Will the Pesticides Keep Starbucks Out of Retail Tea?

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In mid-November, Starbucks (NASDAQ: SBUX) announced its intention to finalize a $620 million deal to purchase tea retailer Teavana Holdings (NYSE: TEA) by the end of 2012. Starbucks intends to acquire the company in a straight-cash deal that values each share of its stock at $15.50.

Based in Seattle, Starbucks is a wildly successful coffee retailer and distributor. It operates over 18,000 stores worldwide and sells its coffee products in many major supermarkets and department stores across North America. In recent years, Starbucks has diversified with investments in juice products as well as the "K-cup" segment of the coffee market.

Atlanta-based Teavana is a natural target for this drive to diversify. The company manufactures and distributes gourmet teas and operates about 300 retail units in North America. It caters to an upmarket clientele willing to pay a premium for pesticide-free loose-leaf teas and tea-infused beverages. Starbucks's board has signaled a willingness to expand the Teavana brand into international markets friendly to the consumption of high-end teas, including India and the Middle East.

If the deal goes through as expected, Teavana shareholders will receive $15.50 per share. This represents a small premium over the stock's December 5 closing price of $15.41. Shareholders who held the stock prior to the merger announcement stand to gain significantly more: Starbucks's offer represents a 53 percent premium relative to Teavana's November 13 closing price of $10.13. The deal is scheduled to be completed by December 31.

The Teavana acquisition brings to mind another Starbucks venture. During the late 1990s, the then-smaller coffee-maker paid $8.1 million to purchase Tazo Teas in a move that drew widespread skepticism at the time. Today, the Tazo brand is an integral part of the company's identity and contributes as much as $1 billion in top-line revenue. Starbucks offers Tazo teas in virtually every store and outlet that serves its own Starbucks-branded products. However, the Tazo brand largely lacks its own separate retail infrastructure. There is just a single Tazo outlet in existence today.

The Teavana deal represents a more ambitious purchase with an even greater potential payoff. Unlike Tazo, it already has a robust infrastructure of retail outlets across a wide geographical area. Starbucks plans to use these existing stores as well as the Tazo store to market-test new Teavana-branded products. It also plans to continue the brand's aggressive retail expansion in its home market as well as abroad. 

Unlike Tazo, Starbucks plans to retain the Teavana name in retail signage and may feature it prominently in its promotional materials. Moving forward, it's unclear whether Starbucks will continue to utilize the Tazo brand apart from Teavana or whether the two will effectively assume a single identity.

The pending merger has been complicated by a high-profile disagreement between Teavana and an investment firm with a large short position in the company's stock. As they involve both the brand image and physical safety of the company's teas, the stakes of this disagreement are high. Glaucus Research recently charged that virtually all of Teavana's teas contain pesticides. This contradicts multiple on-the-record statements from Teavana employees. Glaucus alleges that some of these pesticides are known carcinogens and that the teas that contain them may not be safe for human consumption.

Although Glaucus's allegations caused Teavana's stock price to fall by about 5 percent on the day that they broke, most market watchers apparently believe that the allegations won't affect the deal. However, there could be devastating fallout for Teavana should they prove true. The company has made "pesticide-free tea" the cornerstone of its branding operation and stands to sustain a significant hit to its reputation if it's found to engage in misleading marketing practices.

For its part, Teavana responded to the charges with a statement that outlined its product-testing protocols and denied that its teas were unsafe. In a follow-up letter, Glaucus noted that the company did not explicitly refute the charge that it used pesticides in its teas. Starbucks announced on December 5 that is still plans on purchasing Teavana.  However, investors in both Starbucks and Teavana must consider the possibility that the controversy will ultimately scuttle the deal or at least encourage Starbucks to re-tender an offer at a lower price. 


mthiessen has no positions in the stocks mentioned above. The Motley Fool owns shares of Starbucks and Teavana Holdings and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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