rates. To highlight the World Bank Data, we provide a separate tab in our Search Engine so you can find topics that will help you to do your research. If you would like, we would be happy to send you an Excel file with information on the series that have been added. Global Financial Data plans to provide a new release of data each month to its subscribers to the GFDatabase, US Stock Database and UK Stock Database. We will provide updates on these releases both through our blog and through e-mails. If you have any questions about these releases, please feel free to contact your sales representative.