Sept. 16, 2012, is D Day -- or at least K Day -- for Green Mountain Coffee Roasters Inc. (GMCR)
That’s when it will lose the main patents on K-Cups, the coffee pods that helped make Green Mountain the largest player in the $1 billion-plus U.S. single-serve coffee market.
Once the patents expire, competitors can make their own version of K-cups and threaten the prospects of a company already battling criticism from hedge fund manager David Einhorn that its market-share gains have peaked. Einhorn, president of Greenlight Capital Inc., declined to comment for this story and won’t say if his firm is shorting the stock.
“New entrants into private label could hurt their volume,” said Bea Chiem, a San Francisco-based analyst at Standard & Poor’s, who gives the company a B+ credit rating, four levels below investment grade. When the patents run out, it could also “open up the door for other branded competitors to step in,” she said.
The Waterbury, Vermont-based company fell 39 percent on Nov. 10, the day after reporting fourth-quarter sales that trailed analysts’ estimates, erasing about $4 billion in market value. The shares have since clawed back 26 percent, falling 1.2 percent to $51.69 yesterday. Green Mountain has advanced 57 percent this year, compared with a 3.3 percent slide in the Standard & Poor’s 500 Index.
Green Mountain got into the single-serve coffee business in 2002 when it paid $14.4 million for 41 percent of Keurig Inc., a maker of coffee brewing machines. Four years later it bought the rest of Keurig, selling the brewers at a reasonable price and making money on the K-Cups -- which only worked with Keurig machines -- much the same way Procter & Gamble Co. does with razor blades. Sales have since increased an average of 65 percent a year.
Recently, the company has sought to boost sales and discourage competition by partnering with high-profile coffee brands such as Caribou Coffee Co. (CBOU), Folgers and others to sell K- Cups. Earlier this year, the company signed deals with Seattle- based Starbucks Corp. (SBUX) and Dunkin’ Brands Group Inc. Grocery retailers began selling Starbucks K-Cups earlier this month. Green Mountain has a 71 percent share of the U.S. market in single-serve beverages, according to Mitchell Pinheiro, an analyst at Janney Montgomery Scott in Philadelphia.
The two expiring patents protect technology that maintain a precise amount of coffee in each pod and the means to pierce it to extract liquid. If rivals reverse-engineer K-Cups, they could damage Green Mountain’s main business.
Copying the technology won’t be difficult once the patents expire, Mark Rygiel, a patent attorney at Sterne, Kessler, Goldstein & Fox in Washington, said in an interview.
“The K-Cup is not a complex invention,” he said. Most potential rivals “would understand what’s going on.”
It’s hard to know how important the patents are to Green Mountain, Rygiel said. The company and Keurig own at least 37 patents that protect how the pods look and are made, he said.
“Two patents expiring might end up being very significant, but it doesn’t necessarily mean that,” he said.
Chief Executive Officer Lawrence Blanford remains publicly optimistic, saying sales will rise as much as 65 percent in fiscal 2012 after rising 95 percent last year, seven times faster than the average S&P 500 company.
The company has submitted patent applications for a different K-Cup that uses more coffee, he said on a Nov. 9 conference call. Green Mountain also has a patent for its higher-end “next-generation” coffee machine and capsules, which will be sold starting in 2012, Blanford said.
Still, competitors already are emerging. Rogers Family Co., a closely held coffee roaster and distributor, sells one-cup coffee pods compatible with Keurig brewers for a suggested retail price of $6.99 for a 12-pack. Green Mountain’s 24-pack of namesake brand K-Cups sell for $16.49 on its website.
While Keurig sued Rogers on Nov. 2 for patent infringement in the U.S. District Court in Boston, the Lincoln, California- based company is still looking to buy more coffee-pod making equipment, Jon B. Rogers, the company’s president, said in a telephone interview last week.
Rogers, which is getting calls from retailers wanting to stock the less expensive single-serve pods, isn’t planning to do any advertising for the coffee, he said.
“Things are going so well without it,” Rogers said. “There’s been a lot of word-of-mouth on blogs.” Safeway Inc. (SWY) supermarkets in California will be selling the San Francisco Bay brand one-cup coffee pods, he said.
“The recent rollout of a Keurig-compatible pod from Rogers Family will negatively impact longer-term K-Cup profitability,” Mark Astrachan, an analyst at Stifel Nicolaus & Co., said in a research note last week. The shares have risen sixfold since Jan 29, 2009, when the New York-based analyst changed his rating from “hold” to “sell.”
Taking on Green Mountain won’t be easy because the Keurig brand resonates with consumers, according to John Staszak, a New York-based analyst at Argus Research.
“You can expect some drop-off from the patent expiration,” Staszak said. “But their brand is just so well known, it’s a plus for them in the face of patent expirations.” On Nov. 14 he changed his rating on the company to “hold” from “buy.”
Differing views on Green Mountain’s prospects have turned the stock into a battleground. While about 20 percent of the shares available to the public have been sold short, according to Bloomberg data, eight of 12 analysts recommend buying them.
“Clearly the patents are expiring and everyone is going to be trying to construct a product to go into this space,” said Eric Anderson, a marketing professor at Northwestern University in Evanston, Illinois, who has taught Keurig case studies in classes since 1997. “Whether that can be successful or not is a different story.”
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