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Green Mountain Coffee - A Takeover Target by Coke?

|Includes:Keurig Green Mountain Inc (GMCR), KO, MDLZ, NSRGY, PEET, PEP, PG, SBUX
Green Mountain Coffee Roasters has been one of the strongest companies over the last few years with its razor and razor blade model with its Keurig brewers and K-cups, growing over 50% annually while Starbucks was shuttering stores. Currently, there are upwards of 4.5 million of its Keurig brewers in homes and businesses, with 2.1 million of those brewers sold in Q1 and Q2 alone, and 1.37 billion K-cups sold in Q1 and Q2.  In March 2010, Brian Belski, Oppenheimer's Chief Investment Strategist, listed GMCR as one of 34 stocks out of the S&P 1500 that would be an "attractive takeover target."  This was when GMCR was trading around $30 per share, and when GMCR's acquisition of Diedrich Coffee was still being investigated by the FTC.  Also, Jarden's Mr. Coffee brand is coming out with brewers licensed with Keurig technology and J.M. Smucker will be releasing their Folgers and Millstone coffee products in K-cups this fall to further drive sales.  Cuisinart brewers with Keurig technology were released earlier this year.  Even Wolfgang Puck is getting into the K-cup market.

Since Belski's analysis, the stock has declined over 20% from its $33 highs in April -- roughly $880 million in equity over the last few months . This decline was caused by a few factors alongside the overall market decline; the first being Diedrich Coffee's 55% K-cup growth in their latest quarter, leading some to believe that K-cup sales were slowing. Further, GMCR missed estimates by $0.06 in Q2 due to one-time defect costs ($4.5 million), acquisition costs ($5 million), and lowered Q3 guidance due to acquisition expense. Even with those extra costs, GMCR's net income in Q2 improved 82% to $41.2 million from $22.6 million. Sales growth also proved robust, GMCR showed a systemwide 67% increase in K-cup sales, and part of Diedrich's decline was due to GMCR's own launch of Donut House K-cups in October (versus Diedrich's top selling Donut Shop). Also, in early May, the FTC approved GMCR's acquisition of Diedrich Coffee after a 6 month Second Request delay and fight with Peet's Coffee and Tea, which now gives GMCR dominant control over the K-cup coffee market.

On June 7th and June 25th, theflyonthewall reported there was "takeover chatter" on GMCR.  The question is, who would acquire GMCR?

Some possibilities are the usual giants in the consumer products category -- Procter and Gamble, Unilever, Kraft Foods, Nestle, Pepsico, Mars, and Coca-Cola. 

Kraft already had to pay GMCR $17 million in 2008 due to a patent lawsuit over its Tassimo brand violating GMCR's K-cup patents. With Coca-Cola, GMCR already has an interesting connection with them. In December 2009, Douglas Daft, Coca-Cola's former Chairman and CEO, joined GMCR's board of directors after being with Coke for 35 years from 1969 to 2004, and said in the press release that he is "intrigued by its potential for growth." On May 26th, GMCR's CEO Larry Blanford stated during the Janney Consumer Conference: "As you would walk down the grocery aisle and look at the non-carbonated beverages that are in that aisle, we believe that we can pursue most of the non-carbonated beverage categories that you would find in the grocery store." When asked by one of the attendees at the conference to elaborate, he said, "We have development work underway... we're developing new intellectual property."

This would be a major shift for GMCR from its core coffee and tea offering. In June 2009, GMCR launched "Perfect Iced Teas" which were its first products specifically meant to be consumed cold. Two months ago, GMCR expanded upon that with the launch of the "Brew Over Ice" brand, which includes 2 more iced teas, and its first entry into the iced coffee market with 2 flavors. They also mentioned on their corporate blog about launching two more "Brew Over Ice" products this summer.  However, the comments at the Janney conference allude to more opportunities with non-carbonated products. The non-carbonated category has been dominated by Coca-Cola, Pepsi, and Dr Pepper Snapple Group for years. It's one of the bright spots in the industry since carbonated sales have been stagnant or declining recently. One of the key questions is why would a former Coca-Cola executive who made many millions during his 35 year career with them, join GMCR's board 8 months ago for a small board fee, just to assist them with competing directly with one of Coca-Cola's key markets?  The answer might be an interesting and somewhat surprising one; it's possible he is still working with Coca Cola.  After all, he did leave the door open on helping them in the future.

Another interesting point with Douglas Daft, is that when he joined GMCR's board in late 2009, he still used Coca-Cola's corporate address for his contact information, even though he "retired" from them over 5 years before this:


Signatures: Douglas N. Daft 12/15/2009"

Why would he still use Coke's address for his business contact even though he left them in 2004?  Plus, now he is helping GMCR compete against Coke in the non-carbonated cold beverage market, all while keeping an office at Coke's world headquarters?  Could it be he might be functioning as a liaison before a buyout?  In addition to GMCR competing against Coke in the non-carbonated market, GMCR's core coffee business is one of the largest beverage categories in the U.S., and Coke has virtually no market share.  

With GMCR's sales accelerating at 68% in Q2, Coca-Cola's stagnant soft drink sales, Coca-Cola's former CEO joining GMCR's board 6 months ago, Oppenheimer listing GMCR as a takeover target, GMCR mentioning its development into the non-carbonated market, and the 30% hit to the stock price, this may set up an interesting set of events for an acquisition scenario. Coca-Cola has been known to go after growing companies before, such as it did with Vitamin Water in 2007, when it paid 11.7 times their 2006 sales of $350 million. GMCR's 2009 sales were $800 million, and currently has a $3.2 billion market cap (131.7 million shares outstanding). Using a similar premium as the Vitamin Water deal, that would place GMCR over $70 per share.  A premium could vary widely, but even at 8 times 2009 sales, that would put GMCR north of $48 per share.  A buyout of Green Mountain Coffee Roasters, which owns the brewers, wholesale coffee business, K-cup patents, and manufacturers the vast majority of K-cups (earns royalty on the rest), could draw a significant interest involving multiple parties.  For example, if Coca-Cola were to make an offer, would Pepsico possibly be interested?  Or the same with Unilever versus Procter and Gamble?

Regardless, given GMCR's growth and recent hit to the stock price, I am sure there is more than just Douglas Daft who is intrigued. 

Disclosure: Long GMCR