SBUX - My take on the Starbucks memo from today….

Howard Schultz sent a very clear message today and this is my take on the memo from today….


Dear Partners,


For 40 years, Starbucks has been the world’s leading purveyor of premium coffee and premium coffee innovation. But at no point in our history has our innovation pipeline produced and introduced more successful, breakthrough products for multiple coffee occasions and in multiple form factors than it has during the past few years. Today, Starbucks provides the world’s finest coffee in virtually every format, including single-serve, to more than 50 million visitors to our stores and to millions more through nearly every retail and consumer channel in 54 counties around the world--every week.


Hedgeye - SBUX is sending a very clear message to Green Mountain “you are not in our league.”  The company is completely capable of developing its own innovative products to dominate every segment of the coffee market.

On Tuesday we announced that starting this fall we will also be bringing premium Starbucks Coffee offerings in a single-portion format to guests in 500,000 luxury and premium hotel rooms across the U.S. as part of a new partnership with Courtesy Products, the acknowledged leader in hotel room amenities. But because of the speculation swirling in the marketplace around Starbucks larger plans for single-serve in the U.S. and internationally, I wanted to take a moment to let you know what our intentions for single-serve are...because they are very bold.


Hedgeye - There are many channels of distribution and Starbucks will align itself with the partner that brings it the most economic value.


At the outset, let me share that while it is currently a $4 billion segment growing faster than any other segment of the global coffee industry, the single-serve coffee category in the U.S., and in much of the world for that matter, is in its very early stages of development.


Hedgeye – GMCR’s market cap of $5.7 billion accounts for more than 100% of its current addressable market.  There is still plenty of room within the single-serve coffee category for new market players and for product innovation.

And at this nascent stage there are numerous contenders but no demonstrated, long-term winners related to any format, geography or machine. Let me give you a few examples to illustrate this point: In Germany, where single-serve coffee has been around for some time and almost 40% of households own a single-serve brewer (compared to only 6% in the U.S.) the long-time industry leader is an open system (meaning any coffee roaster can have access to the platform) that has virtually zero presence in the U.S., the largest consumer market in the world. On the other hand, the U.S. industry leader, the Keurig K-cup, is a closed system with U.S. patents set to expire next year--and virtually no presence anywhere in the world outside of the U.S. and Canada. This global market dynamic will change.


Hedgeye - Starbucks is one of the strongest brands in the coffee segment and will shape the single-serve segment globally.  None of the single-serve brewing systems currently available to the market are good enough to be tied to the Starbucks name.

Now consider that approximately 80% of Starbucks customers do not yet own a single-serve coffee machine in their homes. This fact alone suggests that we are, again, at the very early stage of adoption and that Starbucks has a fantastic opportunity to introduce and deliver new single-serve coffee innovations to our customers. 


Hedgeye – Starbucks wants to own the category and will work to revolutionize the single-serve coffee brewing platform.  Below I outline my prediction of what the new Starbucks machine will be like (if not at first, then with later versions: 2.0, 3.0 etc.).  While some of these attributes seem fanciful, they all have founding in both Starbucks’ quest for control and the overall direction of the category (possibly run using Android):

  • The design of the machine will evoke the design and feel of the Starbucks store and experience.  I would think black and green, as well as the Siren logo. (experiences)
  • The name will also likely evoke the store.  “My Barista”, “The Siren”, or other names along those lines are likely.  (experiences)
  • The experience will be customizable, perhaps a touch screen or another user interface that allows the user to provide the machine with specific instructions as to the composition of the coffee they would like. (customization)
  • A “menu” (like a playlist in iTunes), where one can save a recipe or style of coffee for repetitive use and save it with a name like, “Jim – morning coffee”. (customization)
  • Connection to the internet via home computer system to allow the sharing of “menus” and reception of coffee ideas from Starbucks and fellow machine-owners.  This also allows a direct tap into social networking for the new machine.  (community)

We began our journey into the single-serve market with Starbucks VIA, introducing consumers to a delicious cup of coffee in an instant, soluble format. With Starbucks VIA, we also introduced them to a brand platform designed and built to facilitate an ever-evolving pipeline of new products. And Starbucks VIA’s success is undeniable: more than $180 million in system-wide sales in its first year.  This remarkable achievement for a new product was due not just to the premium quality and taste of Starbucks VIA.


It was also due to the successful implementation of a new business model where we bring the assets of the Starbucks brand--our coffee knowledge, our broad retail footprint, the passion of our store partners and our ability to reach and personally connect with millions of people--to create trial, sampling and awareness on a scale that very few, if any, retail companies can accomplish.  With Starbucks VIA, we showed how we can now migrate products through our growing presence in grocery, drug, mass, club and online channels to drive the expansion and globalization of the single-serve segment of the coffee industry.


Hedgeye - VIA was a good start, but Starbucks still needs and plans to take it to the next level.  VIA proves that the company can develop its own product and successfully market it globally.

There are many single-serve systems and solutions and even more in late-stage development. We are committed to supporting and participating in those that enable us to better and more conveniently serve our global customers, wherever they are and however and whenever they want our coffee. 


Finally, let me touch on a subject we are increasingly asked about: Green Mountain Coffee’s Keurig K-cup system. With specialty distribution arrangements and some aspects of its cartridge technology protected by patents for the next 18 months or so, Green Mountain has done a very fine job introducing single-serve brewer technology to the U.S. market.  And as a result it has emerged as an early leader. But as I have said, these are very early days, and history has demonstrated time and again that patents alone do not determine market winners--deep customer engagement, best-in-class experiences and quality do.


Hedgeye - This was the sucker punch.  CEO Howard Schultz typically uses colorful adjectives to describe the success of the Starbucks business (e.g. exceptional, unequivocal, solid).  The fact that he said GMCR has done a “fine job” was a clear signal to me that he is not a handshake away from partnering with the company.  The GMCR storytelling is getting out of hand.  GMCR’s announcement on its last conference call that it has a double secret new machine was purely a defensive move because they are desperate to work with SBUX.

The single-serve segment of the coffee industry is poised for a sea change of innovation. We will win by delivering quality in the cup, every time, and by capturing the hearts and minds of millions of loyal customers, in the U.S. and throughout the world.


Hedgeye - Take it from someone who knows firsthand - don’t bet against Howard Schultz!

Thank you for defining and delivering our Starbucks Experience to our customers, every day. I have no doubt that we will continue to reinvent this category and provide customers with yet another premium coffee experience.


Hedgeye - Our 2010 coffee strategy continues to be positive on SBUX and PEET and cautious on GMCR.


Howard Penney

Managing Director

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The Hunt for Europe’s new Central Banker

As we hit on in a note yesterday titled “Who is Germany’s New Bundesbank President?”, the departure of Axel Weber throws a kink in the race to replace ECB president Jean-Claude Trichet in October, not only due to his experience and gravitas, but also his firm hawkish stance on monetary and fiscal policy.


Below we lay out the main candidates in the running for Trichet’s seat. Sifting through the candidates, it’s clear that each one has a fault of some sort, be it their nationality, past work experience or affiliations. If Weber was the heavily favored candidate before his departure late last week, now Italy’s CB governor Mario Draghi is the favorite, however in our opinion he seems like the best of the rest and we’re critical of his dovish, “Trichet-puppet” posture. 


Given that Europe continues to be in the thick of a sovereign debt crisis, which we believe has a 3-5 year tail, especially considering that European leaders appear unwilling to let member states default on their debt, the stakes for ECB succession are even further elevated. We’re of the camp that a more hawkish stance from the next ECB president would benefit the region given rising inflationary pressures and the need to impose fiscal restraint (including penalties for abuses) on countries that overstep debt and deficit limits.


So without further ado, here are the profiles of the main candidates:



Mario Draghi (Italy)


Position 1: Bank of Italy Governor since 2006, Draghi, 63, appears to be the front runner to replace Trichet.   As chairman of the Financial Stability Board, Draghi has been at the core of international efforts to rewrite the rules of global finance following the credit crisis, experience that should win him the favor of Trichet, who is chair of Europe’s new risk watchdog.  Draghi is viewed as a dovish candidate in the spirit of Trichet.



  • 1976: Economics doctorate from the MIT.
  • 1: Executive Director of the World Bank.
  • 1: Official in the Italian Treasury. He worked on Group of Seven meetings and led the privatization of $105 billion worth of Italian companies.
  • 2002-05: Employed by Goldman Sachs, in which he arranged currency swaps that helped Greece hide the extent of its budget deficit.   


  • Draghi has the backing of Italian Prime Minister Silvio Berlusconi, which should count against him given Berlusconi’s numerous political and sexual scandals over the last years, included a pending trial; the severe debt leverage on Italian balance sheets should serve as a further detractor, symbolic of southern Europe’s fiscal irresponsibility.
  • Draghi’s 3-year stint as a vice chairman of Goldman Sachs reflects poorly against a European populous that blames investment bankers for the region’s credit crisis.   
  • His selection would leave two southern Europeans atop the ECB, with Portugal’s Vitor Constancio as ECB vice president. A third, Jose Barroso of Portugal, runs the European Commission.


Yves Mersch (Luxembourg)


Position 2: Luxembourg Central Bank Governor Mersch, 61, ranks as a German-style inflation hawk, with the ability to speak German, French, and English. A lawyer by training who helped negotiate the 1991 Maastricht Treaty that created the euro, Mersch has sat on the ECB’s council since its inception.




1: Director of the Treasury

Since 1998: Govern of Luxembourg Central Bank

-Previous posts include: IMF and World Bank alternate Governor; European Bank for Reconstruction and Development (EBRD) alternative Governor; European Investment Bank (EIB) board member; and Development Bank of the Council of Europe board member.


Hang-ups: The appointment of Mersch might force Luxembourg Prime Minister Jean-Claude Juncker, Europe’s longest-serving government head, to give up his role as the chairman of the monthly meetings of euro-area finance ministers.



Erkki Liikanen (Finland)


Position 3: Liikanen, 60, has run Finland’s central bank since 2004. As Finland’s finance minister in the late 1980s, he oversaw the boom of the Nordic economy before growth slumped.  After negotiating Finland’s 1995 accession to the EU, he served as European budget and business-promotion commissioner. Liikanen is viewed as a more acceptable candidate than Draghi by Germany, although not known as an inflation hawk, and as a positive sale to Merkel as a northern European.


Hang-ups: Fellow countryman Olli Rehn is now EU commissioner for Economic and Monetary Affairs. As is so often the case, European leaders do not want to be seen favoring one country for top leadership positions, and all things being equal Finland represents a small percentage of the Eurozone GDP to have two high profile leaders. 



Klaus Regling (Germany)


Position 4: Klaus Regling is currently head of the European Financial Stability Facility (EFSF).



  • Critics suggest he’s at a disadvantage because of his lack of monetary policy experience, despite the years he spent working in the International Monetary Fund (IMF), the German Finance Ministry, and private industry.
  • Regling has different plans for the future and has already indicated to German government representatives that he would like to be president of the new European Stability Mechanism (ESM), which will replace the current bailout fund starting in 2013. The European Commission envisions the new facility, which is designed to permanently combat crises in the euro zone, becoming a powerful institution almost as important as the ECB.
  • Given Merkel’s appoint of Jens Weidmann as the new Bundesbank President this week, it is unlikely, due to timing, that Merkel could push through another high-profile countryman. 




Juergen Stark (Germany)


Position 5: Juergen Stark, the ECB's German chief economist, could have been a candidate, but he would not be able to complete a full eight-year term because he has already served on the ECB council for more than four years.



Athanasios Orphanides (Cyprus)


Position 6: A long-shot contender, and the youngest, Orphanides, 48, who heads Cyprus’s central bank and has worked 17 years as a Federal Reserve economist.  He was the first ECB official to argue in favor of 0% interest rates amid the global downturn. He was born in communist-ruled Czechoslovakia and studied at MIT.



The next weeks will be telling to see if Draghi loses his top pole position. While the top candidates come with impressive credentials, there’s a fierce battle brewing over nationality, namely northern versus southern representation. The Germans have largely voted against Draghi in favor of a northern candidate, and the initial read-though would suggest that Draghi is more dovish leaning than Mersch or Liikanen. Clearly the French under Trichet will also have considerable pull, and Trichet looks to be signaling his vote for Draghi. 


There’s speculation that the ECB would like to firm up a decision on the next ECB president by March, perhaps to coincide with the European Summit that takes place on March 24-25, the catalyst for the release of the framework for the new European Stability Mechanism.   


Tick tock,


Matthew Hedrick

FL: Adding an All-Star

It’s not often that we comment on personnel changes, but the addition of Allen Questrom to Foot Locker’s board is worth noting.  For most who have been following the retail sector for more than a few years, you’re probably familiar with Questrom’s successful and widely praised turnaround of JC Penney (’00-’04).  If you go back even further the list includes Neiman Marcus, Federated, and Barney’s.  For those less familiar, Questrom is pretty much a legend of retail turnarounds, known as “The Master of the Turnaround” and “Mr. Fix It”. 


While Questrom has had his fair share of success over the course of his 40+ years in retailing, his strength is deeply rooted in cultural change.  He thrives in extracting talent from people within organizations whose culture may not have allowed or afforded them the opportunity to excel.  Additionally, he has no problem looking for talent outside of an organization, even if this means hiring an “enemy” who may be THE best person for the job.  This sounds silly for sure, especially if you’re solely focused on the quantitative aspects of the FL opportunity.   However,  Foot Locker up until just one year ago was managed by essentially the same team with the same processes for a decade.  The cultural shift from defense to offense for the world’s largest athletic footwear retailer is necessary for this multi-year process to continue. 


There’s still plenty of work to be done, but the reunion of Allen Questrom with Ken Hicks is noteworthy and one that should only add to the merchandising, marketing, and brand segmentation strategies already underway.



Eric Levine



Another in-line Q for another lodger; renovations to impact 1Q


“In the fourth quarter, we saw solid growth in demand and RevPAR, especially in our international and select-service properties. Continued focus on flow through led to significant operating margin improvement at our owned hotels.”

“In 2010 we achieved improvements in key drivers of brand value -- namely associate engagement, customer satisfaction, and our Gold Passport program, which demonstrates our loyalty to our best customers. We also expanded our ability to serve more of our guests when they travel as we opened over 30 hotels across all brands and expanded the number of executed contracts for future hotels. Looking ahead, we continue to focus on our key strategies and goals, reinvest in our hotels, and pursue many opportunities for expansion with existing and new owners. We are focused on creating value over the long-term and are excited about our prospects around the world.”


-Mark S. Hoplamazian, president and chief executive officer of Hyatt Hotels Corporation






  • Owned and Leased:
    • RevPar +4.1% vs consensus +5.5%
      • Constant currency: +4.4%
      • Due to the renovations at 5 properties, RevPAR for comparable owned and leased hotels was estimated to have been negatively impacted by approximately 400 bps.
    • Revenues: $470MM vs. consensus of $479.6MM
    • Sold three Chicago-area properties (Hyatt Lisle, Hyatt Deerfield, and Hyatt Rosemont) for $51 million and entered into a franchise agreement for each property.
    • Sold Grand Hyatt Tampa Bay for $59 million. The Company continues to manage the property.
  • NA Management and Franchising:
    • Full service RevPAR: +3.9% vs. 7.3% consensus
      • Constant currency: +3.8%
    • Select service RevPAR: +9.5% vs. 6.7% consensus
    • Added to portfolio:
      • Hyatt Place Des Moines/Downtown (franchised, 95 rooms)
      • Hyatt Place Pittsburgh-North Shore (franchised, 178 rooms)
      • Hyatt Place Houston/Sugar Land (managed, 214 rooms)
      • Hyatt Escala Lodge at Park City (managed, 153 rooms)
  • International Management and Franchising:
    • RevPAR: +11.7% vs. 13.5% consensus
      • Constant currency: 9.2%
    • Added to portfolio:
      • Hyatt Regency Dusseldorf, Germany (managed, 303 rooms)
      • Hyatt Regency Pune, India (managed, 219 rooms)
  • Total Management and franchising revenues: $73MM vs. 70.6MM consensus
  • Adjusted EBITDA was $118MM (in-line with consensus)
    • Owned and leased $87M
    • NA management and franchising $36M
    • International management and franchising $27M
  • 140 executed contracts (32k rooms) for future expansion; 70% are international
  • Debt of $771MM, cash: $1.1BN; ST investments: $524MM; undrawn RC: $1.1BN.

2011 Guidance

  • Capex: $380-400MM; expects renovations will adversely impact owned/leased segment through 3Q 2011: 300-350bps on owned/leased Revpar and 20-25MM of EBITDA (front-loaded in 1Q)--40/30/30 split among 3 quarters
  • D&A: $280-290MM
  • Interest expense: $50MM


  • Focused on "long-term value", not quarter to quarter volatility
  • "Good growth"- expansion into undeveloped markets
  • Positive customer feedback on recent hotel renovations
  • Margin improvement impressive given most of RevPAR gains were related to occupancy
  • Market share gains in select-service hotels
  • Gold Passport program increased 15% in enrollment
  • New York: 3 more hotels to open in next few years (currently 3 hotels)
  • Increased number of high brands represented from New York from just one to four
  • Andaz: 12 under development (incl. one in Shanghai)
  • Park Hyatt: 40 under development
  • Sold 6 properties for $240MM in 2010
  • Signed contracts:
    • Increase of over 15% in terms of hotel and over 18% in terms of rooms
    • 8 new markets
    • 3/4 of projects require no or little firm capital
  • 70% of hotels worldwide showed improvements in ADR
  • Sold 4 hotels for $110MM
    • Blended cap rate of 5%
  • Owned and Leased segment:
    • Q4 Margins were negatively impacted by 150bps due to renovations
  • NA mgmt & franc segment:
    • 70% growth driven by ADR
    • Stronger corporate/hospitality business
    • 70% of group business on books - in-line with expectations
    • Group rev of 2011, up 20% (Q4 2011 compared with Q4 2010); 50%/50% - occ/ADR driven
    • Transient - slightly higher rate resulted in higher revenues compared to the 4Q 2009
    • Corporate negotiated rate business: represent 10% of NA
      • Mid-to-high rates for 2011, in-line with previous forecast
    • 40% of NA full-service hotels paid incentive fees; peak in 2007 was 59%
  • Int. mgmt & franchise segment:
    • Asia region continues to ramp up; China RevPar up 30% (World Expo); S'pore, Korea, and Indonesia also strong
    • F&B and other rev represent 50% of international revs
    • 80% of international hotels paid incentive fees (similar to 2009); peak in 2007 was " a little north of 90%"
  • 2 special items:
    • $37MM - impairment on timeshare inventory and 2 JVs
    • $20MM gain as a result of the sale of three assets during the quarter.
  • 2011 Capex: not normal run-rate due to renovations
  • Expect to open 15 hotels in 2011--most are new
  • Lock-up shares: 12.8MM registration request with SEC; further details in 10K


  • 2011 SG&A forecast:
    • Inflation will impact costs
    • Adding Real Estate/Finance/Legal headcount
  • 2011 renovation:
    • 5-6% of owned revs
  • 2011 Capex: 20% are for maintenance
    • Traditionally, maintenance capex (80-100MM)
    • Expect normalized levels after 2011
  • Current business conditions: NA slightly hit by weather; international continues to push higher
  • Select service portfolio: as source of capital; will not be owned forever
  •  Business booked:
    • Traditionally, 40% and 25% in 2012 and 2013, respectively
  • 4Q international business:
    • Segment margin: 64-65% 
    • For 2011, should be smoother margins
    • Pipeline:
      • Higher in full-service project
      • India/China: 50% of selling contracts
  • 2011 Owned Property level cost comments: "increase slightly"; healthcare costs up in NA; instituting solar programs - Hyatt Regency in Scottdale; increase in F&B costs due to high commodity prices
  • Mid-week business transient and weekend family business strong