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Starbucks (NASDAQ:SBUX) is acquiring the Tea Company, owned by Teavana Holdings (TEA) for a value of about $620 million. This is the biggest acquisition ever for Starbucks and would take the company beyond its core area of coffee and namesake shops.

Beware Acquisitions

Though this can be interpreted as good news, it should give investors pause. Growth through acquisition is expensive and has historically not worked out well for the acquiring company. Investors should expect the combination of firms through acquisition to result in a host of problems from incompatible cultures to elusive synergies. Investors should stay away from Starbucks given its current strategy and valuations in favor of other related stocks.

It should also be noted that Starbucks' expansion into more products and retail consumer packaged goods is not innovative in today's markets. McDonald's (NYSE:MCD) is doing it too! McDonald's is jumping into coffee mass retail, like many other restaurants and coffee makers. It is parlaying its McCafe brand into products you can find in your grocery store. Thus, Starbucks is not in any way blazing new trails or creating new markets with this move into tea.

Takeover after Takeover

Since 2008, when Shultz returned as CEO to the company, the company has made moves to sustain the firm's revenue growth with energy drinks, juice, instant coffee, a single serve brewer and food that it sells in shops and grocery stores. Starbucks has also dropped the word coffee from its logo. It is now owns Tazo tea as well as Evolution Fresh Inc. It bought Evolution Fresh last year for $30 million. This year, it bought Bay Bread LLC for $100 million. The retail presence is also sought to be expanded in the US with a Tazo shop as well as smaller, new design for stores in Seattle's Best Coffee locations. It plans to take to take these stores throughout the nation. Teavana store concept would give the company access to a new consumer base as well as access to prime store fronts.

The popularity of tea as a beverage is growing. Teavana sells loose leaf in more than 100 varieties. It also has Jasmine Oolong tea of two ounces that it sells for $12.50. Apart from this, it also has Golden Monkey Black tea for $18.50 for sale on its website. It has about 300 stores in Canada, Mexico and the United States and recently, has opened a store in Kuwait. Starbucks wants to add to the international openings. It also wants to sell Teavana in grocery stores as tea is the second most consumed beverage after water.

Teavana had a initial public offering last year. The shares had sold for $17 per share and had dropped 40% through November 13. Even so, Revenue has climbed $168.1 million in the year ended January 29, a rise of 35%. The share price rose to $15.45, an increase of 53%. This disconnect between a dropping share price and rapidly improving fundamentals makes Teavana among the better candidates for acquisitions.

Teavana investors will get cash of $15.50 per share as part of the takeover. The takeover is expected to happen by the end of the year. This would also add about 1 cent per share in earnings to Starbucks' fiscal in 2013. This year, Teavana has traded extremely high at 24.7 times before EBITDA. By November 13, the EBITDA multiple had declined to 11.2. The purchase price at which Starbucks bought the company is 17.5 times EBITDA in the past twelve months.

Tazo tea, bought by Starbucks in 1999, and Teavana, are indeed complimentary brands. The company has to decide whether it would sell both brands together. Tazo sales amount to $1.4 billion in a year.

Emerging Market Exposure

Thankfully, Starbucks is not solely relying on takeovers for growth. The company has indicated that India and China are some of its top markets. Tea is a popular beverage in both countries, more so than coffee. Both nations have a growing middle class which would serve as growing markets for Starbucks products. In India, a joint venture was formed with Tata Global Beverage Services (TGBL) and the first café was opened in last October in Mumbai with plans to open a store in Delhi as well. India, as a country consumes 7 times more tea than coffee. China is also a market where more than coffee is consumed, 12 times more in 2012. Even though coffee consumption will rise 8.5 % in 2012, the consumption of tea will rise by 11%.

There are plans to add 1,000 stores in the U.S. over a period of five years, yet there are 440 fewer Starbucks in the U.S. when compared to the past four years, and more than 18,000 Starbucks locations around the world, even as the company closes stores in the United Kingdom.

Valuation

Investors should be weary of acquiring firms for many reasons. Acquirers tend to pay too much for their target companies. After purchase, many business combinations suffer culture clashes and other hurdles to integration. The synergies imagined prior to acquisition are often not realized. Worse yet, the combined firm is more complicated and harder to manage. As a result, many firms end up spitting out acquisitions. Savvy investors should be aware of this and ought to require compelling valuations to buy acquiring firms.

Starbucks is not trading at such compelling valuations:

Ticker

Company

P/E

P/S

P/B

P/FCF

DNKN

Dunkin' Brands Group

41.46

4.74

9.92

41.61

GMCR

Green Mountain Coffee Roasters

11.31

1.05

1.72

NA

MCD

McDonald's

15.84

3.08

6.08

79.09

SBUX

Starbucks

27.24

2.79

7.16

105.79

Green Mountain Coffee Roasters (NASDAQ:GMCR) and McDonald's are both trading at much cheaper price-to-earnings ratios. On this basis alone, investors should consider each of these two alternatives before thinking one moment about Starbucks.

Source: Starbucks' New Acquisition - A Reason To Buy?