You're Wrong, David Einhorn

Legendary hedge fund manager David Einhorn has gone from bashing Florida real estate to bashing coffee beans.

Shares of Green Mountain Coffee Roasters (Nasdaq: GMCR  ) tumbled 10% yesterday, after Einhorn detailed his bearish thesis for shorting the company behind the Keurig single-cup coffeemaker.

There isn't really anything new in Einhorn's argument. He's pointing to the same patent expirations, accounting concerns, and frothy valuations that have burned Green Mountain bears in recent years. I butted heads with bears including Fusion Investing's Dean Morel (who is an investment analyst for The Motley Fool Australia) and CNBC's Herb Greenberg at much lower price points last year.

The stock has soared 166% since Greenberg bashed Green Mountain's accounting practices 13 months ago -- and that's including yesterday's drop.

I'm sitting in a cozy "I told you so" seat on this one. I recommended Green Mountain to subscribers of the Rule Breakers growth newsletter service at a split-adjusted price of $8.93 a little over two years ago. It remains an active pick, sporting a juicy 824% return. In other words, it's going to take a lot of dark days before I begin wondering if crow is available in K-Cup form.

I'm not smarter than Greenberg. I'm certainly not smarter than Einhorn. That's the guy that nailed Lehman's undoing. It's he -- and not me -- that almost bagged the New York Mets this summer. However, I haven't had a problem calling out Greenberg in the past. Why not call Einhorn wrong on this particular call?

Timing is everything
The one thing that Einhorn has going for him is that – as this is a fresh bearish call on one of the hottest stocks in recent years -- he's ahead of former naysayers. Green Mountain is more expensive now than it was during previous knocks. The patent expiration deadlines are closer. The accounting allegations haven't been entirely cleared up.

However, time also isn't on his side because Green Mountain is far more ubiquitous now. It wasn't until earlier this year that Starbucks (Nasdaq: SBUX  ) and Dunkin' Brands (Nasdaq: DNKN  ) inked deals to hop on the K-Cup bandwagon. These aren't really the kind of moves one would expect if Green Mountain was about to turn into a pumpkin roast because two of its dozens of patents were set to expire next year.

Green Mountain is bigger now. Net sales soared 127% higher in its latest quarter, and earnings grew even faster! It's not all organic. There have been K-Cup makers and regional java heavies acquired along the way, but who would argue that this market isn't as big as the market believes it to be?

Green Mountain estimates that there's now a Keurig in 8% to 10% of the homes in this country. We're not talking SodaStream's (Nasdaq: SODA  ) 20% market penetration in Sweden, but this is a big number in a big country that drinks a lot of coffee.

It gets better.

In its latest conference call, Green Mountain estimates that 25% of the coffeemakers sold in this country were K-Cup brewers. In other words, Green Mountain will continue to gobble up more than 10% of the home market as older coffee machines break down or simply get replaced.

It gets better.

Green Mountain's java brewer sales are growing considerably faster than the other 75%, so it would be premature to even call 25% the ceiling here.

It gets better.

Just last week, Jarden's (NYSE: JAH  ) Mr. Coffee announced that it was expanding its line of coffeemakers with licensed Keurig-brewed technology.

Patents and profits
How many stocks do you know whose earnings estimates have been climbing in recent months? Three months ago, analysts figured that Green Mountain would earn $1.48 a share this year and $2.14 a share come 2012. Now those same pros see a profit of $1.65 a share in the fiscal 2011 that ended last month and $2.61 a share in the fiscal year that just began.

Few will argue that Green Mountain is a bargain at 32 times forward earnings, but is it so outlandish when we're talking about a company projected to grow organic revenue and profitability at a roughly 60% clip?

Before you answer, consider that Green Mountain has beaten analyst quarterly estimates by 10% to 36% over the past year. In other words, the eventual earnings should be higher -- and the projected P/E lower -- than what we're seeing now.

What about fiscal 2013? Isn't that the year where this will all fall apart according to patent expirations in 2012? Tell that to the analysts, who are expecting earnings to climb 47% to $3.87 a share.

It's true that the two patents protecting K-Cup portion packs in this country are set to expire next year, putting an end to a need to pay Green Mountain a few cents for every licensed K-Cup sold. Let's go over a few points that bears aren't addressing:

  • No licensing fees would translate into cheaper K-Cups, which in turn would grow demand for Keurig brewers that are patent- and brand-protected.
  • Green Mountain hasn't historically approached brewers as a profit center, but it will if it can't cash in on the K-Cup end.
  • All of the financials-blurring acquisitions over the years have been done in anticipation of this very event. From Diedrich to Timothy's to Van Houtte, Green Mountain already owns its best-selling K-Cup providers. In other words, it's the biggest beneficiary -- in a roundabout way -- of the patent expiration.  

This doesn't even end there, though. Green Mountain is working on a new espresso-based system and it's also developing a new Keurig-filtered platform that may present new and extended patent protections.

Stealing a page out of the Coca-Cola (NYSE: KO  ) playbook, Green Mountain is also exploring K-Cup beverages with functional and wellness benefits. Did you think that its Swiss Miss deal with ConAgra (NYSE: CAG  ) and its recent rollout of "over ice" cool beverages was the end of the line?

Green Mountain is cheaper than you think and earlier in its product cycle than you believe, Einhorn.

Short it at your own risk.

If you want to follow this caffeinated saga, add Green Mountain Coffee Roasters to My Watchlist.

The Motley Fool owns shares of Starbucks and Coca-Cola. Motley Fool newsletter services have recommended buying shares of Coca-Cola, SodaStream International, Green Mountain Coffee Roasters, and Starbucks. Motley Fool newsletter services have recommended creating a lurking gator position in Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


Read/Post Comments (28) | Recommend This Article (49)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 18, 2011, at 9:53 AM, brightsideLP wrote:

    get real. there is no rhyme or reason for the stock moving up 160%. its all froth and a dynamic of supply and demand + short targeting. Compare GMCR to SBUX = its a big joke. Einhorn is dead on - he might be early, he might be right in time..... but eventually he is right.

  • Report this Comment On October 18, 2011, at 9:59 AM, SUPERMANSTOCKS wrote:

    everyone is eventually right at some point!

  • Report this Comment On October 18, 2011, at 10:23 AM, stevepcarter wrote:

    Excellent rebuttal Rick.

    i agree that Einhorn is just rehashing old news, none of which has slowed the growth so far.

    Yes, it's a high-priced stock, but given the projected growth rate, perfectly justifyable.

    i am a contented consumer of their products and a very happy shareholder.

    More shorts to get squeezed is good for us.

  • Report this Comment On October 18, 2011, at 10:27 AM, TMFBreakerRick wrote:

    brightside, why can't I compare GMCR and SBUX? They both trade at similar P/E multiples if we look out to the next fiscal year (SBUX at a P/E of 19, GMCR at 21), yet one is growing several times faster than the other -- and far earlier in its growth cycle.

    Obviously Starbucks is the less risky bet. I can't -- and won't -- argue otherwise. However, the history of folks who have voiced Einhorn's bearish thesis have been burned badly in the past.

    Rick

  • Report this Comment On October 18, 2011, at 10:42 AM, LQM2 wrote:

    Very thoughtful article, Rick, I completely agree.

  • Report this Comment On October 18, 2011, at 10:57 AM, JavaScotty wrote:

    I was hoping for another GMCR buying opportunity. Thanks Mr. Einhorn!

  • Report this Comment On October 18, 2011, at 12:39 PM, kidchicago2 wrote:

    I'm a subscriber to several Fool services, but this "rebuttal" is embarrassing. Half your argument appears to be that "analysts" are "experts" and they love GMCR. Does the line "Blue Horseshoe loves Anacott Steel" sound at all familiar? And isn't one thesis of Rule Breakers (and most Fool services) that analysts really don't know much about anything? If all we care about is what the investment banking "experts" think, why bother to pay for Fool services? I can just follow the consensus estimates and upgrades.

    Second, you assume that the brewers--which GMCR currently sells at no profit--can be a "profit center" if the K-Cups no longer make GMCR money. In other words, if GMCR's entire "razor blade" business model falls apart, they can shift to selling brewers instead. I guarantee that if GMCR was forced into that corner, the stock would drop to $20 or less. And it wouldn't be a Rule Breaker pick anymore, would it? Selling expensive brewers is not a Rule Breaking business model, and there is no evidence that customers would pay much more for an already-expensive device. You simply assert that they might. Hope is not a strategy for dealing with patent expiration.

    Finally, the assertion that GMCR already owns the biggest K-Cup producers is wrong, and proves Einhorn's point: they only bought the current producers, not Nestle or Kraft, which would be expected to enter the market once K-Cups are off patent. And they HAD to buy those existing producers, at inflated prices, to create the appearance of having a huge moat. That appearance (1) made the stock price jump, which (2) made you look smart and (3) allowed insiders to sell shares at extremely high prices in huge quantities.

    Look, your gains on this stock are impressive. I wish I was long GMCR from 2 years ago. But you seem to be letting ego and pride come before common sense. Would you really pick this stock for your service now, knowing that there is an active SEC investigation and that both Einhorn and plaintiffs attorneys (the latter with sworn statements) have statements from former and current MS Block employees evidencing accounting fraud?

    I agree that GMCR is breaking the rules. But not in the way the Fool usually applauds.

  • Report this Comment On October 18, 2011, at 1:46 PM, daveosome wrote:

    I really don't get why GMCR has a competitive advantage after the patents on K-cups expire. The coffee makers are sold at cost, and the k-cups will become a commodity (competing with all the other retail coffee companies).

  • Report this Comment On October 18, 2011, at 1:51 PM, sammyca wrote:

    Sue for slander, GMCR

  • Report this Comment On October 18, 2011, at 2:20 PM, whatevmatil wrote:

    After reading fooling some of the people, all of the time, it is clear that Einhorn performs an excessive amount of due diligence on situations of this nature. If you are interested in GMCR, you should take his assessment and reasons into consideration. It will take years for this to play out, so it is too soon to determine if he is wrong or not.

    One response to the above – if some GMCR revenue is fake, as alleged, then future EPS estimates do not matter. Good EPS growth expectations is not a rebuttal to the allegation that some revenue is false, it is actually missing the point.

    Just to be clear - Rick I appreciate all your work on this website (it is good work), but it is too soon to say Einhorn is wrong.

  • Report this Comment On October 18, 2011, at 2:54 PM, SFAmiler wrote:

    Einhorn is Finkle. Finkle is Einhorn!

  • Report this Comment On October 18, 2011, at 3:36 PM, brightsideLP wrote:

    The bottom line is simple = GMCR has to sustain its growth to justify its valuation. The market cap is almost $13 billion after its recent fall. This is ludicrous. SBUX marketcap is less than 3 x GMCR. Would you rather own 3 GMCRs or 1 SBUX in its entirety ? Should be a no brainer. GMCR has no competitive moat....they have guaranteed future. The ttm pe is well over 70 and the forward estimate is surely not in the bag. Sustaining their profitibility is not assured.

    The wonderful stock action has been largely hype, hope and targeted short squeezes. To think GMCR will double from here (ie. North of a 25 BILLION valuation) is pure fantasy. Sure anything can happen over the short run in this casino market we have - but it being a sustainable valuation is something I would scoff at.

    Not only is SBUX a safer bet....I would bet a lot of money that over the next 3 years it runs circles around GMCR in performance. Both might even be down over that time frame....but I feel its going to be the chopping block where GMCR ends up.

    Collapse will be ala CROX

  • Report this Comment On October 18, 2011, at 3:47 PM, VelobiciOptions wrote:

    "All of the financials-blurring acquisitions over the years have been done in anticipation of this very event. From Diedrich to Timothy's to Van Houtte, Green Mountain already owns its best-selling K-Cup providers. In other words, it's the biggest beneficiary -- in a roundabout way -- of the patent expiration. "

    Dont understand this at all.

    Would seem that GMCR is buying some of the K-Cup coffee makers in order to mitigate the patent expiration. Dont see how that makes GMCR "the biggest beneficiary....of the patent expiration.

    If the patent lasted forever, these purchased companies can make K-Cups without paying patent royalites.

    If the patent expires, these purchased companies can make K-Cups without paying patent royalites.

    Dont get it.

  • Report this Comment On October 18, 2011, at 4:38 PM, DonkeyJunk wrote:

    Invoking Ben Graham is a good way to shoot down speculative buys. The P/E on GMCR terrifies me.

  • Report this Comment On October 18, 2011, at 5:29 PM, memoandstitch wrote:

    What is a "lurking gator position"?

  • Report this Comment On October 19, 2011, at 11:10 PM, suntannedmonk wrote:

    http://www.businessinsider.com/gaap-uccino-the-story-of-keur...

    You should read the slides, I think you might change your mind.

  • Report this Comment On October 20, 2011, at 10:44 AM, chopchop0 wrote:

    All of you fools doubting Einhorn must be backing up the truck now. Look how much GMCR has gone on sale the past few days ;)

  • Report this Comment On October 20, 2011, at 8:00 PM, Mega wrote:

    Einhorn demolished your arguments before you even posted this article. You didn't even attempt to respond to his points, just repeated the bull case.

  • Report this Comment On October 23, 2011, at 5:25 PM, hank321 wrote:

    I am neither buying nor shorting Green Mountain. I'll make my investments elsewhere. For their sakes, i hope the folks who bought it long ago do not hang on too long; falling in love with a popular equity is inviting disaster. Take your profit, and find a new darling, ...it is much less risky,....unless the management at some point starts to pay a dividend,...that would make me reconsider the situation.

  • Report this Comment On October 24, 2011, at 1:52 AM, BuffettJunior1 wrote:

    I've been warning people about GMCR for about 2 years now. This company is an outright fraud! Just because the stock has increased does not mean it’s a good company. Both Enron’s and WorldCom’s stocks increased for many years before their frauds were uncovered.

    People you cannot value companies using P/E ratios anymore. Earnings are becoming easier and easier to manipulate every year. Follow the cash! That's what runs a company not net income. GMCR's cash flow is getting worse and worse every year. The company has actually been losing money the past few years, however, its net income does not reflect that.

    The management at this fraudulent firm can’t manipulate their financials forever. The time will come when their frauds will be uncovered and this stock will crash.

    To the author of this article, SHAME ON YOU! I suggest you go back to school and take some accounting classes. I cannot believe you get paid for posting such bad information. I feel bad for those who don't know any better and listen to your bad advice. When they lose money your the one they should blame.

  • Report this Comment On October 24, 2011, at 1:54 AM, BuffettJunior1 wrote:

    Sorry to post again, had to fix something.

    I've been warning people about GMCR for about 2 years now. This company is an outright fraud! Just because the stock has increased does not mean it’s a good company. Both Enron’s and WorldCom’s stocks increased for many years before their frauds were uncovered.

    People you cannot value companies using P/E ratios anymore. Earnings are becoming easier and easier to manipulate every year. Follow the cash! That's what runs a company not net income. GMCR's cash flow is getting worse and worse every year. The company has actually been losing money the past few years, however, its net income does not reflect that.

    The management at this fraudulent firm can’t manipulate their financials forever. The time will come when their frauds will be uncovered and this stock will crash.

    To the author of this article, SHAME ON YOU! I suggest you go back to school and take some accounting classes. I cannot believe you get paid for posting such bad information. I feel bad for those who don't know any better and listen to your bad advice. When they lose money you're the one they should blame.

  • Report this Comment On October 24, 2011, at 1:35 PM, TommySun2011 wrote:

    Spot on rebuttal! David Einhorn's all wet on this one. Green Mountain's delicious Kcups for coffee, tea, cocoa for the kids (winter's upon us) and ice teas (loved them this summer) are cheaper at $13.99 plus club member and new flavor discounts than anyone! Free shipping, auto repeat orders and excellent 24/7 service will be hard to beat. My surfer friends all use them and we usually have two Keurig machines at home and more at work.

    What group of people want the same beverage and flavor at the same time?

    Einhorn made analysts pause and consider, but NAWWWW, GMCR is up 7% today. Go Green Mountain. Thumbs down Einhorn naysayer.

  • Report this Comment On October 24, 2011, at 2:45 PM, BuffettJunior1 wrote:

    So just because you like their K-cups you think this stock is a good buy?

    That must be the dumbest thing I've heard in a long time.

    Its fundamentals that matter in the long run. This company is losing hundreds of million in free cash flow, it will eventually catch up with them.

  • Report this Comment On November 10, 2011, at 4:21 PM, brightsideLP wrote:

    lol haha

  • Report this Comment On December 24, 2011, at 3:55 PM, kcanant wrote:

    "Short" Einhorn at your own risk.

    GMCR price 14 Oct 11 9 before presentation:$92.09

    GMCR after presentation $82.50

    GMCR yesterday $45.60

    I guess that the question is: How low is low enough?

  • Report this Comment On May 03, 2012, at 9:44 AM, catoismymotor wrote:

    This morning it opened at -39%. Perhaps he was right after all?

  • Report this Comment On June 17, 2012, at 7:00 PM, pravchaw wrote:

    I am writing this as GMCR sits at $19 and sinking, Clearly the author was very wrong. There is obviously a feeling that accounting fraud may be underlying the numbers.

  • Report this Comment On July 11, 2012, at 3:05 PM, adhill wrote:

    The Motley Fool has been pushing accountability for some time now. How about some accountability here?? The author was and is dead wrong. This is simply a case of an investor (the author) falling in love with a stock. There is always a time to own and not own a stock. As far as I can tell, all the authors more recent articles are STILL bullish on GMCR. Give it up, man!

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