An arbitrator on November 12, 2013, ruled that Starbucks (SBUX) should pay $2.23 billion in damages plus $527 million in pre-judgment interest and attorneys' fees to Kraft Foods (KRFT). The ruling put an end to the years long battle between Kraft Food and Starbucks.
In November 2010, Kraft initiated an arbitration proceeding to challenge Starbucks's attempt to terminate the agreement that both companies entered in 1998, to market and distribute Starbucks brand coffee in the U.S. grocery stores.
Both the companies first came together in 1998 with a distribution agreement (roast and ground coffee agreement), under which Starbucks was contracted with Kraft Foods to distribute Starbucks brand bagged coffee in the grocery stores to establish and drive the specialty coffee category. At that time the business was generating about $50 million in annual revenues.
The partnership was so successful that later in 2004 both the companies further expanded their partnership to include the new brands (Seattle's Best Coffee and Torrefazione Italia coffee brands) from Seattle Coffee Company, which Starbucks acquired in July 2003.
The contract was set to renew automatically for successive 10-year periods with no expiration date. One way to not renew the contract was a valid termination. The only other way that can get Starbucks out of this agreement was by taking over the business by paying Kraft Foods the fair market value of the business along with, in certain instances, a premium.
The things run smoothly and very successfully for about 12 years i.e. till 2010 when the business was generating nearly $500 million in yearly sales.
In August 2010, Starbucks showed its intentions to do away from the partnership and made an offer to buy the business, which Kraft rejected due to the disagreements about the compensation offered. Later, on November 10, 2010, Starbucks end the contract citing the breach of the contract as the reason behind it and accused Kraft of breaking the terms of their deal. Following the developments, Kraft initiated the arbitration proceeding to challenge Starbucks's attempt to end the agreement.
Starbucks reaction to the ruling:
The company showed a strong disagreement with the arbitrator's conclusion and once again blames Kraft's breach of contract as the reason behind the termination. As said by the company in related press release:
"We are pleased the arbitration has ended; however, we strongly disagree with the arbitrator's conclusion"
"We believe Kraft did not deliver on its responsibilities to our brand under the agreement, the performance of the business suffered as a result, and that we had a right to terminate the agreement without payment to Kraft."
"I would add that taking our packaged coffee business back from Kraft was the right decision for Starbucks, our brand and our shareholders."
Surprisingly, on the contrary to its disagreement with the ruling, the company showed no intentions to contest the ruling any further. In-fact the company tried to show the brighter side of the termination decision in the related press release by mentioning the growth of the business since its break-up with the Kraft.
Kraft obviously showed its happiness about the decision.
"We're pleased that the arbitrator validated our position that Starbucks breached our successful and long-standing contractual relationship without proper compensation," said Gerd Pleuhs, Executive Vice President Legal Affairs & General Counsel of Mondelez International. "We're glad to put this issue behind us. We can now fully focus on growing our global snacks business."
Kraft will direct the net proceeds from the ruling to Mondelez international (MDLZ)*.
*Mondelez International spun off Kraft Foods Group as an independent company. Based on an agreement Mondelez and Kraft, Kraft will give the net proceeds to Mondelez International.
Mondelez International intends to use the proceeds to repurchase Mondelez International Class A Common Stock.
For Kraft (Mondelez) it's a big financial and moral victory. The proceeds are intended to be returned to shareholders through share repurchases, which is an excellent news for the investors of Mondelez.
For Starbucks and its investors, the ruling is a big negative with huge financial implications and can also hurt the company's image in the business world.
The ruling has cost Starbucks over $2.7 billion. Starbucks has already restated its Q4 results after the ruling. Now, the company's Q4 results show a loss of $1.23 billion, which includes the income tax benefit of $820 million.
Its current "Cash and cash equivalents" are not big enough to cover such a big payment (see the table below). The company's will have to raise some debt to fulfill its obligation, which will put strain on the company's balance-sheet. This will also lead to the higher interest expenses for the company in the near future.
However, beyond the financial implications, it will hardly affect the normal business or the growth initiatives of the company.
The biggest loss for the company is beyond financial loss, as the ruling, in a way, has put all the responsibility of the breakup on the company, and quashed the company's blame that Kraft is responsible for the breakup. This can hurt the company's image in the business world.
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