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Green Mountain Shows One-Cup Brew Never Cheaper: Real M&A

Green Mountain Never Cheaper With Discount to S&P 500
Green Mountain is now cheaper than the benchmark gauge for U.S. stocks and traded last week at the steepest discount to Starbucks Corp. in almost eight years. Photographer: Daniel Barry/Bloomberg

Single-serve coffee has never been more affordable.

Green Mountain Coffee Roasters Inc., the maker of Keurig one-cup brewing machines and coffee pods, has tumbled 71 percent in the past year amid slowing sales growth, inquiries into accounting practices and criticism from hedge fund manager David Einhorn. Its price-earnings ratio, which at last year’s peak was six times more expensive than the Standard & Poor’s 500 Index, fell to 11.2 on June 1, the lowest since the company went public in 1993, according to data compiled by Bloomberg.

Green Mountain is now cheaper than the benchmark gauge for U.S. stocks and traded last week at the steepest discount to Starbucks Corp. in almost eight years. While the $3.6 billion brewer’s overestimation of K-cup sales led to a second-quarter revenue disappointment that wiped out 48 percent of its market value in one day, analysts are still projecting net income will rise 79 percent this year. The Waterbury, Vermont-based company’s profitability and depressed valuation may now be enough to lure private-equity bids, said Detwiler Fenton & Co.

“Green Mountain is the undisputed leader in the U.S. in single-serve coffee,” Marc Riddick, an analyst at Williams Capital Group LP in New York, said in a telephone interview. “It’s certainly a lot less expensive than it was a year or so ago. If you want to participate in that marketplace in the U.S., then yes, it would be attractive.”

Board Turmoil

Today, Green Mountain rose 6.9 percent to $24.52, the largest gain in almost a month. It was also the fifth-biggest advance in the S&P Midcap 400 Index.

“We don’t comment on speculation,” Suzanne DuLong, a spokeswoman for Green Mountain, said in an e-mailed statement. “We are focused on continuing to capitalize on our leadership position in the single serve market and believe we are well-placed to deliver growth and new innovation that will drive value creation for our shareholders.”

Green Mountain has faced turmoil within its board of directors as founder Robert P. Stiller on May 8 was stripped of his chairmanship after he violated company policy when he sold stock to meet a margin call. On May 24, director Douglas N. Daft resigned from the board for personal reasons.

Einhorn, the founder of Greenlight Capital Inc., has criticized the company about its lack of transparency and “litany of accounting questions” and said the market for its single-cup brewers is limited. Jonathan Doorley, a spokesman for Greenlight Capital, said yesterday that Einhorn declined to comment further.

Valuation Discount

Green Mountain is also the subject of a U.S. Securities and Exchange Commission investigation, first disclosed in September 2010, according to regulatory filings. Two months later, the company restated earnings dating back to 2007.

The issues led to a 79 percent drop in Green Mountain’s shares since its market capitalization reached $17.1 billion in September. The decline was the second steepest in the Russell 1000 Index through yesterday.

At its peak last year, Green Mountain had an earnings multiple of 81.5, six times higher than the S&P 500 and three times more expensive than Seattle-based Starbucks, according to data compiled by Bloomberg.

Green Mountain’s price-earnings ratio closed at a record low of 11.2 on June 1, less than the S&P 500’s valuation of 12.9 times profit and Starbucks at 30.7, the data show.

Shares of Green Mountain closed at $22.95 yesterday, valuing the company at 11.4 times earnings.

Leveraged Buyout

A leveraged buyout is “definitely possible” if a private-equity firm thinks Green Mountain’s valuation is reaching its bottom, Jim Sanderson, a Boston-based analyst at Detwiler Fenton, said in a phone interview.

While Green Mountain’s second-quarter revenue of $885.1 million trailed analysts’ estimates for $971.7 million as K-cup sales fell short, an acquirer would still be getting a company that’s projected to grow faster than U.S. equities on average.

Green Mountain’s revenue this fiscal year, which ends in September, is expected to increase 46 percent to $3.9 billion, according to analysts’ estimates compiled by Bloomberg. While that’s a slowdown from last year’s gain of 95 percent, it would be more than 8 times the average estimated rate of 5.3 percent for the S&P 500, the data show.

The coffee brewer is also projected to post record net income of $527.8 million in fiscal 2013 as its profit margin expands to an all-time annual high of 10.2 percent, analysts’ estimates show.

Coffee Leader

“The growth numbers have made people very interested,” said Riddick of Williams Capital. “The biggest, most attractive thing about the company is the fact that U.S. consumers are very happy with them.”

Still, “you’re not talking about a stable marketplace” because the single-serve coffee industry is still changing rapidly, Riddick said.

A buyer of Green Mountain would gain the leader in the U.S. single-serve coffee market and the fourth-largest company in the coffee production industry, which is worth about $7 billion annually in the U.S., according to researcher IBISWorld Inc.

There are as many as 12.2 million Keurig machines in use, accounting for almost 14 percent of all U.S. households with a coffee maker or brewer, Green Mountain Chief Executive Officer Lawrence J. Blanford said last month. A potential acquirer would also get access to the company’s deals to sell Starbucks, Dunkin’ Brands Group Inc. and Caribou Coffee Co. branded K-Cups portion packs.

Patent Expirations

Buyout firms would be interested “because Green Mountain is the perfect type of company that you hold for a couple of years,” Rick Munarriz, a Miami-based analyst at the Motley Fool, said in a phone interview. “It’s definitely an attractive acquisition target.”

Still, Green Mountain’s profitability may decline as competition increases when its main patents for K-Cups expire in September, said Mark Astrachan, an analyst at Stifel Nicolaus & Co. in New York, who advises selling the shares. Closely held Rogers Family Co. and Esio Beverage Co. are already starting to compete.

“You’re going to see earnings be further pressured,” Astrachan said. “There’s a ton of discounting going on right now with K-Cups. You’re going to see pricing come down even in advance of the patent expirations.”

Green Mountain’s negative free cash flow of $143 million in the last 12 months may also deter private-equity firms from making a bid, according to Sachin Shah, a Jersey City, New Jersey-based special situations and merger arbitrage strategist at Tullett Prebon Plc. Financial suitors need cash to help pay down debt assumed in a buyout, he said.

‘Dicey Situation’

“It’s a dicey situation,” Shah said in a phone interview. Right now, buyers “don’t know all the facts.”

Another company in the industry may eventually be interested in acquiring Green Mountain after the accounting concerns are cleared up and management improves its ability to accurately forecast growth, Shah said.

“As a public company, it has been a disaster in the past few months,” the Motley Fool’s Munarriz said. Some investors “want Green Mountain hitched at this point because it’s not working too good as a bachelor.”

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