Merger and acquisition activity throughout the single-use coffee market has been sparking antitrust questions. The existence of a monopoly would really depend on how the Federal Trade Commission (FTC) decides to divide up the coffee business. These questions come on the heels of a bidding war between Vermont-based Green Mountain Coffee Roasters (GMCR) and Peet’s Coffee & Tea Inc. (PEET) for the California-based Diedrich Coffee (DDRX). Peet made an initial offer for Diedrich in early November 2009, in an effort to gain access to its manufacturing and distribution networks, as well as to acquire the licensing rights to produce K-cups under an existing deal between Diedrich and Green Mountain. K-Cups are the one-time use portion packs created by Green Mountain Coffee.
Green Mountain made its initial play for Diedrich toward the end of November in an effort to outbid Peet. After multiple attempts at striking an attractive price for Diedrich, the companies finally agreed to a tender offer of $35 a share, in an all cash transaction. Once Diedrich’s board of directors decided to go with Green Mountain’s offer over Peet’s, Diedrich was required to pay a termination fee of roughly $8.5 million to Peet’s Coffee & Tea. In actuality that termination fee was picked up by Green Mountain. The acquisition is expected to close in the first quarter of 2010. Meanwhile, the proposed acquisition still needs to pass regulatory and shareholder approval before it can be consummated.
Regulatory approval will largely depend on the FTC’s decision on how to slice up the coffee market. Green Mountain is a relatively small player in the aggregate coffee business. However, it comprises roughly 80% of the single-use coffee market. And it continues to broaden its geographic reach through small regional bolt-on acquisitions. For example, the company bought Canadian-based Timothy’s Coffees of the World, Inc. during fiscal 2010’s first quarter (ended December 31st). And in 2009 it bought the Tully’s Coffee brand to facilitate its expansion into the western United States. Meantime, shareholder approval will not likely pose a problem, considering shares of Diedrich have traded as low as $0.21 in the past 52 weeks, and the buyout price represents a very nice premium.
Green Mountain’s Keurig-brand coffee machines make up the lion’s share of the single-use business. And it has licensed the technology to Mr. Coffee, Cuisinart, and Breville to develop their own machines to utilize Green Mountain’s one-time use K-Cup portion packs. One potential competitor, Nestle (NESN), has developed its own line of high-end Nespresso single-use coffee machines, which it sells through the company’s boutique shops in major cities around the world. Nestle’s line uses similar looking coffee pods. However, the Nespresso line targets a wealthy clientele, a fact that is evident in the pricing of its machines (starting at $199). Meanwhile, Green Mountain has been targeting businesses such as law firms, real estate agencies, and hotels, as well as individual consumers. And the company appears to have positioned its machines as a convenient more cost-effective alternative to the local coffee shop, with machines costing as low as $89 and K-Cups about $0.60 a cup (Nespresso’s single servings average about the same amount).
The past may give some insight into the Federal Trade Commission’s upcoming decision on this matter. Back in 2002, the FTC blocked the takeover of Claussen Pickle Company by a private investment firm that already owned Vlasic Pickle Company. The FTC stated that the proposed acquisition would eliminate competition and the unique rivalry between the two national pickle brands. Claussen is the dominant producer of refrigerated pickles and Vlasic acts as the main price constraint on Claussen. The FTC decided that if the deal went through the resulting company would have had a monopoly share of the refrigerated pickle market in the U.S.
However, the current situation within the coffee market appears to be a bit different. Green Mountain’s 2008 sales were about $500 million, while Diedrich’s were roughly $40 million, and Peet’s were $285 million. The pickle case would have combined that business’s two largest competitors, where-as the coffee situation is a slightly different story, all together. The joining of Green Mountain and Diedrich would equate to approximately $540 million in revenues (based on 2008’s data, as Peet’s has not yet released financial results for fiscal 2009). This is a relatively small portion of the $20 billion U.S. coffee industry. The fly in the ointment is the single-use segment, which Green Mountain dominates. At present, it is still unclear how the FTC will rule. Green Mountain recently withdrew its application to the FTC, stating that it does plan to reapply, but that it wanted to give that governing body enough time to process all of the information it has received regarding the case.
Should this deal go through, Green Mountain Coffee would be able to add three more leading brands to its specialty coffee list; Diedrich Coffee, Coffee People, and Gloria Jean’s Coffees. It already offers Van Houte, Newman’s Own Organics, Caribou, and Emeril’s, as well as specialty tea brands Celestial Sesonings and Twinings all in K-Cup portion packs. And it would afford the company a nice base of operation in California, a la Diedrich’s existing manufacturing and distribution facilities.
Clearly Green Mountain has a winning strategy. Its share price is up more than 285% in the past 52 weeks. Should the deal go through, it would probably result in increased sales and earnings due to a widened geographic reach. However, we think that the stock already factors some of the benefits of this potential deal into its price. Accordingly, if the proposed linkage does fail to be completed GMCR’s price may pull back a bit.