Nestle agrees to pay $7.15 billion in royalties to Starbucks to reinvigorate its coffee business

Nestle’s stratgic alliance with Starbucks underscores the fact that it is not shy to partner with its peers midst fast changing market conditions.

On Monday, in a strategic move aimed at creating a global coffee alliance, Swiss food giant Nestle disclosed, it has agreed to pay Starbucks $7.15 billion in cash for the rights to its Starbucks’ coffee chain’s products around the globe.

The deal essentially reinforces Nestle’s position as the world’s top coffee company and fortifies its place midst a fast-changing market.

Starbucks stated it will use the proceeds to speed-up the buyback of its shares and expects the deal to add to its earnings per share (EPS) by 2021, at the latest.

As for Nestle, it stated it expects the deal to impact its EPS by 2019.

String of Consolidations

This coming together of Nestle and Starbucks, in a highly fragmented consumer drinks sector which recently has seen a number of deals, is significant.

Fueling the spate of consolidation in this sector is JAB Holdings, the private investment arm of the Reimann family, Europe’s billionaire investor, which has has recently narrowed the gap with Nestle with a string of deals including Douwe Egberts, Peet’s Coffee & Tea and Keurig Green Mountain.

“This global coffee alliance will bring the Starbucks experience to the homes of millions more around the world through the reach and reputation of Nestle,” said Kevin Johnson, Starbucks Chief Executive.

Coffee is a popular drink with younger generations who have grown up with Starbucks, who typically seek out smaller brands and are willing to pay a little extra premium for exotic beans.

This means, specialty drink companies can brew up their margins and reap in greater profits in comparison to the mainstream packaged food industry.

As per a source in Nestle, it would be paying market-linked royalties to Starbucks after the initial fee and will not be purchasing any industrial asset(s) as part of the deal. It will also take on around 500 Starbucks employees as part of the deal.

Nestle has stated the deal will not impact its ongoing share buyback program.

According to Euromonitor International, the deal is expected to strengthen Nestle’s position in the U.S., which is currently at the number 5 slot with less than 5% of marketshare.

“Nestle is far and away the largest hot drinks company globally, with more in sales than the next five largest hot drinks companies combined,” said Matthew Barry, an analyst at Euromonitor. “However, Nestle’s leadership position is less secure than it once was.”

At the world stage, other big players, including Italy’s Lavazza, currently at world No. 3, are catching on.

In 2017, Nestle’s CEO Mark Schneider identified coffee as the strategic area for investment; Nestle purchased a majority stake in Blue Bottle Coffee, a small upscale cafe chain, in September 2017 and acquired Texas-based Chameleon Cold-Brew in November 2017.

Nestle is under shareholder pressure to improve its performance midst migration of consumers to newer brands.

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