Starbucks Is Small Beans To Kraft But Green Mountain Partnership Would Be Interesting

Not a big factor in KFT price

Kraft Foods is the second largest food and beverage company in the world after Nestle. It also competes with PepsiCo, General Mills and Kellogg. The company manufactures and markets packaged food products including chocolates, gums, snacks, beverages, cheeses, convenient meals and various packaged grocery products. Kraft operates in over 80 countries and distributes products to about 170 countries.

Recently, Starbucks decided to unwind its agreement with Kraft, under which Kraft distributed Starbucks bagged coffee as well as its Seattle’s Best coffee brand in supermarkets and other food retailers since 1998. ^[]

Although Kraft manufactures and distributes both food and beverages, the beverage division accounts for only 12% of our Kraft stock value estimate and so the potential downside to a loss in beverage market share is small in the context of the company’s total operations.

We maintain a stock value estimate of $35.56 for Kraft, which stands about 16% ahead of current market value.

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Limited Downside to Kraft’s Stock Value…

Kraft and Starbucks began arbitration proceedings late last month as Kraft tried to prevent Starbucks from ending the agreement. Kraft asserts that is has contributed towards growth of Starbucks’ packaged coffee business from $50 million in revenue to about $500 million over the last 12 years.

Drag the trend-line in the chart below to see how various beverage market share shifts affect Kraft’s stock value.

We currently project that Kraft’s market share in beverages will increase to around 15% by in the coming years with further growth of its own Jacobs and Maxwell House coffee brands coupled with a shift of consumers from high calorie carbonated drinks to healthy and nutritious juice drinks.

However, the loss of the Starbucks partnership could pose potential downside. Starbucks could challenge Kraft’s market share through a partnership with another distributor like Green Mountain Coffee Roasters (which sells Keurig coffee machines and the popular K-Cup coffee packets). ^[] Starbucks could also distribute its own product as it attempts to grow its Packaged Coffee and Tea business, which seems likely given the emphasis on this are in its recent earnings announcement.

The loss of the Starbucks partnership presents downside risk to Kraft’s beverage market share. Our estimates currently project growth in Kraft’s market share of nearly 100 basis points over the Trefis forecast period. However, if Kraft’s market share drops instead to 13% (in line with 2006 levels), the stock value downside would be around 3%.

See our full analysis of Kraft here

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What An AOL Buyout Would Mean For Yahoo!

May find a good fit with AOL content

According to a report from Reuters, ^[]AOL is actively exploring a breakup involving a complicated series of transactions that may lead to a merger with Yahoo. We believe that Yahoo might be interested in AOL’s content business as it would complement Yahoo’s own content business.

We estimate that AOL’s display ad business constitutes around 60% of the $25 Trefis price estimate for AOL’s stock, which gives us a valuation of around $1.6 billion for the content business alone. As a comparison, Yahoo’s display business is around 22% of our estimate of almost $26 billion in enterprise value, or around $5.7 billion on a standalone basis. We believe that a marriage of the two could make sense as we explain below.

Yahoo and AOL Content Business Merger Makes Strategic Sense

AOL has three main business lines: display ad business, search ad business and dial-up Internet subscriptions business. Yahoo’s core business is display ads and search ads, although it has started to focus more on its content business over the last few years. Yahoo partnered with Microsoft on Bing to drive its search technology, which allows Yahoo to free up its resources from its search business and concentrate its efforts on expanding its content business. Yahoo may not be interested in AOL’s dial-up business since it is a dying business for AOL, and does not provide any synergies to its existing business.

Hence, we believe that AOL provides Yahoo with an ideal platform to aggressively expand its content offerings and drive its display ad business.

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AOL’s strength lies in maps, entertainment news and blogging, which provides an ideal fit for Yahoo properties related to sports, finance and email. AOL has an average of around 118 million monthly unique visitors as of 2009, and we expect it to increase to 127 million by the end of the Trefis forecast period.

On the other hand, Yahoo has around 600 million average monthly uniques as of 2009, and we expect this to increase to around 800 million by the end of Trefis forecast period. Depending on what a combined platform might look like, Yahoo’s hope would clearly be that with expanded content capabilities from AOL and its search business, Yahoo’s traffic would increase by much more than the current combined traffic figures which would boost advertising revenues. This would also help grow the search business which we estimate is around 25% of Yahoo’s value.

While it remains difficult to quantify the financial impact of this until we know of a rough structure, we can look at the independent value drivers of the two companies and see that a couple of scenarios could makes sense.

You can see the complete $24.97 Trefis price estimate for AOL stock here.

You can see the complete $18.53 Trefis price estimate for Yahoo stock here.

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