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Can Green Mountain Lose the Albatross?

Danny is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Green Mountain Coffee Roasters (NASDAQ: GMCR) is known for their nearly ubiquitous Keurig coffee brewer, which brews single servings of coffee from their patented K-Cups.  Back in the glory days it seemed the stock and the company could do little wrong.  It is estimated that Green Mountain controls nearly 85% of the single serve market.  We’ve known for some time those K-Cups would be losing their patent protection in September of this year.  Even so, the stock rallied to new highs as investors put aside their fears of the upcoming patent expiration on news of numerous partnerships for branded K-Cups including Starbucks (NASDAQ: SBUX), Folgers, Caribou Coffee, and Dunkin Brands.  High double digit growth was the siren that kept investors coming back for more. 

Recently, however, fortunes have turned and Green Mountain is drifting precariously close to the rocks. Their stock has been in a downward spiral, with the price falling more than 80% since hitting all-time highs in September of last year.  Lately, it seems this company can’t get a break.  Have they been saddled with an albatross?  Is it a curse?  Unfortunately, it is largely a situation of their own making.  Consider the following points: 

  • The SEC has been investigating Green Mountain and one of their distributors, M. Block & Sons, regarding their revenue recognition practices.  This is not the first time the specter of an SEC investigation has haunted Green Mountain.  It was September of 2010 the SEC first notified Green Mountain that it was conducting an inquiry. 
  • Shareholders have filed a class action lawsuit alleging that Green Mountain disseminated “materially false and misleading statements and/or concealing material adverse facts.” 
  • Green Mountain has been embroiled in a patent lawsuit with JBR, Inc. aka Rogers Family Company, for infringing on its K-cup patents. 
  • As the result of a margin call that violated their internal trading policies, Green Mountain removed Robert Stiller from his position as chairman of the board and William Davis from his position as lead director. 
  • Short sellers have camped out on the stocks doorstep, including well known shorts David Einhorn and Whitney Tilson.  Shorts allege that Green Mountain has been engaged in channel stuffing, or artificially inflating sales figures using distributors or retailers to hide inventory that is not yet sold. 

These holes in their sail are not the only ones Green Mountain needs to patch to prevent them from drifting into the rocks.  The pending loss of patent protection has brought myriad potential competitors out of the woodwork.  Safeway (NYSE: SWY) and Kroger (NYSE: KR) have both announced plans to launch their own private label K-Cups.  Safeway has partnered with Rogers Family Company and plans to sell K-Cups at prices below those of Green Mountains offerings.  With control over the shelf space, these retail giants can promote their own brands over those of Green Mountain and reap more of the profits.  Recession weary price conscious consumers can still be lured away by a bargain.

Additional pressure from the cost conscious end of the market may come from Wal-Mart.  Wal-Mart (NYSE: WMT) is reported to have partnered with ESIO Beverage to develop a brewer that they claim will compete head-to-head with Green Mountain's Keurig.  Wal-Mart has since confirmed they plan to carry the brewer later this year.  Considering the clout this retail powerhouse brings to the table, they cannot be ignored as a competitor. 

Starbucks recently announced that they will launch their own single-cup coffee brewer in time for the 2012 holiday.  The system, name Verismo, will brew espresso and brewed coffee.  While Starbucks contends that they will not be directly competing with Green Mountain, they hold sway over a great many of the country's java junkies.  These consumers are those with additional discretionary spending cash and are willing to pay up for quality.  They may be willing to shell out for a Starbucks branded brewer, taking potential or existing customers from the Keurig base.

Green Mountain has been known by investors for their success employing the razor and blade business model, so named for the practice employed by Gillette.  Razors have historically been sold at cost, while the blades have been sold at a significant markup.  Green Mountain has sold their Keurig brewers at cost, making their money on the repeat business of K-Cup sales.  That model is now in danger of collapse.  With the K-Cup patents beginning to expire and lower cost K-Cup alternatives coming to the market, it is doubtful that Green Mountain will continue their domination in the single serve market.  With a large base of installed brewers, Green Mountain will continue to be one of the major players in the single-serve coffee market, but now they will share the stage with the myriad competition encroaching on their market.  Consumers on the lower end of the market are loyal to their wallets and pocketbooks.  Those at the upper end may be swayed by name brand and quality.  Where does this leave Green Mountain?  Caught in the middle.  With all these things working against them, Green Mountain's days of high double digit growth are likely a thing of the past. 

With the issues of an SEC investigation into possible accounting irregularities, shareholder lawsuits, patent expiration, increased competition and all this amidst the removal of high level board members for questionable stock trades, is it any wonder that investors are abandoning Green Mountain like rats from a sinking ship?  Add to this slowing K-Cups sales, and what is an investor to do?  I was long Green Mountain and sold those shares for more than 120% gain in February of 2011 when I could no longer ignore the writing on the wall.  There are many companies out there with outstanding prospects, well respected management, and a better mousetrap.  Why should an investor lay out their hard earned money on a company with all these anchors weighing them down?  In my opinion, they shouldn’t.

I have posted here about an industry and two companies I think are worth your time and investing dollars.

What's your opinion?  Are Green Mountain's prospects washed up like so much driftwood on the beach?  Am I all wet?  Post your opinion below.  All are welcome.

Danny Vena owns ahares of Starbucks and the following options: JAN 2013 $27.00 calls on Green Mountain Coffee Roasters. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services recommend Green Mountain Coffee Roasters 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. If you have questions about this post or the Fool’s blog network, click here for information.

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