Can Starbucks Do for Tea Rooms What It Did for Cafes?

Last week, Starbucks (SBUX -0.35%) announced that it will buy tea company Teavana (NYSE: TEA) for $620 million, or $15.50 per share, about a 50% premium over what shares had been trading at. The bears say Teavana is just the latest in a series of acquisitions the company has made lately, and at some point management will have too many balls in the air and drop them all. The bull case is even simpler -- if Starbucks can manage it, the growth potential is huge.

The bear case
In addition to Teavana, Starbucks also recently purchased juice company Evolution Fresh for $30 million and Bay Bread bakery for $100 million. Meanwhile, the company is building up its consumer products group, with the notable introduction of its Verismo single-cup brewer, pitting it against Green Mountain Coffee Roasters (GMCR.DL).

Contrary to common wisdom, diversification isn't always a great thing. Famed investor Peter Lynch is well known for coining the term "diworsification," the situation that arises when a company expands into areas it lacks an edge in. Starbucks is not a juice bar, nor a bakery, and while both things are tangentially similar to cafes, I'm not convinced that Starbucks' edge in coffee will translate perfectly to these other concepts.

It's possible that the company's edge will translate to tea, but Teavana is really more of a mall retailer, focused on selling tea and tea accessories, not any sort of tea room where patrons stay and sip. If Starbucks plans to do for tea rooms what it did for cafes, it will take a significant amount of time and investment to rework Teavana into that image.

Companies often diversify into unrelated businesses because their core business is slowing down, and acquisitions can either provide new growth or mask the slowdown. The trouble is that it's more often the latter, and when company management ends up with too much on its plate, all the businesses suffer. Before long, the core company spins off or sells the unrelated businesses, leaving investors right back where they started.

The other problem with diversification is that it's unnecessary. An investor who wants exposure to juice bars, bakeries, or tea retailers could have just bought shares of Jamba (JMBA), Panera Bread (PNRA), or, yes, Teavana. There is such a vast wealth of pure plays for almost any investment these days, investors don't need companies to diversify for them. That's what mutual funds are for. Aside from selling each other's products in the respective stores, Starbucks' collection of companies doesn't seem to offer investors any clear synergies that they couldn't have obtained from buying shares of other companies themselves.

The bull case
In a press release, Starbucks stated that the Teavana acquisition "now positions us to disrupt and lead, just as we did with espresso starting three decades ago." What Starbucks did back then was get Americans to expect more from coffee than the swill served in diners and gave us the idea of a "third place" -- neither home nor work, but a place people could socialize, study, and read the news, all over a cup of coffee -- i.e., a European-style cafe.

Such a place exists for tea as well, and if you live near a big city you can probably find a few quiet little tea rooms that even serve British-style afternoon and high tea services. They aren't nearly as common as cafes in America, however, and if Starbucks can bring them mainstream, it would present a very significant growth opportunity. After all, tea is the second most consumed beverage in the world after water, but Americans consume only about half the global per capita average.

Starbucks hardly needs the growth, anyway. The company opened about 1,000  new stores during the recently ended fiscal year, but any worries about saturation should be dashed by the 7% growth in systemwide comparable-store sales, with 8% growth in America. Total revenues grew 13.7%,  fueled in part by the stunning 46.6% growth in its consumer products group, dashing worries that non-core strategies could be a distraction.

The Foolish bottom line
I think if anyone can pull off bringing tearooms mainstream, it's Starbucks. It would provide a huge growth opportunity in America, where tea ranks only seventh in a list of the most consumed beverages, but it would also give the company a strong foothold in countries like China and India, where tea is much preferred over coffee.

Teavana has the product assortment to make tea popular. The hard part will be taking those products and reinventing Teavana as a restaurateur instead of a retailer, without losing sight of its many other projects, and its core business.