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Shares of Teavana Holdings (TEA) rose more than 52% in Wednesday's trading session. The specialty retailer of loose-leaf teas and related merchandise was acquired by Starbucks (SBUX). Shares of Starbucks lost 2.9% during the regular trading session, but recovered a bit in after-hours trading.

The Deal

Starbucks announced on Wednesday that it will acquire Teavana, a leading premium retail tea brand with global sourcing capabilities. Starbucks will pay $15.50 per share for Teavana, for approximately $620 million in an all cash transaction. Roughly 70% of shareholders in Teavana have already approved the deal through written consent.

Teavana currently operates 300 company owned stores in the US and Canada, with 19 franchised stores predominantly in Mexico.

CEO and founder Howard Schultz commented on the deal, "We will do something very similar over time with Teavana as we will do for tea what we did for coffee. The two brands will co-exist and Starbucks will develop a line of "super premium" Teavana branded products for retail sale. There's no incremental expense other than building new stores and new tea bars."

For its full year of 2011, Teavana generated $168.1 million in annual sales, on which the company net earned $17.8 million. The $620 million deal values the firm at 3.7 times 2011s annual revenues and 35 times annual earnings.

The company guides for full year revenues of $222 million to $231 million for its fiscal 2012. Net income is guided to come in between $20.8 and $21.8 million. The valuation comes down to 2.7 times 2012s annual revenues and 29 times annual earnings. Teavana generates more than half of its revenues in loose leaf teas, with the remainder of sales being generated in merchandise and beverages.

Starbucks expects that the deal will be to accretive in the first year following the acquisition by roughly $0.01 per share. The company expects that the deal will be closed before the end of the year, as the company does not expect regulatory hurdles.

Valuation

Starbucks ended its fiscal year of 2012 with $2.0 billion in cash, equivalents and short term investments. The company operates with roughly $550 million in debt, for a net cash position approaching $1.5 billion. Financing of the Teavana deal should therefore be possible within the firm's existing cash balances.

Starbucks generated $13.3 billion in annual revenues for its fiscal 2012. The company net earned $1.4 billion, or $1.79 per diluted share. Trading around $49 per share, the market values the firm at $36.5 billion. This values operating assets of the firm at $35 billion, which values Starbucks at 2.6 times annual revenues and 25-26 times annual earnings.

Starbucks currently pays a quarterly dividend of $0.21 per share, for an annual dividend yield of 1.7%.

Investment Thesis

Year to date, shares of Starbucks have risen some 6%. Shares steadily rose from $45 in January to a peak at $62 in April. Weaker earnings and concerns about lower economic growth, and consequently discretionary spending, send shares to low forties in the summer. Shares are currently exchanging hands at $49 per share.

Over the past years, shares have risen from lows of $10 at the end of 2008 and the beginning of 2009 to highs of $60 earlier this year. Between 2009 and 2012, Starbucks expanded its annual revenues from $9.8 billion to $13.3 billion. Net profits grew even faster from $391 million for its fiscal 2009 to $1.38 billion in 2012.

The deal with Teavana is an excellent addition for Starbucks. While the acquisition adds a merely 1.7% in annual revenues, it has the potential to expand its revenues rapidly. Tea is the second most consumed beverage in the world. The $40 billion global market is growing at roughly 10% per annum, according to Starbuck's presentation. The payback period of just 18 months for an average Teavana store is very short and allows a quick role out of the brand without significant capital expenditures.

The deal multiples are fair given the strong growth of Teavana and the strong balance sheet. The valuation, including the acquisition premium, is comparable to Starbucks' own valuation both on revenue and earnings multiples.

Starbucks can increase the opportunities for cross selling, and boost tea beverage sales in Teavana's stores. Starbucks aims to open over 1,000 Teavana stores in the coming five years.

I remain on the sidelines, while I applaud the acquisition. The long term strategic rationale of the deal makes sense. Yet the short term impact will be limited and I see few short term triggers for further gains.

Source: Starbucks - Acquisition Of Teavana Is A Great Deal