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This is one for the record books; 93% of the purchase price is goodwill!

Last night it was announced that Peet’s (PEET) will buy Diedrich (DDRX) for $26 a share or $213 million.  Shockingly, of the $213 million purchase price, $200 million is goodwill.  The last time I saw something this outrageous was when Wendy’s purchased Baja Fresh and we know how that ended!

Using the estimates on Bloomberg, the purchase price is about 17x calendar 2010 EBITDA.  In June 2009, DDRX reported full-year EBITDA of $2.8 million, with full-year estimates of $9.7 and $15.2 million for the years ending June 2010 and 2011, respectively. 

Diedrich competes with Green Mountain (GMCR) in the single serve “at home” segment of the coffee market.  Peet’s is paying a significant premium to get into that segment of the market and is making a big bet that current growth rates will continue for many years.  On the conference call last night, management seemed desperate to get into the single serve category.  Maybe desperate is a strong word, but management suggested that if it did not do this deal now, it would be missing something. 

Given the massive amount of goodwill, the deal is dilutive to 2010 earnings.  PEET’s original 2010 guidance assumed the company would earn $1.25 per share on $330 million in revenues and $44 million in EBITDA.  The 2010 pro-forma estimates for the combined companies are $440-$460 million in revenues, $62-$64 million in EBITDA and $0.80-$0.90 in EPS.  Given last night’s close of $34.50, PEET is now trading at 38x calendar 2010 pro-forma EPS.  As a point of reference, GMCR is trading at 44x NTN EPS estimates. 

I understand the growth at GMCR, DDRX and the “at home” segment has been a moon shot for the past two years.  The success of this acquisition of DDRX by PEET is dependent on that growth continuing for many years to come.  If not, the company will be eating that dilution for years to come.

To justify the acquisition, PEET’s senior management put together a business plan that appears to be on the aggressive side.  The estimates that management put out there do not appear to assume any slowing of the current trends in the “at home” segment of the coffee category.  For 2011, revenues are expected to be between $550-$580 million, EBITDA $98-$103 million and EPS of $2.00 to $2.20.  Management specifically cited cost savings and revenue synergies for the increase in revenues and EBITDA.  At the low end of the range, management is looking for a $33 million increase in EBIT on a $110 million increase in revenues.    

While the cost savings could definitely be real, the revenue synergies are more suspect and put at risk the aggressive assumptions if there is a slowing of the trends in the “at-home” segment of the market in the coming years. 

This acquisition could prove problematic in the coming years, but right now, it does not make sense to fight the wave of growth facing the key participants in the “at-home” segment of the coffee market.