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Starbucks May Cut Keurig Free, But Keep K-Cups

By Rich Duprey - Feb 1, 2016 at 8:45AM

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The coffeehouse ensures customers they'll still be able to get their favorite single-serve blend.

If you're a Keurig-owning Starbucks fan, no need to worry you won't be able to get your favorite coffee in a single-serving size: K-cups will endure, even if the two companies themselves part ways. Image source: Starbucks.

The hard times Keurig Green Mountain (GMCR.DL) has fallen on could be getting harder. In announcing its fiscal year 2016 first quarter earnings, Starbucks (SBUX 3.87%) CEO Howard Schultz said that while the coffee shop's coffee would still appear in K-Cups, its five-year old partnership with the at-home coffee appliance maker may be at an end.

And it could all be because of the very thing it was counting on to help it survive, the deal to take Keurig private.

Keurig's cup runneth over
In early December Keurig announced it had accepted a buyout offer of $13.9 billion from private equity firm JAB Holdings, an amount equivalent to $92 a share, or a huge 78% premium over the stock's closing value the day before the deal was announced. While it was still far below Keurig's all-time high of $155 a share it hit back in 2014, it was significantly better than the $17 a share it had sunk to in 2012 as its patent protection expired and there was widespread fear it couldn't rebound.

It was the year before that, however, that Keurig and Starbucks inked a deal to make and sell K-cups under the Starbucks brand name as well as the Tazo brands for use in Keurig Green Mountain's single-serve brew systems. They subsequently amended their agreement to end the exclusivity arrangement, which allowed Starbucks to triple the number of products being sold, but also let Keurig take on other partners like Peet's that it immediately signed up.

But the intervening years haven't been kind to Keurig as it botched the rollout of its second generation coffee brewer, the one that was supposed to return it to growth, as well as a serious misstep in introducing a cold beverage system in partnership with Coca-Cola.

Beginning of the end?
The one-two punch left the coffee maker reeling and its stock subsequently lost two-thirds of its value, until investor group JAB Holding stepped in with its buyout offer. Yet that will likely be the undoing of its relationship with Starbucks, because JAB is more a competitor than potential partner for the coffeehouse.

Although it invests broadly in various premium consumer brands such as Bally, Coty, and Jimmy Choo, it also owns a number of top coffee brands and coffee shops such as Baresso, Caribou Coffee, Jacobs Douwe Egberts, and Peet's.

Creating a global coffee powerhouse is clearly the aim at JAB Holding, but it's a strategy that puts it in direct competition with Starbucks, a situation Schultz addressed when he updated investors on its earnings.

He assured retailers Starbucks was "in the K-Cup business to stay," putting them at ease over fears they might lose business if the one reason many people bought their Keurig brewers in the first place was to abandon the market. However, he also hinted he wasn't about to prop up a rival. "However, at this moment," he went on, "the only matter that remains unresolved is whether we will be doing so in conjunction with Keurig or on our own."

Both Keurig Green Mountain and Starbucks benefited from their K-cups deal, but now that they are about to become rivals, it's likely time the deal is killed. Image source: Starbucks.

Schultz might not have come out and said the partnership was over, but you can pretty much put a fork in it. It's done. And that should worry Keurig regardless of whether it has an acquisition deal in hand or not. It has admitted that if it lost one of its big name partners like Starbucks or Coke not only might its gross margins take a hit, but its ability to attract consumers to buy its appliances would be impaired as well.

While JAB Holding must have realized the risk, there seems to be little downside for Starbucks in ending the deal given that Keurig is a fading brand. When it was the premier coffee appliance on the market, there were mutual benefits to be gained. Consumers likely won't care who is putting Starbucks coffee in pods just so long as they are, and Schultz maintains "there would be no dilution whatsoever in our current ability to deliver to the market or retain the margin which has been so attractive since we started."

Keurig Green Mountain, though, may find it's as satisfying as a day old cup of joe.

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