Starbucks has been rocked by news it must pay Kraft a whopping $2.23bn in damages after ending its supply arrangement with the FMCG giant in 2010, but insists it has adequate liquidity to foot the bill.
The dispute dates back to November 2010, when the Seattle-based firm announced its unilateral intention to terminate an agreement giving Kraft Foods Group the exclusive right to sell, market and distribute Starbucks roast and ground coffee in grocery and other retail outlets.
Kraft Foods Group, which became part of Mondelez International in October 2012 but was immediately spun off, began arbitration proceedings later that month alleging improper termination of contract.
(Kraft, which supplies the North American grocery market, will therefore transfer the Starbucks damages to Mondelez on the basis of a separation and distribution agreement governing this restructure.)
‘Kraft did not deliver’ - Starbucks
Troy Alstead, CFO and group president, Starbucks Global Business Services, said the firm “strongly disagreed” with the arbitrator’s ruling that it should pay Kraft $2.23bn in damages plus $527m in interest and attorney’s fees.
“We believe Kraft did not deliver on its responsibilities to our brand under the agreement, the performance of the business suffered as a result, and that we had a right to terminate the agreement without payment to Kraft,” he added.
While Starbucks disagreed that Kraft was entitled to damages, Alstead said the amount awarded reflects the value of his firm’s at-home coffee business and continued global growth opportunities.
“We have adequate liquidity both in the form of cash on hand and available borrowing capacity to fund the payment, which will be booked as a charge to our fiscal 2013 operating expenses,” he said.
Alstead insisted that Starbucks’ packaged coffee business was stronger since it reassumed control from Kraft in 2011, with ‘channel development’ sales – ground and whole bean sales, bottled frappucinos, single-serves and other products – up $3.2bn and profits up 47%.
He said Starbucks now has a much stronger at-home portfolio and the ability to expand in premium single-serve via K-CUP Packs and Verisimo; until 2011 Starbucks was limited to pods compatible with Kraft’s Tassimo.
‘Now we can focus on snacks!’ – Mondelez
Mondelez said it would use the damages award – subject to 37% state and federal tax plus other expenses – to repurchase stock.
Gerd Pleuhs, executive VP legal affairs and general counsel, Mondelez, said the firm was pleased that the arbitrator validated its position that Starbucks was guilty of a contractual breach.
“We’re glad to put this issue behind us. We can now fully focus on growing our global snacks business,” he added.
Mondelez said the $2.23bn included compensation for the fair market value of the agreement with a premium for improper termination.
Wells Fargo: Ultimately, Starbucks believes taking back its highly profitable coffee business was the right thing to do
Commenting on the decision - which is binding and cannot be appealed - Bonnie Herzog, senior analyst at Wells Fargo, said: "Starbucks could face some slight pressure, but given the incredibly strong long-term drivers of its business, we believe any pullback will be short-lived.
"Though these damages were large and higher than anticipated, ultimately, Starbucks believes taking back its highly profitable coffee business was the right thing to do. Assuming this is a lump-sum payment due immediately, Starbucks has ample cash on its balance sheet to pay these damages since it had been anticipating having to pay something."
Kraft first began marketing Starbucks roast and ground coffee in 1998, and Mondelez said it built the business up in value from circa. $50m in sales to $500m by 2010.