An employee pours coffee from a round glass jug into a mug at a Starbucks Corp. coffee shop (Photographer: Taylor Weidman/Bloomberg)

Nestle Bets $7 Billion on Starbucks to Revive Coffee Sales

(Bloomberg) -- For years, a smoldering George Clooney would sip his espresso and ask: “Nespresso...what else?” Turns out the answer is: Starbucks.

In the third-biggest transaction in Nestle SA’s 152-year history, the Swiss food giant will spend $7.15 billion for the right to market Starbucks Corp. products from beans to capsules, marrying its international distribution network with the allure of arguably the biggest name in java.

Nestle won’t get any physical assets in the deal. Instead, Chief Executive Officer Mark Schneider is harnessing the name recognition of Starbucks, with its 28,000 outlets around the globe and massive draw in the U.S. Nestle has struggled there for years with its own products like Nespresso and Dolce Gusto.

Nestle could use a jolt -- sales rose at their weakest pace in more than two decades last year. By entering a marketing pact with Starbucks, the Swiss company is revealing the limits to growing with Nescafe and Nespresso.

“Nestle needed a big brand, and they needed one fast,” said Alain Oberhuber, an analyst at MainFirst Bank in Zurich. “Starbucks is the only strong brand in roast-and-ground. It’s a rather defensive move -- a bit late -- but nevertheless, a strategically absolutely vital step.”

Starbucks shares rose less than 1 percent in New York trading. The company said it will use the deal proceeds to accelerate stock buybacks. Nestle gained as much as 1.8 percent in Zurich. Its shares have dropped about 7 percent this year.

Nestle’s Nespresso portioned-coffee business is one of its largest growth engines, but knockoff capsules -- including Starbucks-branded ones -- that are compatible with the machines have dented revenue. The new deal will give the Swiss company control of Starbucks capsules, among other products. It comes as Nestle’s Nescafe brand of instant coffees has lost market share in four of the past five years, according to Euromonitor.

Starbucks is the second-most-valuable brand in fast food, according to BrandZ’s Global 2017 report, which estimates it’s worth $44 billion. Schneider agreed to pay 3.6 times sales for the consumer-products business, higher than the average of 3 times for major global food deals, according to Andrew Wood, an analyst at Sanford C. Bernstein.

“This will be his first big M&A test,” Wood said. “Nestle’s acquisition track record over the last 10-15 years has been less than stellar.”

Nestle is making a new offensive in the U.S. a decade after Nespresso renewed a push into that market, enjoying limited success as most coffee drinkers avoid small espressos. Nestle has been struggling to gain market share in that market, given the prevalence of Starbucks and Green Mountain, which was bought out by Europe’s billionaire Reimann family. Their JAB Holding Co. has spent more than $30 billion building a coffee empire by acquiring assets such as Peet’s and combining with Mondelez International Inc.’s coffee business.

JAB is the biggest danger for Nestle, MainFirst’s Oberhuber said. The Nestle-Starbucks alliance comes just as JAB purchases Dr Pepper Snapple Group Inc. for $18.7 billion, diversifying in soft drinks.

Nestle Bets $7 Billion on Starbucks to Revive Coffee Sales

Starbucks intends to remain in the K-Cup pod business with JAB’s Keurig and is in talks with the company, Chief Executive Officer Kevin Johnson said on a conference call with analysts.
Nestle will take over about 500 Starbucks employees who will remain based in Seattle.

Starbucks will continue to produce packaged coffee and other goods in North America, while Nestle will be in charge of the rest of the world. Sales will be booked by Nestle, which will pay royalties to the coffee chain. The agreement adds prospects for growth outside of North America, where Starbucks outlets are less prevalent.

The Swiss company gets the rights to sell packaged coffee products in supermarkets, restaurants and catering operations under the flagship Starbucks brand and others including Seattle’s Best Coffee, Starbucks VIA and Torrefazione Italia. The deal includes the Teavana tea brand as well.

Starbucks sees the deal contributing to profit by 2021 or sooner, and will use proceeds to accelerate share buybacks. The chain expects to return around $20 billion to shareholders through 2020 via buybacks and dividends, according to a statement.

The alliance with Nestle will help Starbucks gain brand recognition abroad, executives said on the call. They also said Starbucks was in talks with a number of parties, but they picked Nestle after several months of contacts with Schneider.

Slower Growth

Now one of the world’s largest restaurant chains, Starbucks has transitioned from explosive growth of past years to a steadier pace of expansion. This has left some investors underwhelmed in recent quarters, with the shares rising less then 1 percent in 2018.

Nestle is taking a page from JAB’s strategy, as it begins to build a patchwork quilt of different brands in coffee instead of focusing almost exclusively on Nescafe and Nespresso. Last year’s $425 million purchase of a stake in Blue Bottle Coffee was a step back into the roast-and-ground segment, whose growth prospects have revived as consumers become more sophisticated about coffee. Nestle also added niche brand Chameleon Cold-Brew last year to expand its portfolio in the U.S.

That added complexity may make it harder to run the coffee business, and there’s a risk that the Starbucks food-service sales cannibalize those of Nescafe.

“Being a big brand is not an automatic passport to future success,” said Peter Walshe, BrandZ global strategy director at Kantar Millward Brown in London. “We see that in the coffee category, with the rise of smaller brands. Brands that are perceived to be making people’s lives better, are innovative and deliver a great experience, are the most successful. Both Starbucks and Nestle do so very strongly.”

©2018 Bloomberg L.P.