There continues to be a good deal of buzz generating around Green Mountain Coffee Roasters (GMCR) over the last few weeks. Whether it is with regards to losing incremental market share or its expansionary and developmental plans for next year, the stock has seen some violent swings in share price since reporting earnings on November 20th. At present, I think most of the speculation surrounding the company is definitively centered on its developing cold beverage platform. In this article I aim to look more closely at the Keurig's future cold beverage platform currently being developed. I also aim to develop a conversation surrounding what the end-product needs to do to address this new and growing category of at-home carbonated beverages. The development of additional brewer platforms by Green Mountain could prove to provide a stable investment thesis for investors who are looking toward future revenue and earnings growth drivers for the company.
The market has probably accepted the late 2014 launch of the Keurig 2.0 which has been widely debated as the right or wrong move for the company in light of the failed Vue product line. It remains to be seen whether or not a closed Keurig 2.0 system will generate the same sales volume as other Keurig brewers in the sales channels. GMCR is developing the Keurig 2.0 in response to its market share erosion since the company's patents expired on K-cups in September of 2012 and as private label competition has entered the single-serve coffee market and with cheaper pricing per K-cup/Pod. As a reminder, a closed system generally does not do well in the sales channels over an extended period of time and as competing products offer open-ended systems. BlackBerry (BBRY) is a perfect example of a closed ecosystem which failed to reach a broader user base as competitors opened their operating systems to greater functionality and formatted systems. So when the Keurig 2.0 comes to market, and by the time a consumer needs to replace his/her brewer with their usage of private label coffee pods, will that consumer buy the Keurig 2.0 or another open-ended system that continues to allow the use of private label coffee pods at cheaper prices than licensed K-cups? How many differing private label coffee pod companies will be partnering with GMCR by this time is another question to consider? It is also likely that GMCR will be inclined to purchase certain private label coffee producers should they not be inclined to partner with GMCR directly. But with this Keurig brewer likely to make its debut at the upcoming International Home and Housewares Show, many of these questions will likely be answered by then. So let's move on to some of the most recent chatter surrounding GMCR.
A couple of analysts recently made remarks regarding Green Mountain Coffee's foray into the cold beverage platform product development. The first remark came from an analyst at Bank of America/Merrill Lynch. The comment read as follows:
Green Mountain beverage system could disrupt market, says BofA/Merrill. The firm said its review of Green Mountain's patent applications (patent review) indicate the company's planned Keurig Cold platform is being designed to carbonate beverages via a single-serve cartridge and will not need a CO2 tank, which it feels would enhance convenience.
I had the pleasure of engaging in a conversation with BofA/Merrill, as I wanted to verify the term single-serve being used in the research note and its definitive correlating product; was it correlated to the machine or the CO2 cartridge. The analyst did validate that his note correlated the term single-serve to the CO2 and not the actual machine which is still in question and largely depends on the cooling mechanism application in the machine, if desired. Keep in mind that this was just a patent review as they have yet to see a finished product for any aspect of the cold beverage platform.
It became very apparent to me during the conversation that the analyst knew very little about the at-home carbonation market when questioned further about the understanding of convenience. He mentioned the convenience is in the single-serve cartridge. When asked where these cartridges are purchased he suggested retail establishments and online. We then asked how this would enhance convenience. It got pretty funny from this point, but cordially. The fact is that whether it is a refillable C02 cylinder or a disposable C02 cartridge they are both available at the… store or online, yep! The replenishment steps are identical! Then the analyst was asked why it is more convenient to introduce a single-serve cartridge for every drink rather than an affixed cartridge in the unit for 60-130 liters of drinks like the SodaStream (SODA) machines or other machines selling in Europe. Essentially for every single drink you would have to open the machine and introduce a CO2 cartridge along with a flavor portion pack, further adding steps and to the wastefulness of the product. Then the analyst was asked how this potential disposable C02 cartridge benefits the environment. The silence was a little more than appreciated!
The last point of inquiry was the use of the disposable cartridge as it pertains to the patent. Based on the design architecture there isn't a distinct gas compression mechanism to interact with the CO2 cartridge other than internal zeolite distinction which, as the patent outlines, produced a 4 volume carbonation. Full carbonation is appropriately consumed at an 8 volume. A 4 volume carbonation system does not have the ability to carbonate colas and root beer equivalent drinks. The analyst admitted that he hadn't much understood the concept entirely, but was pointing out the broad strokes. I could go on and on about how the analyst was educated on why a system is met with success or failure, but I think some investors are catching on to the key points here.
What the public does know presently about the cold beverage platform is that it is very price sensitive and needs to show benefits greater than that of the existing cold beverage packaged product market. The company won't just be competing with other cold beverage platforms like SodaStream or Cuisinart, but with the likes of Coca-Cola (KO), PepsiCo (PEP), Dr Pepper (DPS), Arizona Tea, Kraft Foods (KRFT), Welch's, Seneca Foods (SENEA), Nestle and all the cold beverage products readily available in the market today. The cold beverage brewer platform from Keurig has to be of similar value to that of existing beverages and beverage systems and it has to have benefits like ease of use, customization capability, an eco-friendly benefit, and better for you beverages which taste great. Benefits are going to be essential in such a brewer platform so pricing is a crucial element toward getting the consumer engaged with those benefits. Remember, there is no convenience to a cold beverage brewer as it involves many more steps than the present way for which the consumer drinks cold beverages; a very simple fact that has been recognized by Brian Kelley himself during the September 2013 Analyst Investor Day event. A slide show presentation of the event can be accessed here.
Esio attempted to market a hot/cold beverage brewer system in 2012. It failed in a very short period of time and if one looks at the Esio patent they will quickly see that GMCR is very much following in the footsteps of Esio. Wal-Mart (WMT) gave the product a shot with initial pricing at retail of $199.99. Remember, the product was single-serve with portion packs, cooling and heating mechanisms, water tank and all necessary electrical components. The Esio beverage brewer did not offer carbonation capability and yet was still priced at $199.99. Within a matter of 9 months the price was reduced to $149.99 before being clearance out of the Wal-Mart stores for $49.99. Essentially, the product was well-designed and functioned strongly, however there were no benefits to the consumer as the price per liter of beverage was beyond that of any cold beverage that one could easily grab from the fridge and pour directly into the glass. Cost per liter was well over $1.00 per glass, roughly 60% above the average cost per glass for a cold beverage and 28% above that for a hot beverage. The system had licensee partners such as Brisk Iced Tea, Campbell's (CPB) V8 and proprietary flavors as well.
The public recently learned that the cold beverage platforms have no designated launch date as offered by the CEO Brian Kelley on the most recent quarterly conference call with analysts and investors:
And then obviously any new invention like a cold system, we're quite confident and we're making great progress on it and we've not announced an exact date of launch, but we're moving quite well and I can assure you we're watching with a very disciplined way the sequencing of this and then the quality and the execution.
We would be inclined to believe that a cold brewer platform would come to market in the 4th quarter of 2014 or early 2015 and depending on the rate of adoption by the retailers for the Keurig 2.0. Additionally, we would believe that not much of the published patent will be recognizable in the end product as is usually the case when developing consumer products. So basically we don't know what the end product will be and nobody does; the job of an investor is to logically deduce the possibilities and probabilities.
In addition to this knowledge, most investors have also learned that GMCR will not initially be using the same portion packs to dispense flavors into the cold beverage brewer system. The company is creating all new production lines to manufacture and produce a new form factor of dispensing flavors for the cold beverage brewer. Remember, one of the benefits of the do-it-yourself cold beverage brewer is to customize the flavor to suit your individual tastes. Keurig's motto is "the perfect cup all the time". Customization in the cold beverage brewer category is a must as has been demonstrated by companies which have failed to deliver on this consumer demand. A single-serve K-cup offering doesn't allow for this customization of flavors. Additionally, if you don't want a customized cold beverage, what do you need the brewer for; just go buy bottle of Gatorade or case of Pepsi.
GMCR will possibly create a flavor dosing package similar to that of Cuisinart's and SodaStream's which allow the consumer to add as much flavor syrup as they want for each beverage. If GMCR chooses to ignore this point of necessary demand on the part of the consumer, they will likely see lackluster sales performance much like the Esio product which offered single-serve flavor pouches that did not offer the consumer the benefit of drink customization.
Maybe the consumer likes Pepsi or Gatorade, but in smaller doses because of the high sugar content and high fructose corn syrup. Maybe the consumer doesn't drink diet sodas because of the aspartame ingredient. These are more issues GMCR has to conquer. Remember, anybody can build a brewer, but what makes the beverage is a whole other consideration to analyze. Furthermore, not a single analyst has addressed these issues. Makes you wonder what they really understand about the beverage market and the addressable market size for the products GMCR is developing.
GMCR has to differentiate its flavor offerings from the competition and offer beneficial flavors otherwise there is no reason to buy a brewer. Some point to convenience with regards to GMCR's Keurig products. Unfortunately, that is what we call "inaccurate low hanging fruit and faulty analysis" for the cold beverage category. After all, what is more convenient than pouring a glass of Coke straight from a bottle into a glass? Why would you need a brewer unless it offers benefits?
Following some comments from Coca-Cola CEO Muhtar Kent at the Beverage Digest Conference recently, Akshay Jagdale of Keybanc believes a Green Mountain deal with Coca-Cola could be on the table if the maker of the Keurig can offer a quality cold-platform product. Kent called the single-serve dispensing line of products more of an opportunity than a threat, but seemed to suggest further innovation will be needed. If you have never witnessed an analyst taking a tid bit from an off-the-cuff question and answer session well this is a perfect example of such an occurrence. If one dissects Muhtar Kent's comments they come to realize that KO's CEO simply said that single-serve dispensing lines of products can be an opportunity, but he didn't say for whom that opportunity could benefit. Could it be KO, GMCR, SODA, PEP or anybody in general? Was this just a comment of admiration or a warning shot across the bow for all single-serve system players in the market that KO has plans to do something on their own? Seems to me the analyst has only considered one possibility and with a $100 price target, well maybe there is incentive to see it in the light he painted for investors. But forget the opinions; let's use some logic with regards to the offering from Akshay Jagdael.
First, what would be the benefit of a partnership for Coca-Cola with Green Mountain Coffee Roasters? Coca-Cola has the ability to package things the way they want, or do they? Actually they don't as the size and scale of their business have dictated the form factor for delivering cold beverages to the market for over 100 years. Changing the way cold beverages are delivered to the market would severely disrupt their business and negatively impact the overall economy. That is how big and essential their business is to the global economy. Additionally, the bottlers, whether owned or private have longstanding contracts which specifically dictate packaging outlines and offer the bottlers right of first refusal as it pertains to the differentiation of packaging. Do you know how many times the bottlers have accepted a new packaging form factor over the last several decades? The answer is readily recognizable at your local retail outlet. But let's say all permission is granted; why then would Coca-Cola need to partner with Green Mountain and share profits. Coca-Cola clearly has the production and distribution capability in place; so just put your syrups directly into the market using your own production lines or existing partner lines for all at-home carbonation systems to use. Why would Coca-Cola limit themselves to Keurig users? This offers very little logic.
Coca-Cola doesn't need greater brand awareness or to address the at-home market for cold beverages; it is the market for at-home beverages and on-the-go beverages. Essentially the same beneficial partnership that exists with Starbucks (SBUX) and Green Mountain wouldn't have the same benefit for Green Mountain and Coca-Cola. Starbucks wanted to make it more convenient for its consumer to enjoy a cup of Starbucks coffee at home, but I'm pretty sure Coca-Cola is already well appreciated and consumed at home so there simply is no comparing such a need or benefit with the SBUX/GMCR partnership as the analysis proves.
Moreover, how big is the existing user base for the cold beverage brewer systems in the world? IRI Group recognizes the home carbonation cold beverage platform market to be roughly 9 million strong around the world with over 7 million of those users engaged and actively using SodaStream cold, carbonated beverage platforms (Information provided by IRI Group paid research). Green Mountain hasn't yet offered such a brewer platform in the market, there has been no consumer testing of their product, there is no user base and no available prototype. There will need to be an established user base which will take years to build if the product line offered by Green Mountain is successful. For all of these reasons, Muhtar Kent commented by stating that more innovation needs to take place and the Keybanc analyst said a deal could be on the table. The Kebyanc analyst didn't state any deal was even a possibility in the near future, just on the table given the potential. But again, the logic dictates the probability of such a deal which seems extremely slim and lacking benefits for Coca-Cola while exposing the leading carbonated soft drink provider to risks for its brand. One doesn't usually see business done this way.
Lastly, as it pertains to a possible opportunity for a Coca-Cola partnership commentary, how does the firm participate in the at-home carbonation industry using a partner's cold beverage platform successfully? The existing Coca-Cola business is completely different from the proposed at-home carbonation business and the one essentially renders the other as antiquated and obsolete with a high potential of cannibalization. Investors should ask themselves the following questions: "Remember the last time Coca-Cola or Pepsi offered their flavor syrups to another beverage provider? Why would Coca-Cola hand deliver its loyal customer over to another beverage provider with that partner offering a number of additional flavor options to choose from and possibly the consumer abandons the Coca-Cola flavors in favor of the partner's flavors altogether? Why hasn't Pepsi or Coca-Cola partnered with SodaStream and its loyal user base that will continue to grow for the foreseeable future and has a proven product and track record with technology that has already eclipsed that being offered by the impending product offerings from GMCR? Are they just comfortable waiting another 3-5 years for GMCR to establish a user base that will only pale in comparison to that of SODA's at that time, making the logic that much more ridiculous?" This is generally not how business is done, not sound business in anyway. As logic dictates, any which way one travels down the analytical road regarding the potential for a deal between KO and GMCR, you hit a brick wall each time.
My last point of articulation regarding the potential of GMCR's cold beverage platform is this: Where is the scale? Based on what we know to date, there will be one machine to offer consumers that produces cold, carbonated drinks if desired. As a consumer, it is all or nothing and at one specific price point. There doesn't seem to be a pricing scale that allows the consumer to test a lesser priced model in the works. Retail buyers look for such scalability when entering into an agreement to distribute products, especially in a new or newer category. This could represent another issue that GMCR will need to consider and overcome in order to reach a commercial audience for its cold beverage platforms. The Esio was just one machine and that one machine failed for a host of different reasons. We hope a Keurig cold beverage platform is not met with a similar fate.