Amazon.com Inc. Prime Video Gets an Upgrade and Keurig Green Mountain Inc Joins Global Coffee Portfolio

An international consumer products conglomerate based in Europe adds Keurig Green Mountain (GMCR.DL) to its portfolio, putting up a cool $13.9 billion for the struggling company. And at Amazon (AMZN 1.49%), its Prime TV service just got even better for their estimated 50 million members, as the tech giant introduced Showtime, Starz (STRZA), and other networks to its streaming service.

Tune in as Motley Fool analysts Vincent Shen and Sean O'Reilly dissect the coffee buyout and the potential impact of Amazon's newest streaming TV offering.

A full transcript follows the podcast.

This podcast was recorded on Dec. 8, 2015.

Sean O'Reilly: Keurig Green Mountain gets bought out for $13.9 billion on this consumer goods edition of Industry Focus.

Greetings Fools, I am Sean O'Reilly joining you here from Fool headquarters in Alexandria, Virginia. It is Tuesday, Dec. 8, 2015, and joining me to talk about a $13.9 billion K-Cup is the coolest cat in town, Mr. Vincent Shen. What's up Vince?

Vincent Shen: Not much. Thinking about this deal right now and how very lucky some investors were. Think Coca-Cola(KO 0.63%). And how very unlucky other investors were.

O'Reilly: Did you see? We'll talk about this a little later. Coca-Cola is actually recording a gain on the investment of, they invested like billions of dollars, right? They made $25 million.

Shen: Yeah and this is a really, they swung from quite a bit of significant loss to this eking out this really small gain. But we'll get to that later.

O'Reilly: Yeah and actually before we dive into the, obviously the big consumer goods news of the week, the acquisition of Keurig Green Mountain by JAB Holding. Also some big news out of Amazon. They announced that, and apparently my Prime subscription's about to get a little bit more valuable. So what's going on real quick?

Shen: Sure. So there had been rumors about this over the past couple weeks, I think. Where people were basically hearing that Amazon would be offering its own or offering through its Prime TV service subscriptions to other well-known video services, networks, premium networks even, and then potentially selling prepackaged bundles of its own to further the cord-cutting movement I guess.

And that's been officially confirmed today with the company basically announcing its streaming partners program. So, as part of Prime TV now you can also sign-up for subscriptions to networks like Showtime -- $8.99, Starz -- $8.99, Sundance -- now $6.99, Comedy Central Standup -- $3.99. A whole bunch of different other content.

O'Reilly: And those are sizable discounts as I understand it, to what you would have to pay for a streamed subscription to Showtime or Starz which is actually about 11 bucks.

Shen: Yeah.

O'Reilly: So these are very decent prices.

Shen: So you're saving a couple dollars per month absolutely if you do it through Amazon, and there's definitely some other perks there too.

O'Reilly: Now this isn't to be confused with Amazon's -- they're just in talks to do this. But I wanted to point out, this isn't to be confused with Amazon's plans to try to get major networks to do a streaming Internet service to literally directly compete with cable channels.

Shen: Oh yes, so ...

O'Reilly: Cable companies I should say.

Shen: There's of course some of the rumors behind that as well. Still we still haven't heard any new rumblings of that. But at the same time, yeah it should definitely be noted that this streaming partners program does not include live television.

O'Reilly: Yeah and my understanding just the last I heard was they had reached out to ABC and NBC and everything, but it's kind of awkward because NBC is, of course, owned by Comcast who doesn't want to lose the cable subscriptions. But on the other hand, and one of the reasons the Showtime and Starz are probably doing a discount for the subscriptions that's actually been announced, Amazon Prime has 45 million members. That's a big enchilada.

Shen: So I think that's what I would consider to be the first major reason why networks would want to sign up for this streaming partners program. Because when you think about it at first, I personally would be a little bit concerned when you have -- because the thing is here and that Amazon mentions in the press release, is that they will be managing a lot of things for their video provider.

So that includes driving subscriber acquisition, handling customer service, managing billing, serving the content obviously, managing compatibility across a lot of different set-top boxes and other devices. So you're really handing over the reins essentially to Amazon entirely. But the perks there are also, they are managing all those things, right? They are giving you access to what you said about almost 50 million of its Prime members, and you know I think another issue is that for a lot of these smaller services, like Showtime has its own streaming service, right?

The problem is that it's hard to break into that top 3, 4, 5 where you already have Hulu, you already have Netflix, you have Prime TV, you have HBO Go. And if you're one of these small services to break into that, to get access to that same kind of subscriber numbers, this immediately puts you in a position to benefit from that exposure with Amazon of course. And it will be really interesting to see just how many people sign up.

They're offering a lot of free trials for every single network so that you know, these are obviously the costs are on top of your $99 annual Prime payment. But it's on a monthly basis. It will be really interesting to see what kind of numbers they get and how successful this is for Starz even. And this is their first rollout of a streaming service at all. And they're doing it in conjunction with this Amazon program.

O'Reilly: Cool. Well before we move on to Keurig Green Mountain, I wanted to point our listeners to be newly redesigned Focus.Fool.com. There you'll discover a special offer to join the Motley Fool Stock Advisor newsletter for all Industry Focus listeners.

All loyal IF listeners have access to a special discount on Stock Advisor that works out $129 for a full two-year subscription. Just go to Focus.Fool.com to take advantage of this offer. Once again that's Focus.Fool.com.

So Vince, Monday morning I got a push notification from my Wall Street Journal app on my phone, and my jaw quickly hit the floor. Keurig Green Mountain had been bought out for $92 a share. Almost 100% premium, it was like 70-something because it was at 50 bucks before. Anybody see this coming?

Shen: Yeah. A lot of people who were short the stock did not see it coming, I'll tell you that.

O'Reilly: Game over.

Shen: The thing is, I kind of wanted to approach this in three kind of steps. So first we can talk about some of the terms of the deal, the valuations based on the offer price that you mentioned which was quite a premium. And we'll get to that as well. Then I want to talk about, a little bit about the buyer, their strategic rationale, what this will mean for Keurig. And then I want to talk about some of the winners and losers -- other winners and losers from this deal.

O'Reilly: Awesome. So first and foremost, I already mentioned the price, but let's just say it again and then how much higher, everything.

Shen: Sure. So just keep in mind on Friday, Dec. 4 the Keurig shares closed at $51.70. And on Monday after the news, they closed at $88.89 which was up 72%.

O'Reilly: So there's a little bit of an arbitrage spread there, but --

Shen: So the actual buyout price of $92 meant it actually comes out to about 78% premium to that closing price. And it actually gets even higher with data from Bloomberg, where they basically said, "This buyout represents the largest premium in history for the beverage industry for deals larger than $5 billion" when you compare the purchase price with the 20-day average price.

And because that 20-day, when you use that 20-day average, it actually comes out to almost 90% premium or something insane like that. In terms of the stock already was getting battered this year. Year-to-date is down 61%.

O'Reilly: Well I was about to say wasn't its 52-week high like $145 something?

Shen: Oh yeah, actually it hit its high last November at $150, over $150. So it has traded down, it's lost 2/3 of its value since then, only to get this nice windfall.

O'Reilly: It almost seems like that's the reason that the buyer JAB had to pay up the 92. Because anything less than that, they would've been shareholder lawsuits and all kinds of stuff thrown at the company.

Shen: That's true, but the thing is at the $51.70 from the Friday closing price, it was trading about 16.6 times trailing 12-month earnings. And then when you look at the offered purchase price of $92, you're looking at about 29.5 times. Now based on recent results, Keurig's fiscal year actually ended at pretty much September, and for the fiscal fourth quarter, revenue down 13%, earnings down 15% year-over-year. For the fiscal third quarter, revenue down 5%, earnings down 24%. And then they were either flat or down slightly for the two quarters before that too.

So that obvious downturn resulted in some of the weak trading. But paying 29.5 times for that, for what you're seeing is trending down into basically an unsuccessful Keurig 2.0 rollout when they did not allow third-party pods. And people went up in arms about that. Then you also have the pretty lukewarm reception to the Keurig Cold, and I think again this was a very nice turn of events for people who probably or otherwise in the red for their Keurig position.

O'Reilly: So let's talk about a little bit about JAB Holding, the acquirer, because one -- I don't think anybody's ever heard of them, two, they should have though because they keep buying consumers brands. And the other thing is it almost seems like this deal at this price only could make sense for these guys.

Shen: That's actually got a good way to put it. And I'm kind of glad you mentioned too, the thing about this JAB Holding company being relatively unknown. And I think that's almost by design, because this is an investment firm, first of all, that people should know.

They manage the money of the Reimann family which is one of the wealthiest families in Germany. I think when I checked their net worth overall, it's something like $20 billion. The family's very private, they're pretty well known for two things I thought were interesting also is that they do not get involved in the business affairs, and they also ...

O'Reilly: That's very Buffettesque.

Shen: ... and they also, I think it was when they turn 18 or something along those lines, they have to basically sign some type of agreement, where they promise to stay out of the public eye.

So overall this is a very private family. And the thing is JAB previously has already really aggressively added to its coffee portfolio. So kind of what you're talking about in terms of the valuation, what they're willing to pay, when you look at JAB's overall strategy it starts to make a little bit more sense why they would pay that huge premium.

Whereas before they had already acquired brands like Peet's Coffee & Tea, Stumptown Coffee Roasters, Intelligentsia Coffee, Caribou Coffee, even the parent of Einstein Brothers Bagels. So they're in this process right now of where they've built themselves into the number two player in terms of the world coffee, or packaged coffee market, which I think is already worth something like $80 billion.

Number one is, I believe Nestle still. But this kind of ...

O'Reilly: Particularly in Europe.

Shen: Yes and this will narrow the gap. And you have to think about the fact that in 2013 JAB purchased I think it was the D.E. Master Blenders, the coffee company, for $10 billon. Then last year they joined that with the coffee business of Mondelez International to create Jacobs Douwe Egberts. So they have this huge conglomerate now.

And now in addition to Keurig... where Keurig, at least within the U.S. where it dominates, it has like 80-90% market share in terms of the individual pod market and 20% of the coffee market overall. This narrows that, so that I think for Nestlé now they'll command maybe like 20, mid-20 percentage of market share worldwide. And this gives JAB maybe high teens.

So again they're narrowing that gap. This is a big strategic move for them to get access to Keurig's technology, to their U.S. presence which the business might be weak currently, but that doesn't mean that it's not an opportunity for them to roll out Keurig brewers to Europe where it currently does not compete at all.

O'Reilly: Right.

Shen: And just get a bigger piece of that pie.

O'Reilly: I almost, I mean there's a lot of things, and this is what I meant by saying that this deal at this price -- I mean they're paying a growth multiple for not growth company right now -- only makes sense for them. Because all of a sudden they have a bunch of different coffee brands, and this is just one thing they could do.

They could throw in some pods and you already have 20 million Keurig machines installed in the United States. And those pods, I think it's something like 80% of Keurig's revenues. I mean that's where the money is. So to roll those out and actually give that business a shot in the arm alone, I don't know that could be ...

Shen: Well even if you consider Keurig's had a lot of success doing these kind of promotional partnerships. So, they have their Starbucks coffee in the pods.

O'Reilly: Which may not last.

Shen: Yeah they, with the new kind of competitive landscape now where Starbucks is competing directly out of JAB Holding, a lot of their ...

O'Reilly: Peet's Coffee, yeah.

Shen: So whether that partnership continues we'll have to see. But guess what? There's a whole new portfolio of brands now that Keurig can leverage into new pod offerings, new people or new customers to target, like we said in Europe for example, with these brewers and definitely a big opportunity there. Whether it's worth that almost 30 times trailing-12-month earnings for the purchase prices, is another question.

O'Reilly: Okay, so bring it back around. Who are the winners and the losers from this deal?

Shen: Sure.

O'Reilly: Besides the shareholders that are obviously a winner.

Shen: So we talked a little bit about already obviously of, for JAB what their strategic vision was for this. So excluding them, it did still have a pretty surprising effect. So going back to who we mentioned earlier. We have Coca-Cola, right? So Coca-Cola made a series of two investments where they're buying up a stake and partnering with Keurig on the Keurig Cold -- which that happens to serve very famous, you can make Coca-Cola with it right at home. That was what they thought would be a big selling point for the system. And Coca-Cola had amassed I think 16, 17% stake in Keurig.

O'Reilly: Yeah. They had paid $1.25 billion for 10%, and then that started that huge run-up. And then they paid way more, like a way higher price for the other 6, 7%.

Shen: Yes.

O'Reilly: And their dollar-cost averaging is about, I think, 90 bucks, and they're making $2 a share.

Shen: That's what I calculated out as well. So they own almost 26 million shares, which is really funny when you think about it like this way. On Friday, they were worth $1.34 billion. On Monday they were worth $2.38 billion ...

O'Reilly: Unbelievable.

Shen: ... due to that trading activity. So their cost basis around 90, $91. They went from being under water almost $1 billion, to now being very slightly right about $26 million dollars in the black on this investment. And the thing is, Coca-Cola CEO, Muhtar Kent has mentioned that they'll look forward to continue collaborating with JAB I'm sure on the Cold and other technology devices and offerings. So it just seems like an even bigger opportunity now potentially for Coca-Cola where it's like, OK let's leverage this not just in the U.S.

O'Reilly: Cool. So I almost wonder if Coca-Cola will get cast to the wayside or something. Because JAB clearly doesn't care about soda. And the Cold hasn't gotten the greatest reception. But, oh well.

Shen: I think part of their view just might be a little bit longer term in that, OK the Cold came out not that long ago, a couple months ago. It'll take some time to, one -- get those efficiencies to bring the price down honestly to a more reasonable point. Because before it was offered at $300. A lot of people were kind of scoffing at that initial price. But that will come down, the pod prices will honestly likely come down as well, to a point where it sustains a better user base.

Like that 20 million that they currently have for the hot brewers. And other than Coca-Cola to some other investors that got quite a bit of surprise for some of the short-sellers. So interestingly enough for Keurig their short interest increased from 5.7 million shares at the beginning of 2015 to between 15 and 16 million shares ...

O'Reilly: Oh man.

Shen: ... in October and November. So that represents about 10% of Keurig's total shares outstanding. When for the S&P 500 overall, the median short interest or something that would be considered high is around 2%. So the fact that it was at 10% just shows you how bearish some the activity, the trading activity had become.

And in particular, David Einhorn at Greenlight Capital was one of the more well-known vocal investors shorting this company. He had a position in 2011 that he closed out in 2014, and he basically said, "Alright well that was a pretty unsuccessful shorting experiment on our part." And then he doubled down this year and the price collapsed this year, that we talked about -- it's down 60% year-to-date -- did really well for him. I think it was like his third best play in his portfolio, only to have this happen. So he's still making money on the deal. I think his, he ...

O'Reilly: Shorted like $120, $130, yeah.

Shen: ... it was like a $100, $102, something like that. But he just lost a huge, huge gain.

O'Reilly: This just speaks to how hard it is to short. Because technically those people weren't wrong. Keurig was not doing well.

Shen: Well really twice he kind of had the right idea, but he couldn't live out, he basically couldn't survive through the position long enough to gain. And there was a previous dip before this current one in those shares. But he just got very unlucky with the boost now.

O'Reilly: Got it. Well thank you for your thoughts, Vince.

Shen: Thank you, Sean.

O'Reilly: Hopefully we get another crazy buyout next week.

Shen: Yep.

O'Reilly: And if you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at [email protected]. Again, that is [email protected]. And as always people on this program may have interests in the stocks that they talk about. And the Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear on this program.

For Vincent Shen, I'm Sean O'Reilly. Thanks for listening and Fool on!