Green Mountain Roasted by Einhorn

NEW YORK ( TheStreet) -- On Monday, David Einhorn -- the famed founder of Greenlight Capital -- revealed that his latest short play is Green Mountain Coffee Roasters ( GMCR). While the bulls would have you believe the company can earn $9 a share, Einhorn says try $3.50 -- making the company's market premium far short of market expectations.

News of the strategy sent the coffeemaker's stock tanking nearly 10% on Monday. Shares fell another 15% when slides from his presentation were released on Tuesday.
David Einhorn

The coffee roaster was the best performing stock in 2009 and its shares gained nearly 20% in 2010. The stock wasup nearly 200% this year. Green Mountain also had blowout earnings in its most recent quarter, selling roughly 30% more Keurig branded pods and coffee makers than forecast.

For Einhorn, the bullishness along with an ongoing Securities and Exchange Commission investigation of revenue recognition was cause for a reexamination of the company's earnings.

Einhorn's own investigation come up with three major concerns:
  • The company is a "serial issuer of stock" that has allowed insiders to cash out $172 million of shares at an average price of near $90 a share.
  • The company's capital spending "is growing much faster than the business, when the business should be growing faster than spending." According to Einhorn's crunching of forecasts, Green Mountain is set to spend $740 million in 2012, $431 million of which he says is "unexplained" and also twice as much as forecast net income.
  • His final, and most damning concern, is of accounting "shenanigans" in acquisitions which Einhorn argues is a reflection of a wider symptom in revenue recognition. In past acquisitions of Tully, Timothy's, Diedrich and Van Houtte, nearly the entire price paid for targets has been accounted for as goodwill, he says.

Green Mountain, founded in 1981 as a coffee wholesaler-- transformed itself to a higher margin coffee machine and pod seller through its 1998 stake in Keurig and 2002 controlling stake in the company. With Keurig K-cups, the company can have thin profit margins in its coffee wholesaling and Keurig brewer machines businesses, while capturing "monopoly profits" in its K-cup pod selling businesses.

But that's all about to end, says Einhorn. He believes its K-cup patent is set to expire next September and that when competitors enter the business, the company will only earn profits of 12 cents a pod and overall revenue of less than $1 billion -- lower than bull forecasts of roughly double that level.

With a key piece of earnings set to expire in 2012, Einhorn's thesis is that the company has overpaid for mergers to fend off competition to sell K-cups, and it's now spending a tremendous amount to reinvent the K-cup with a dubious market forecast.

If the patent expires, private label competition from Kraft ( KFT), Sara Lee ( SLE), Nestle and Maxwell House may eat at 20% of Green Mountain K-cup profit.

As such, the company has stated this it is looking to create a new sized pod that will taste better and require new machines. The question is whether consumers will upgrade to Green Mountain's new closed system or move to generics when today's K-cup becomes open ended. Einhorn pointed to the latter and that on the project, "green mountain is burning cash."

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In a dizzying deep dive into Green Mountain's revenue recognition practices, Einhorn said that its partnership with distributor Mblock, a focus of the SEC inquiry, led to questions of revenue recognition that allowed the company to report a surprise 27% beat in K-cup sales' June earnings. The earnings number and a similar May beat caused the stock to soar. Einhorn says his look at filings show that as the company issued shares this year, insiders sold theirs. While Einhorn stopped short of saying there was a fraud, he painted the connection between revenue recognition, its earnings beats and insider selling in chronological order.

Overall, Einhorn had two anecdotes for his short play. Like with the saying 'follow the money' in "All the Presidents Men," his look at capital spending, purchase accounting and revenue recognition showed a company losing cash from operations. Comparatively, its K-cup distribution deal with Starbucks ( SBUX) isn't as compelling as the market thought, Einhorn said, and the company is going to lose a monopoly profit source.

While the company's off stock price charts and analysts bullish forecasts of K-cup consumption that may lead to $2.35 billion in profits and depict a company with products management has called "the iPod of coffee," Einhorn isn't won over. He said it's the opposite, "come to think of it, I wish it had Apple's (price to earnings) multiple," -- it would make the short he's just announced all the more valuable.

-- Written by Antoine Gara in New York

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