Green Mountain Eclipses Starbucks

MARCH 9, 2011   THE WALL STREET JOURNAL

By JOHN JANNARONE

Who says acquisitions destroy value?

One of the best-performing stocks of recent years is Green Mountain Coffee Roasters, valued at nearly $6 billion compared with $30 million at the start of 2000. The catalyst for such a caffeine-fueled ride: the acquisition of Keurig, purchased in two parts in 2002 and 2006 for a combined $119 million. That modest sum gave Green Mountain ownership of Keurig's single-serve machines and leadership in the now fastest-expanding segment of the U.S. coffee market.

Even Starbucks is waking up and smelling Green Mountain's success. The Seattle company tried its luck with single-serve pods brewed in Tassimo machines, a competitor to Keurig, but the venture was pulled March 1.

It's unlikely Starbucks will stay on the sidelines long. Sales of coffee for Keurig machines rose 75%, to $1.6 billion, in 2010, estimates Akshay Jagdale of KeyBanc Capital Markets. That's more than 90% of U.S. single-serve sales, he says. Starbucks's only comparable product still on the market is a single-serve format called Via that doesn't require a machine, but its revenue totaled just $22 million after its launch partway into last fiscal year.

Taking on Green Mountain would be a tough proposition. A big reason is that Green Mountain owns both pod production and machines. Like the razor/razor blades business model, that allows it to sell machines at cost and rely on pods for the profits. Tassimo, however, charges more for its machines, which are manufactured separately by BSH Bosch.

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Associated Press

One option for Starbucks is to create its own single-serve machines and go head to head against Green Mountain.

Even the powerful Starbucks brand didn't appear to make inroads on Keurig. After Starbucks coffee became available on Tassimo machines a few years ago, Keurig's sales rose more quickly, says Canaccord analyst Scott Van Winkle.

One alternative strategy for Starbucks is to create its own single-serve machines and go head to head against Green Mountain. But Mr. Jagdale estimates it could take three to five years to develop a patent-protected machine and pod model. That would mean sacrificing important time while households are adopting single-serve machines.

Acquiring Green Mountain also would be problematic. Given Starbucks's market capitalization is about $25 billion, such a purchase would require a dilutive share issue or a large debt offering.

That points to potential for an agreement in which Starbucks produces the coffee and pays Green Mountain to package it in Keurig-compatible pods. Green Mountain already has made its Keurig machines available for other brands, including Dunkin' Donuts and Newman's Own. Adding the Starbucks brand arguably would tie up the market even tighter for Keurig machines.

But with Starbucks still nowhere in the booming single-serve market, the pressure is on Chief Executive Howard Schultz to swallow his pride.

Write to John Jannarone at john.jannarone@wsj.com