Should Starbucks Buy Peet's Coffee?

(Starbucks' (SBUX) rumored takeover of Peet's Coffee (PEET) report updated with CEO Howard Schultz' ambitious goals to grow the company's grocery business more than tenfold.)
SEATTLE ( TheStreet) -- Peet's Coffee & Tea ( PEET) shares gave up some of their recent gains Tuesday as rumors continued to circulate that Starbucks ( SBUX) could be looking to take it over. The specialty coffee roaster and retailer saw its share plunge earlier in March after news broke that Starbucks and Green Mountain Coffee Roasters ( GMCR) announced a long-anticipated partnership, leaving Peet's out of the lucrative deal.

Peet's shares fell 2.5% to $47.80 Tuesday afternoon but remain nearly 13% higher than the opening price on March 15, the day takeover rumors first began in earnest. The stock had plunged 11.4% on March 10, the day Starbucks and Green Mountain announced a deal in which Starbucks and Tazo tea-branded K-Cup portion packs will be available for Green Mountain's popular Keurig single-cup brewing systems later this year. Investors were clearly disappointed that Emeryville, Calif.-based Peet's had been left out of the profitable partnership.

Reports began circulating on March 15 that Peet's and Starbucks recently held talks to discuss a potential sale. Details remained limited but Starbucks CEO Howard Schultz has indicated the Seattle coffee giant would look to make an acquisition, likely sometime this year.

"Though there have been no reports of any formal announcements regarding any merger or acquisitions from either companies, the analysts and industry sources claiming familiarity with Starbucks anticipate the takeover of the Emeryville, Calif.-based Peet's specialty coffee retailer and roaster by Starbucks," noted Zacks Equity Research.

Peet's has said it would look to make a move into the single-serve coffee market, a growth area Starbucks also plans to penetrate, evidenced by its recently announced partnership with Green Mountain.

Peet's would be an attractive target for Starbucks, some analysts say, given its mature distribution network and premium pricing. The pair already shares some history, too; Peet's was Starbucks' original coffee bean supplier in 1971, according to the Financial Times.

"If Starbucks buys the coffee roaster, it can use Peet's relationships with major retailers, who will allow a "triad of premium brands" on store shelves, with Peet's offering super-premium, Starbucks as premium and Starbucks' secondary brand Seattle's Best Coffee positioned as "fighting" premium," Zacks noted.

On March 23 at Starbucks' annual shareholder meeting in Seattle, CEO Howard Schultz told investors he wants sales of the companies coffee and other products at grocery stores and other retail outlets to rival its traditional coffee shop business, meaning the operating segment would have to grow more than tenfold from its 2010 revenue of $707.4 million.

Peet's super-premium brand offering on store shelves could help Starbucks progress toward that ambitious goal.

"Peet's Godiva-flavored coffees would also give Starbucks leverage if it enters the single-cup brewer market, which many perceive as a huge area of growth in the coffee industry," the firm added.

Zacks maintained a neutral rating on Peet's shares, and held a Zacks #3 Rank for Starbucks, indicating a short-term hold rating.


Still others caution the rumors remain just that, and an actual deal is still extremely speculative. Some consider that Starbucks would be more likely to consider acquiring a food and/or confections company as it looks to expand its operations beyond coffee.

Peet's retail stores may compete too closely with the in-store operations of Starbucks to make a merger financially viable, say some industry experts.

Sources told Financial Times that Peet's would be a better target for companies like Kraft Foods ( KFT) or Nestle SA's ( NSRGY).

Janney Capital Markets analyst Mitchell Pinheiro said a Peet's buyout by Starbucks would dilute the buyer's marketing bandwidth. "Why would you need another super-premium coffee brand, when I'd argue Starbucks is the number one super-premium coffee brand in the country, if not the world?" he asked.

He added that devoted Peet's customers, known as "Peetnicks," are typically anti-Starbucks and could become disillusioned with the brand if Starbucks were to take it over, choosing instead to spend their coffee dollars elsewhere.

While a number of large companies often buy up smaller firms without customers realizing it -- think Hershey's ( HSY) ownership of Scharffen Berger Chocolate and Colgate-Palmolive's ( CL) acquisition of Tom's of Maine -- that could be unlikely in this case, given the high-profile nature of the Starbucks-Peet's takeover rumors.

Pinheiro, who covers Peet's but not Starbucks, nevertheless attended the latter's analyst conference in New York last year, saying that he "was impressed by the enormous opportunity they have to deploy capital in China.... Why they would spend capital anywhere but on international growth at least for a year or two is beyond me."

He said Kraft Foods ( KFT) would make more sense as a bidder for Peet's, especially since it no longer carries a premium coffee brand since its distribution partnership ended bitterly with Starbucks on March 1.

Pinheiro said any buyer of Peet's would have to pay a premium to the company's current market capitalization, around $617.4 million as of Friday's closing price. He estimated Peet's could fetch as much as $700 million to $800 million.

Starbucks hinted last month that a partnership such as the one with Green Mountain was in the works when it told news outlets in February it had plans to announce a new product for the single-serve coffee market "in the near future." The Seattle coffee shop chain did announce a distribution agreement with Courtesy Products, a privately held provider of in-room coffee service to hotels across the U.S.

Starbucks already sells individual instant coffee packets under its Via brand, but speculation among analysts had been mounting that Starbucks was poised to push more aggressively into the single-cup brewing market now dominated by Green Mountain's Keurig machines and K-Cup portion packs .

Analysts from Credit Suisse estimated that the Green Mountain deal will add 15 cents per share to Starbucks' earnings in fiscal 2012, and 23 cents per share in fiscal 2013. The partnership also adds weight to Green Mountain's Keurig platform, already the leader in the at-home and in-the-office single-cup brewing market.

Canaccord Genuity consumer analyst Scott Van Winkle noted that the Starbucks-Green Mountain deal lessens the risks of K-Cup competition. "The deal's impact on Green Mountain shares is rightfully more than the impact on near-term earnings or cash flow," Van Winkle added. "We believe that the Starbucks partnership reduces risk by at least 20% and thus have increased our near-term price-to-earnings target by 20%."

Peet's Coffee

Maxwell House coffee is owned by Kraft Foods. Until recently, Starbucks had been providing coffee discs for Kraft's Tassimo single-cup home brewers . That agreement officially ended March 1 after a drawn out, public legal battle between the pair in which Starbucks claimed that Kraft neglected and mismanaged the partnership.

Despite Tassimo's success with some consumers, Green Mountain's Keurig brewing system enjoys market share of around 80%, according to Reuters, dominating other competitors as well, including Sara Lee's ( SLE) Senseo brewer and Nestle SA's Nespresso system.

Earlier this year Starbucks unveiled a new, wordless logo . At the time, CEO Howard Schultz said that the wordless logo, in part, "gives us the freedom and flexibility to think beyond coffee."

The new logo, officially launched this month, also represented Starbucks expansion plans, and the rumors circulating about a Peet's takeover could very well be the latest round of the Seattle coffee shop chain's growing global footprint.

With all this in mind, what do you think? Should Starbucks be angling to acquire Peet's Coffee? Take our poll below and see what readers of TheStreet think...

Should Starbucks acquire Peet's Coffee?

Yes -- Starbucks' takeover of Peet's would allow it to further dominate the in-store coffee market.
No -- Starbucks should continue to concentrate on growing its single-serve presence and focus less on store growth.

-- Written by Miriam Marcus Reimer in New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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