What’s Starbucks REALLY Getting for $620M?

by James Brumley | November 20, 2012 9:32 am

Now that the dust is finally settling from Starbucks‘ (NASDAQ:SBUX[1]) big deal to gobble up Teavana Holdings (NYSE:TEA[2]), traders can take a breath, take a step back, and ask the more important question:

What’s a coffee shop chain going to do with a relatively minor tea company?

More than that, however, is whether the deal makes sense given the price tag. But like so many things in life, the answer is: “It depends.”

Just the Facts

For those who have been out of the loop since Thursday, the news is simple enough — Starbucks is acquiring Teavana Holdings for $620 million. But while Starbucks certainly needs no introduction, Teavana might.

The Atlanta, Ga.-based company is — as the name implies — a purveyor of loose-leaf teas. It also sells many tea-related accoutrements in its 302 North American retail shops. Though not a large company, it has made a name for itself within tea-totaling circles as the place to get most any kind of tea you want; the quality is top-notch, too.

Just for perspective on just how top-notch it is, Teavana generated a rather erratic $168 million in revenue last year, and did $189 million in sales over the past four reported quarters. That’s a solid growth pace, though nothing unusual for the company. Teavana did $124 million in sales for 2010, and was legitimately on pace to drive $286 million in revenue for 2013.

Even better, the company (unlike many of its peers) has proven it’s able to turn a decent portion of that revenue into a profit. The company earned $17.7 million last year (net margins of 10.5%), and has carved out a profit of $16.7 million (net margins of 8.8%) on the $189 million revenue it has seen since this time in 2011.

Point being, Starbucks could have done a lot worse. There’s clearly some growth here, and though the acquisition’s price tag was a frothy 36 times trailing earnings, if anybody knows the value of a brand name, it’s Starbucks.

Still, the few folks who are wondering about the integration of the two companies aren’t just the usual naysayers looking for something new to critique.

Not as Compatible as They Seem?

Starbucks was built from the ground-up serving coffee. Though it sells its wares through its stores and other retail venues, retail sales of goods other than drinks isn’t SBUX’s core business.

Teavana, on the other hand, doesn’t serve tea to any meaningful degree. It predominantly provides loose-leaf tea for its customers to make at a different time, in a different place.

It’s not unreasonable to presume the java aficionados that are willing to spend four bucks for a caffe latte are the same folks who would insist on something besides Lipton when it came time to switch beverage gears — in fact, the buzz is that Teavana was aiming to reproduce the Starbucks experience in Teavana’s shops. However, there’s no assurance the cross-selling and cross-marketing opportunities are going to pan out the way Starbucks seems to think they will.

And to be clear, that is the $62 million question at this point.

The media already has speculated where all of this is going, and how each company can leverage the other’s customer base. The most common assumption to date is that Teavana teas will be added to the retail offerings at Starbucks’ stores. Doing so raises one question, though: To what degree will that displace sales of Tazo Tea, a brand that already generates $1.4 billion in annual sales for Starbucks following the 1999 acquisition of the brand?

Motley Fool’s Jason Moser might have opined the most bullish yet most alarming idea of all, however, saying, “They’re going to take this and make it their own” — meaning Starbucks probably wants the name, and little else.

To give credit where it’s due, Starbucks did turn the Tazo brand into something solid. Teavana doesn’t need tweaking, though; it’s growing just fine on its own. Moreover, if Starbucks’ only intent is to add Teavana in its stores, to what extent will that cannibalize Tazo’s sales? Perhaps a little, or perhaps a lot.

One additional question that needs to be voiced: Given how Teavana was growing just fine without Starbucks, is it possible by “making it Starbucks’ own,” the things that make Teavana great will whither away?

One Way to Get it Right

All that said, there is one way in which Starbucks could potentially add real value to the Teavana name without getting in its way. In a word: China. (Though Europe gets a close second, and India a solid third place.)

Make no mistake: Starbucks can cultivate rabid, caffeine-crazed fans all over the world, even in China, where tea still dominates coffee as a preferred drink. Nevertheless, and as was noted in early November[3], the company is aiming to double its store count in China to 1,000 by the end of 2013.

What if the company can add Teavana (and Tazo) tea to the retail mix inside those stores? It’s a natural fit for obvious reasons, and though China’s 1,000 stores would still pale in comparison to the 18,000 Starbucks already in place all over the world, China’s contribution to the top and bottom line would be stunningly strong on a per-store basis.

The same theory would also apply to European and Indian Starbucks, as those locales are as laden with tea drinkers as the U.S. is with coffee drinkers. India and Europe aren’t being treated like high-growth zones by the company, though, most likely because Starbucks is struggling to even get a strong coffee foothold in those regions.

It’s all a big if, however, since it’s still not clear what Starbucks is looking to do with its new brand name. Investors simply need to watch closely, as leveraging Teavana by “making the tea its own” might not actually bear much fruit. It might just bear redundancy.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

  1. SBUX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SBUX
  2. TEA: http://studio-5.financialcontent.com/investplace/quote?Symbol=TEA
  3. as was noted in early November: https://investorplace.com/2012/11/3-reasons-why-starbucks-stock-will-be-even-better-in-2013/

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