Monday, June 10, 2013


An ongoing legal dispute between Kraft (KRFT) and Starbucks (NASDAQ:SBUX) may end up providing investors with a solid investment opportunity with the coffee retailer.  The two companies have been battling in court since 2010 over an agreement under which Kraft distributed Starbucks’ packaged coffees, including whole beans and ground coffee, to grocery stores and other retailers.  Kraft claims that Starbucks unilaterally decided to end their agreement, and Starbucks says that Kraft failed to aggressively promote its brands, which include Seattle’s Best Coffee, in stores.  

The deal between Kraft and Starbucks began in 1998, when Starbucks was selling its coffee in just 4,000 stores with annual sales of about $50 million.  When Starbucks backed out of the agreement in 2010 sales had grown to about $500 million a year, and Starbucks packaged coffee was sold in 40,000 stores across the United States and Canada.  Starbucks reportedly approached Kraft in August 2010 about ending the partnership and made a $750 million offer to buy out Kraft’s rights in the deal.  Kraft said the offer was below fair market value and declined.  In October 2010, Starbucks sent a letter to Kraft stating that Kraft had breached the agreement.  Starbucks said that Kraft had done a poor job of marketing their products and had failed to share important information.  They also claimed that that Kraft’s Yuban coffee was unfairly competing with Starbucks.  Kraft defended its efforts on behalf of Starbucks, citing strong growth in Starbucks sales during their agreement.  

Since then the companies have continued to carry their disagreement through various legal proceedings and arbitration.  In April, Starbucks announced in its quarterly filing that it now expects a binding decision from an arbitrator to be handed down in the second half of its fiscal year ending September 2013.
The expected end to this legal battle may provide investors with a unique opportunity.  Moses Li states that, “analysts are expecting SBUX to pay at least $1 billion in addition to any legal fees to Kraft for damages.  Although these expectations are general knowledge to the public, SBUX shares are hitting all-time highs, indicating that it has not been reflected in the valuation. In addition, with roughly only $1.67Bn in available cash, it is safe to assume that SBUX will tap into debt options in order to finance the settlement and keep on-going operations. The new debt plus the payment for the settlement will almost definitely harm the company's bottom line. If we combine this with the fact that the stock is more sensitive to downside news, SBUX may take a dip after the lawsuit ruling.”  

Li also goes on to explain, Starbucks is on the path to becoming a large international powerhouse. Furthermore, the company has stated that it expects China to easily outpace the Canadian business revenues within the next couple of years. Most of these growth plans are set to impact EPS in FY2014, FY2015, which explains the current valuation; investors are paying a premium for the future's potential. We also cannot forget the continued success of SBUX's loyalty cards, channel development, and food sales growth. Much of the growth's future success depends on the competencies of management, but we have no reason to doubt Mr. Schultz and his ability to grow a company aggressively.”

Li further explains the potential investment opportunity that could arise out of this lawsuit. “Last summer, SBUX took a 29% plunge from highs of $61.67 due to general market volatility and poor earnings calls. Of course, by no means can we assume an identical decline if SBUX loses the lawsuit, but for discussion's sake, let's examine a similar decline after the lawsuit decision or another potential market correction. With 15% from today's share price of $62.46, the price will be $53.01. Furthermore, forward P/E will become 21.7. At these hypothetical valuation levels, Starbucks will be more than attractive because you will be buying the future's growth with a fair or even cheap valuation.”

In light of all of this, it might be well worth your while to take a serious look at Starbucks as a potential long term investment.

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