Is Nestle Overvaluing Starbucks’ Packaged Goods Business?

Starbucks (NASDAQ: SBUX) and Nestle announced plans for a $7.2 billion license deal that would allow the latter to market, sell, and distribute the coffee giant’s brands in Consumer Packaged Goods (CPG) and Foodservice. This global coffee alliance, which brings together the world’s leading coffee brand and retailer, and the biggest food and beverage company globally, gives Nestle a stronger footing in its fight against JAB Holdings, the world’s second largest player in the coffee space. For Starbucks, on the other hand, this deal paves way for expansion into markets where the company has no CPG presence. Starbucks will also be supplying the coffee to both the Nespresso and Dolce Gusto machine platforms, opening its access to the addressable, single serve coffee market.

We have a $65 price estimate for Starbucks, which is higher than the current market price.

Benefits To Starbucks

The primary aim of the deal for Starbucks is the growth it can attain from the sales of its CPG and Foodservice goods through international markets where it currently has a negligible presence, as mentioned earlier. Currently, Starbucks sells its CPG products in roughly 28 countries, which is minuscule when compared with the nearly 190 countries where Nestle is operational. Hence, the scale which Nestle will be able to provide the company is massive, something Starbucks on its own would not be able to attain without incurring significant expenditure. Furthermore, Starbucks has other matters to deal with, namely focusing on its critical markets – the U.S. and China.

Introducing the Starbucks brands to the Nespresso and Dolce Gusto system platforms, which together form the world’s leading at-home coffee systems, having considerable strength in markets outside of North America, also gives the company a significant platform for growth. Another factor that comes into play here is that the $7.2 billion, roughly $5 billion after taxes, will aid Starbucks in returning greater cash to its shareholders. Consequently, the company has raised its three year commitment for dividend payments and share repurchases to $20 billion, from $15 billion earlier.

While the deal will hamper revenue and EPS growth for Starbucks in the short term, and expected to have a negative impact of two to three points in FY 2019, it should become accretive to the EPS in three years or earlier. The share buybacks will help in this aspect.

Comparison To Similar Deals

As part of the deal, Nestle will give Starbucks an up-front payment of $7.15 billion for a segment that generated roughly $2 billion in revenue. This implies a price-to-sales multiple of 3.6. However, according to Bernstein analyst Andrew Wood, the long term average of the sales multiple in food deals has been about 3X. It is even higher than the 3.11 transaction value to sales multiple paid by JAB Holdings to acquire Keurig Green Mountain. When compared with other deals JAB has undertaken, this partnership seems even pricier – 2.75X for DE Master Blenders and 2.46 for Peet’s Coffee and Tea.

If we use a multiple of 3 and 3.11, the transaction value would be $6 and $6.2 billion, significantly lower than the current amount. The reason for the premium price could be the fact that while Nestle currently is a dominant player in the global coffee market, in the U.S. its share is much smaller (Nespresso at 2.5%, Nescafe at 2.3%) when compared to the bigger players, including Starbucks (12.2%), Folgers (11.2%), and Maxwell House (7.1%). We have created the chart using our interactive platform. You can click here for our interactive dashboard, and input your own transaction multiple to determine the fair deal value.

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