Many individual investors might be baffled after looking at a chart that shows Starbucks (NASDAQ:SBUX) rising on a day that the company announced that it lost $2.76 billion in arbitration to Mondelez International (NASDAQ:MDLZ) So what gives? Let's take a look.
First, what was at issue was an agreement which Starbucks entered into with Kraft (UNKNOWN:KRFT.DL) in 1998 to distribute and market its coffee beans in avenues other than Starbucks retail shops (grocery stores, etc.). Kraft, which subsequently spun off the Mondelez snack unit (which will receive the settlement), took this coffee business from a $50 million a year business in 1998 to $500 million in 2010.
Nevertheless, Starbucks decided to take back its packaged coffee business. Kraft/Mondelez sued and prevailed.
Strategy and Pricing
Starbucks originally tried to say that it owed Kraft nothing. After Starbucks realized that it would lose in court, it offered $750 million to settle. Obviously Kraft/Mondelez believed it was entitled to more. Undoubtedly, analysts had already factored in a higher damage award into what they thought was a fair price for Starbucks' stock.
The judgment exceeded all estimates, which would imply that Starbucks might drop while Mondelez could rise. However, Starbucks, despite this hit to the balance sheet which absorbed its entire cash hoard, rose 1% in trading.
William Blair's Sharon Zackfia had this to say about Starbucks:
"Excluding the actual judgment itself, we expect that the arbitration will prove roughly $0.02 to $0.03 dilutive to our 'fiscal 2014 estimate on lost interest income, versus our prior estimate of $2.65, guidance of $2.55 to $2.65, and consensus of $2.66.
While there is a fair question as to whether the pay‐off from Starbucks' decision to take direct control of the package coffee business was worth the pay‐out, the company likely would not have been able to pursue other opportunities such as K‐Cups while still tied to Kraft (which owns Tassimo). All told, we suspect the arbitration outcome is likely to modestly crimp our estimates, but we continue to like Starbucks' shares given robust sales trends, still‐strong expansion prospects, and extraordinarily high visibility on 15% to 20% annual EPS growth."
Meanwhile, the concern for Mondelez is that the one time cash infusion does not address slowing growth trends in the junk food business, as well as management issues. The after-tax proceeds of the judgement would represent about 3% of Mondelez's worth, and the company let it be known that it would use this windfall to buy back its shares, decreasing the share count and increasing earnings per share. Indeed, the company's stock rose slightly less than 3% on the news.
I'd also like to point to a fellow Fool's article by Andrew Marder, which is the antithesis of my thinking on the subject. Mr. Marder states that this hit to the balance sheet, in excess of cash flow for a year and a half, "is no big deal."
Mr. Marder's analysis, backed by the movement of the both stocks on the day of the announcement, implies that the the only thing that matters when valuing a stock is a company's ongoing earnings stream. Assets and the balance sheet appear to be nearly meaningless.
Yes, Starbucks is a great company with a fantastic brand and room for expansion. Yes, this hit is diminished by the tax credit the company gets, but the stock rising after being hit with a larger-than-expected judgment is a head-scratcher.
To me these stock movements and the thinking described by Mr. Marder are evidence that investors greatly discount the value of real balance sheet assets (cash, real estate, etc.). No wonder Carl Icahn is so interested in Apple and the $150 a share in cash it has. Icahn's share buyback idea, which would create a rise in earnings per share, would actually work in creating shareholder value based on the current investing climate. . Investors, please beware.
Margie Nemcick-Cruz owns shares of Apple, Mondelez International, and Kraft Foods. The Motley Fool recommends Apple and Starbucks. The Motley Fool owns shares of Apple and Starbucks. 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.