Starbucks: Kraft Blocking Distribution Transition

SEATTLE ( TheStreet) -- Starbucks ( SBUX) and Kraft Foods' ( KFT) ongoing coffee distribution battle is heating up.

Starbucks told a federal judge on Thursday that Kraft is unfairly preventing it from ending their 12-year-old distribution agreement, where Kraft dispenses Starbucks' products to grocery stores and other retail outlets, hampering its attempt to move its distribution operation to a new partner, privately held Acosta.

The coffee shop giant said Kraft's court-issued injunction against Starbucks, filed in early December, will negatively affect its bottom line. Starbucks, which earlier this week unveiled a new logo, has accused Kraft on numerous occasions of mismanaging the distribution of its products, including store displays and marketing, and failed to take measures to "address the erosion of Starbucks market share."

Starbucks said its grocery sales fell to 26.7% in early 2010, from 32.7% in 2004. "It is Starbucks, rather than Kraft, that faces the threat of harm," Starbucks' filing noted. "Leaving Kraft in control of distribution of Starbucks' products pending a resolution of the parties' dispute -- allowing Kraft to do lasting damage to Starbucks' brand -- threatens harm to Starbucks that is both immediate and difficult to calculate."

Kraft's spokesman Mike Mitchell countered to Reuters that Starbucks' grocery sales declines in 2008 and 2009 coincided with the overall economic downturn and during a time when coffee competitor Dunkin' Donuts "aggressively" marketed its own coffee products.

In Thursday'sthat filing, Starbucks alleged that Kraft is blocking its attempt to shift its distribution business to Acosta, including sending a cease-and-desist letter that threatened Acosta with interference claims if it moved ahead and began marketing or distributing Starbucks products before or after March 1, according to a Reuters report.

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Kraft's Mitchell told the newswire that there had been "no valid termination of the agreement. The contract is still in force. Therefore, there's no transition," though he was unable to confirm to Reuters whether or not Kraft sent the alleged letter to Acosta.

"Kraft's efforts to interfere with an orderly transition of the (consumer packaged goods) business have caused significant harm to Starbucks," Starbucks' filing said.

"This is a clear case of irreparable harm that we believe justifies the granting of a preliminary injunction," Mitchell told the newswire.

Starbucks argued that it "has given Kraft many months notice to allow it to plan for life after Starbucks ... Kraft does not -- and cannot -- allege that this termination will have any significant impact on the company as a whole," adding that partnership accounts for just 1% of Kraft's revenue, meaning termination of the agreement would not cause irreparable harm.

Starbucks' initial claims were found in an Oct. 5 letter from Starbucks' attorney Aaron Panner to Deanie Elsner, president of North American beverages at Kraft. Starbucks, in another letter dated Nov. 5, released hours after its stellar quarterly earnings report, said Kraft "made no effort" to cure the breaches and so the deal would end.

Unless Kraft fixed the breaches within 30 days, one of the letters said, their deal -- in which Kraft sells Starbucks and Seattle's Best bagged coffees at retail outlets -- would end in March.

In late November, Kraft started an arbitration proceeding, challenging Starbucks' decision to terminate their 12-year supermarket distribution partnership. Kraft maintained that the contract remains in effect indefinitely, subject to "certain limitations and protections," and that Starbucks can't just walk away from their deal.

"Starbucks unilaterally and unjustifiably declared in public statements the agreement's termination, needlessly risking confusion among customers about the agreement's status," said Kraft's general counsel, Marc S. Firestone on Nov. 29.

Under the protections of the indefinite agreement, Kraft needs to be given sufficient adjustment period to deal with the end of their partnership and must be compensated with the fair market value of the Starbucks business partnership, plus, possibly, a premium of up to 35% of that value, Kraft said.

Analysts have speculated that a termination payment could cost Starbucks as much as $1.5 billion.

In seeking the injunction, Kraft hoped to stop Starbucks from moving ahead with business operations as if the agreement had already been terminated. Kraft argued "the contract is still in force."

Kraft argued that it helped Starbucks build its retail grocery coffee business significantly over the years, from $50 million in annual revenues in 1998, when their partnership was formed, to $500 million today.

This argument was repeated last month, adding that revenue for coffee in the U.S. grew 8% last year on volume and market share growth. Kraft added that Starbucks, most recently in April of last year, commended the role Kraft played "in building a 'highly profitable' CPG business, citing Kraft's 'world-class' capabilities in manufacturing, research and development, marketing and distribution."

"In effect, Starbucks is trying to walk away from a 12-year strategic partnership, from which it has greatly benefited, without abiding by contractual conditions. Kraft reasonably expected Starbucks to honor the contract," Firestone declared.

In a statement last month, Starbucks said, "We have both the capabilities and experience to make this a seamless transition for our customers. Kraft's self-serving and blatantly disruptive actions risk creating unnecessary confusion for our shared customers, and in turn their consumers. Starbucks will vigorously oppose any action on Kraft's part that would prevent Starbucks from rightfully assuming full control of our brand and business, and look forward to presenting our case through the pending arbitration process."

Peet's Could Benefit

The schism between Starbucks and Kraft could benefit coffee up-and-comer Peet's (PEET), according to Stifel Nicolaus analyst Steve West.

"(When) Starbucks and Kraft part ways, we believe Peet's could be a nice fit to deliver Starbucks into the distribution business," he noted in late November while conceding that "we have no knowledge of any M&A negotiations or discussions between Peet's and Starbucks or any other party."

The analyst speculated that Peet's stock, trading then around $38 and currently around $39, could garner as much as a 40% premium to recent pricing, pushing it up as high as $54, with EV-to-EBITDA, or enterprise value to earnings before interest, taxes, depreciation and amortization, to about 13.5 times his fiscal 2011 estimates.

"It appears Starbucks prefers a distribution agreement to maximize profit and minimize risk (similar to current KFT agreement only with more of the profits), however, this may not be viable now that the SBUX/KFT disagreement has become so public and negative," West wrote at the time.

West added that Peet's direct-store delivery system covers around 80% of all grocery locations "with established relationships at virtually all of club, mass and drug" store outlets, "needing minimal investment to achieve full coverage in the midwest and south."

The increasingly popular single-serve coffee market could also be an entry point, the analyst speculated. "Additional premium brands (Peet's and Godiva) could significantly leverage a potential Starbucks single-cup brewer, possibly giving it enough market weight nationally across all retail channels to challenge Green Mountain's ( GMCR) K-Cup supremacy."

-- Written by Miriam Marcus Reimer in New York.

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