“Before all else, be armed.”
-Machiavelli
For Howard Schultz, it is all about winning. Even when he doesn’t want to communicate it, he does. The word “Machiavellian” has come to represent, for many people, any human behavior that is cynical and self-interested. While Schultz seems to have a strong social conscience – and this is meant as a compliment – we can’t help but believe that the single-serve strategy being employed by Starbucks seems to rhyme with The Prince, Machiavelli’s most famous book. An appearance by Mr. Schultz on CNBC yesterday illustrates this perfectly.
We have been of the opinion for some time that Starbucks has never really intended to sit idly by and allow Green Mountain to dominate the home brewer market. When Starbucks signed an agreement with Green Mountain in early 2011, we noted that the long term commitment of Starbucks to the Keurig brewer was conspicuous in its absence. On the one hand, K-Cups are not a significant enough portion of the business to merit the amount of attention that Starbucks investors have been paying to the Green Mountain fall out. On the other hand, while K-Cups only represent approximately 12% of the company’s earnings, the longer term upside for Starbucks appears much greater if it were able to capture a significant portion of what is currently Green Mountain’s business.
Timing is everything and we believe that Starbucks is acutely aware of this as it cuts its teeth in the single serve business. Showing its hand too early would obviously increase pressure on Green Mountain and possibly negatively impact Starbucks’ K-Cup business as it currently stands. For that reason, we believe that Starbucks is to Green Mountain what the Trojan Horse was to Troy. The partnership of Starbucks with Green Mountain is allowing Schultz and his team to get his product to customers in the home/office channel while building their knowledge of the single-serve category. Manufacturing its own brewer is a clear step towards independence from Green Mountain and, we believe, when the stockpile of ammunition is sufficient, Starbucks will attack the home brewer segment. Like a true Machiavellian Prince, Schultz will do so in one fell swoop – when the timing is right to do so.
Within the CNBC interview, Schultz responds to a question on Starbucks’ new machine being a sign that his company is unwilling to commit to a longer-term single-serve partnership with Green Mountain. His statement that Starbucks “has the winning hand” offers us a glimpse of his competitive nature. Irrespective of any wooden platitudes describing the complementary nature of the two companies’ respective brewers, his “winning hand” comment (a slip?) was a signal of intent.
Below is a paraphrased transcript of the exchange between Schultz and CNBC with our commentary on each exchange.
CNBC: Howard, you're coming out with your own single service machine later in the year to compete with the Keurig from Green Mountain. Is that a sign you're unwilling to make a long-term commitment to Green Mountain and the K-cups you currently have a partnership on?
Schultz: I think the introduction with Verismo coming out this holiday is misunderstood. It's not in competition with Green Mountain. It is a complimentary machine -- Starbucks will have the winning hand because of VIA -- the platform we're on with Green Mountain with their 12 million machines of install base, and we already have 15% share and that's going to grow with us and them. We're coming out with a machine that's going to do something no other machine does, and that is make a perfect latte because we've cracked the code in terms of the technology on fresh milk, but it's a complementary machine. Our partnership with Green Mountain is stable; I've talked to them. You have to separate their problems and what happened with their chairman from the fact remains their install base is 12 million machines and those customers want Starbucks k-cups, and we're going to provide them.
HEDGEYE: We believe that the premise of this question was slightly off base in that the original agreement between Starbucks and Green Mountain gave no indication of any intent to maintain a long term partnership.
The introduction of Verismo, with respect to Mr. Schultz, is not misunderstood. Some consumers will replace their Keurig machines with it, some will not; they are in competition with each other. We would not be surprised if Starbucks were already working on a home brewer that competes offers brewed coffee as well as espresso.
It’s difficult to prove and we are not qualified to make such an assertion, but the statement (or slip?) that “Starbucks has the winning hand” does not suggest that Schultz intends to curb his competitive instincts in his approach to single serve or any other area of his business. Before he expresses it outwardly with respect to single serve, he will ensure he is armed and prepared.
CNBC: Are you friends, are they enemies, are they frenemies? What is your partnership with Green Mountain?
Schultz: We have a very good partnership with Green Mountain and they knew all along we have interest in the espresso platform. The espresso platform we introduce this fall it's going to be a game changer but not at their expense. I think the market has overreacted with regard to us coming out with a machine they believe is going to be competitive to Green Mountain. We will coexist. We will sell k-cups in a big way and create a next generation game changing machine this holiday in every Starbucks store and every retail store in the country.
HEDGEYE: The companies will co-exist but you can be sure that their respective positions in the home brewer segment will be different than they are today. Schultz is handling an awkward situation very well but he is well aware of the opportunity that usurping Green Mountain in the single serve industry represents over the long term.
Howard Penney
Managing Director
Rory Green
Analyst
