Starbucks-Kraft Dispute Percolates on Market Share

SEATTLE ( TheStreet) -- Starbucks ( SBUX) and Kraft Foods' ( KFT) ongoing coffee distribution battle continued to heat up ahead of a Jan. 27 hearing.

Kraft Foods alleged in a court filing Friday that market share performance did not factor into its contract with Starbucks, a partnership whereby Kraft dispenses Starbucks' products to grocery stores and other retail outlets in the United States, Canada, Britain and other countries.

Starbucks has repeatedly claimed that Kraft neglected and mismanaged the partnership, including store displays and marketing, and failed to take measures to "address the erosion of Starbucks market share," all of which supposedly cost Starbucks millions in lost sales and a smaller market share in its grocery-based coffee sales business. Starbucks said its grocery sales fell to 26.7% in early 2010, from 32.7% in 2004.

The coffee shop chain hopes to end the 12-year arrangement by March 1 and move its distribution operation to a new partner, privately held Acosta.

In Kraft's latest court filing, the processed food maker claimed that market share performance was not a factor in its distribution agreement with Starbucks.

"We dispute its relevance. It's hypothetical. That has no bearing on the question of whether they have the right to terminate and walk away for nothing on their own time table," Marc Firestone, Kraft's general counsel, told Reuters.

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Starbucks spokesperson Alan Hilowitz countered Friday that "declining market share is clear evidence of Kraft's failure to perform its basic obligations under the agreement," adding that "it's disappointing but not surprising that Kraft would congratulate itself for ever-diminishing returns."

Starbucks already offered Kraft $750 million to end the partnership but Kraft turned the sum down. It insists that, 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.

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

If Starbucks is able to convince a judge that Kraft's alleged mismanagement of its products caused a material breach of contract, payment for damages could be reduced or even eliminated.

Kraft sought an injunction against Starbucks on Dec. 6 which Starbucks later said would negatively affect its bottom line. In seeking the injunction, Kraft hoped to stop Starbucks from moving ahead with business operations as if the agreement had already been terminated.

Kraft spokesperson Mike Mitchell has said that there had been "no valid termination of the agreement. The contract is still in force. Therefore, there's no transition."

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

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.

In mid-January Kraft claimed it faces "irreparable harm" if Starbucks is allowed to end the partnership.

Starbucks asserted 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 the partnership accounts for just 1% of Kraft's revenue, meaning termination of the agreement would not cause irreparable harm.

Starbucks said Dec. 23 no irreparable harm would come to Kraft "given that this is fundamentally a commercial dispute that can be resolved through the arbitration procedures the parties agreed to in their contract."

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.

Starbucks is due to report its fourth quarter earnings after the closing bell on Wednesday. Analysts' consensus call is for Starbucks to book fourth-quarter profits of $294.5 million, or 39 cents per share, on revenue of $2.93 billion.

In trading Monday afternoon Starbucks shares rose 0.6% to $33.40. Kraft also gained 0.6%, to $31.54.

-- Written by Miriam Marcus Reimer in New York.

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