Starbucks (NASDAQ:SBUX) has had a good run as the country's pre-eminent coffee outlet in cities and towns across the nation. The company has been able to distribute its products in supermarket and warehouse stores across the United States. However, Starbucks has now run into a buzz saw with Kraft Foods' parent company Mondelez International (NASDAQ:MDLZ) and has been ordered to pay a significant fine.
The legal problem was triggered by Starbuck's early termination of a contract with Mondelez to provide coffee to the many retail outlets that carry their bagged coffee products. The company offered $750 million to get out of the arrangement, but Mondelez, then still under the name of Kraft Foods, refused the deal.
CEO Howard Schultz initiated the termination, stating the falling sales figures for the their bagged products in stores. Starbucks alleges that Mondelez violated a number of contract breaches and mishandled the brand, causing a loss of revenue over the 1998 to 2010 period.
Mondelez Fights Back
Kraft Foods contested this representation of their handling of Starbucks products. They disputed any wrongdoing, understanding that it was more likely that the Mondelez deal conflicted with Starbucks plan to expand as a global consumer-products company, such as with their single-serve product Via. The Starbucks-Mondelez deal was supposed to renew automatically every 10 years. Getting out of the Mondelez deal was critical to the company's goals.
Kraft, and then Mondelez, called in the arbitrators to settle the dispute.
After hearing the evidence, an arbitrator ordered Starbucks to pay a whopping $2.23 billion dollars to Mondelez. In addition, they will have to pay $527 million in pre-judgment interest, as well as attorney's fees. Starbucks will not be able to appeal the decision.
What's Next For Starbucks
SBUX now operates over 9,400 company operated stores and 8,700 licensed stores. You can even get your Starbucks latte on a train riding through Europe. The stores have added items like oatmeal, salads, pastries and lunch sandwiches. Starbucks has also expanded its food offerings with La Boulange and by forming a strategic agreement with Damone to create and develop a line of dannon-branded fresh dairy products.
The world may stop spinning if it were not for Starbucks!
It seems to us that the company is really stretching to continue it's growth plans and will come up against very robust competition as it enters the breakfast and lunch food business. These diversification efforts away from basically a nice place to have a great cup of coffee will also be very financially expensive.
As a result of the litigation, Starbucks has had to restate its 4th quarter earnings for the year, showing an operating loss of $2.2 billion. Although the company says it has plenty of cash on hand to pay the fine, the unexpectedly high amount may hamper the company's plans to expand their businesses aggressively.
The huge fine could also possibly impact it's share buyback which would impact EPS. This defeat also shines a poor light on Howard Schultz who is widely respected on Wall Street.
The company's expansion in to so many other areas will be costly and will be met with very strong competition from well capitalized competition.
Starbucks has had an incredible run over the past year and trades at a very high P/E of 36. Investors would be wise to take some profits in SBUX given the company's expansion strategy into the casual food business and the $2.23 Billion dollar slip up with Mondelez.