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Anh Hoang
Anh Hoang
Articles (264)  | Author's Website |

The Short-Sale Case for K-Cup Owner, Green Mountain Coffee Roaster

December 03, 2011 | About:

Green Mountain Coffee Roaster (NASDAQ:GMCR) used to be considered the great darling of the stock market for the last 03 years, when the stock went from around $6 in November 2008 to around $107 in September 2011, making all the early entrance investors of GMCR extremely happy and wealthy in the short period of time. And it has been subject to the painful correction when the stock experienced the free fall from $107 to $43 only within two months, and now it is around $56/share.


When value investors see any sudden and significant drop in the stock price, they often smell opportunities. Especially it was the drop of one of the most beloved ticker in the stock market; they would be getting more excited. So as value investors, should we begin with long position in GMCR at this price taking all business and financial consideration of the business combined?

Let’s briefly look at the valuation and some key operating matrix first:


For the valuation, it is trading at quite high valuation, with earnings yield of only 2%, P/B at 3.2 and P/CF at 20.6. However, the entire operating figures look astonishing, in EBITDA growth rate, the ROE, etc. The growth rate is very high, the 10 year EBITDA grew at 36.8%, 05 year growth of 66% and 136% year on year growth. But those growth rates were already in the past, whether they can achieved the equivalent or greater growth in the future, the investors like us have to figure it out.

GMCR Business and Starbucks deal

Anyone who is interested in GMCR story should read the detailed analysis of David Einhorn when he presented it in Value Investing Conference. GMCR began its growth when it acquired 42% of Keurig business, singe cup brewing machine for the coffee market, in 2002 for $15million and acquired the rest of the business in 2006. It grew the business via both channels of direct sales and license agreements. And when the stock price went through the roof, the company considered itself as the technology company. The company’s CFO once said: “we are the technology company with the host of patents”. And Larry Blanford, the CEO commented: “I would define our company today as really a single serve beverage company that is sitting on top of this magnificent technology, call it disruptive technology platform.”

One of the big deal that people often mention in GMCR business is the Starbucks deal, signed in March 2011. The agreement happened to be in two ways round. On one way, the GMCR would buy roasted coffee from Starbucks, package it into the K-cup and sell into the retail channel. Then GMCR pays Starbucks a royalty for that. It is called “Licensing”. On the other way, Starbucks buys and roasts coffee, delivers to GMCR, GMCR then package it into the K-cup for Starbucks to sells in its channel. Starbucks will pay GMCR the costs of packaging and manufacturing. So in effect, GMCR is doing “contract manufacturing” for Starbucks. The agreement between the two is non-exclusive and multiyear, and it doesn’t apply to the next generation brewer of GMCR.

As being the Technology Company and Starbucks deal not applying to next generation brewer, the patents of the K-cup is the extremely important key to GMCR success. Even though GMCR said that it had the broad portfolio of patents, in the SEC filings, it mentioned the two principal patents associated with the current generation of K-cup portion packs would expire September 2012. That is the very big risk for GMCR although it is said that it had the pending patent applications, if being issued, would valid until 2023. After September 2012, competitors and others would be legally able to produce K-cups themselves.

So the business operation could not be estimated confidently to grow at that past rate into the future. We would have to wait after September 2012 to see what would happen in its operation and its performance after patent is expired. The business might not be very sustainable, the earning power is susceptible. How about its asset value and its financial position?

Financial Position

As of September 2011, the D/A ratio is more than 40%, including 18% of total asset putting into the long-term debt. The big items in the asset are inventories (21%) and goodwill, intangibles (41.2%).

USD million 2009-09 2010-09 2011-09
Cash and cash equivalents 242 4 13
Inventories 137 262 672
Net property, plant and equipment 136 259 579
Goodwill 100 386 789
Intangible assets 36 220 529
Long-term debt 73 336 576
Total liabilities 224 671 1,286
Additional paid-in capital 451 474 1,500
Retained earnings 137 214 412
Total stockholders' equity 590 699 1,912
Total liabilities and stockholders' equity 814 1,371 3,198

The financial position of GMCR is being dampened over time; the investment into inventories, PPE, especially the item of goodwill and intangible assets has made the financial position less strong. Over the past 02 years, it is reported to pour $1.4 billion in cash on three acquisitions at the very high valuations. The large investment to grow its business is mainly to “increase the portion pack packaging” and “expand physical plants”. So how can GMCR finance the expansion and the acquisition? By using cash, issuing a lot more stocks (indicated by the more than 3 times increased in the “additional paid-in capital” from 2010 to 2011), and taking in a lot more debt in the past 02 years (it grew from $73 million only to nearly $580 million).

Cash flow

On the note of cash flow generating ability, GMCR is not the brilliant, but consuming cash, maybe. Even though the net income kept increasing from $8 million (when it began acquiring all Keurig), to $201 million in 2011, the jump of more than 25 times, its cash flow from operation has been extremely modest, with the maximum of $38 million in 2009, and it has only $1 million in the fiscal year of 2011. In addition, GMCR kept reinvesting to grow the business, making the capital expenditure growing at extremely rapid rate and making the free cash flow plunging into worse negative conditions. If taking into account the rich valuation acquisition it has made in the last 02 years, the free cash flow position would be much much worse, running to nearly negative $1.2 billion, equivalent to 13% of its total market capitalization.

USD million 2006-09 2007-09 2008-09 2009-09 2010-09 2011-09
Net income 8 13 22 56 80 201
CFO 13 30 2 38 -11 1
Capex -14 -22 -49 -48 -118 -283
Acquisitions, net -101 -41 -459 -908
Free cash flow -1 8 -47 -10 -129 -283

Insider holding

The executive team is holding very little stock in the company, only the large holding which is concentrated in the hands of Robert Stiller, the founder and the chairman of the board, with more than 9% stake in the company. And altogether, the insider holds more than 10% of the company. So the insider action of Robert Stiller alone would be watched out very carefully. Below is the trade made by him since the middle of 2008:


In the very first glance, Robert Stiller kept selling shares in the market, since 2008, no buying action at all. And recently, he closed out some more position and realized more than $21 million in May 2011 and realized further more than $53.7 million when the price was at the peak of $107/share in August this year. With his consistent action, value investors should be worry about the motives behind his trade and about the long term prospect of the company.


With the high cash out flow onto making acquisitions, expanding the business financed by issuing stocks, taking more debts, and the fundamental of GMCR business relying on two patents which would be expired in just 9 more months, I would consider shorting GMCR gradually from now on with little amount, then increasing the amount much more when it approaches September 2012. Due to the time uncertainty in the stock market, investors might consider to buy call option besides shorting to somehow offset the possible loss if the stock experiences short-run advance in its price.

This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.

About the author:

Anh Hoang
Money manager in global equities, especially in U.S. and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam.

Visit Anh Hoang's Website

Rating: 4.2/5 (16 votes)


Yreuven - 6 years ago    Report SPAM
Finally a rational article that is unbiased nor discussing unmaterial issues like opinions about the coffee. Great job.
Ryandarcy - 6 years ago    Report SPAM
When most k-cup purchasers buy their coffee, they have no idea from whom the coffee comes. GMCR's only durable competitive advantage seems to be its patents. Once the field is wide open to competition, they'll have to compete on branding alone, and I have doubts that they'll be able to transition quickly and effectively from a monopoly to a highly competitive branding outfit. I can even envision k-cup knockoffs becoming available at places like Dollar Tree and other 99 cent stores. I'm short GMCR.
Ry.zamora - 6 years ago    Report SPAM

I've read part of Einhorn's report, and I was very much intrigued by his charges of accounting malpractice. I've long been curious, but currently possess no free time to delve into it. (Working on two companies atm :P)

Can Einhorn's findings be deduced from anything in the filings?

Yreuven - 6 years ago    Report SPAM
We did our own research and also read einhorn's and antar's work, which were both really terrific work by the way. I agree completely with both. Our original theory to short gmcr was because of gross overvaluation of a trend that is bound to end (patent expiery or not) We then realized that although the company keeps generating more money in revenues, the earnings and balance sheet continued to deteriorate at a rapid pace. 13mm cash is not even enough to run a big factory, let alone a 2.6bb business. Raising money will have to happen by mid January. Then, The numbers wouldn't add up precisely as they are supposed to in last years filings, leading me to believe that management either lacks mathematical intellect or is cooking the books. Then we noticed that management is selling the stock at such a rapid pace as if it's poisonous. at the conclusion we determined that this company has one too many red flags where at the best case scenario they'll have raise money, reinstate past earnings, write down inventory and past acquisition, lower guidance and settle class action lawsuit (but insurance policies usually pay for class actions). At that point market may determine valuation should be 0.5\sales now and 1\sales when they finalize issues. They restart venture being worth less with a future full of possibilities. At worst there is fraud found (rather then admitted) lawsuits from more parties, contracts with majors (ie sbux dknd etc) become void or get terminated, jail sentences for a few at the top becomes a realistic possibility if not reality, and they are worthless. Cult following moves on to another company. Our fund is short gmcr and position recently increased by 25%.

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