November 29, 2010 / 1:52 PM / 7 years ago

Kraft-Starbucks coffee conflict heats up

<p>A general view of the Kraft Foods Inc headquarters in Northfield, Illinois February 10, 2009.John Gress</p>

NEW YORK/LOS ANGELES (Reuters) - Starbucks Corp and Kraft Foods Inc began airing a messy divorce on Monday, fighting over who gets what in the dissolution of a partnership through which Kraft sells bags of Starbucks coffee to supermarkets and other retailers.

Starbucks wants to end its 12-year deal with Kraft, saying it breached their contract. Kraft denies any breach and contends that if Starbucks wants to back out, it must pay Kraft the fair market value of the business plus a premium of as much as 35 percent, based on how Starbucks carries the business forward.

At stake for Kraft is $500 million in annual sales with strong profit margins. Kraft does not discuss individual brands' profits, but analysts have estimated the Starbucks coffee's operating margin at 20 percent or more.

Starbucks could have to pay more than $1 billion to buy back the business and run it, said Baird analyst David Tarantino, a risky move for a company that specializes in operating coffee shops. Sources familiar with the business say the figure could be more than $1.5 billion.

Kraft, which also distributes Starbucks' Seattle's Best coffee and sells Starbucks discs for its Tassimo brewer and Tazo teas, said it had launched arbitration proceedings to challenge Starbucks' attempt to end the agreement without compensation.

Starbucks shares closed down 1.1 percent at $30.79 on the Nasdaq, while Kraft shares fell 0.5 percent to $30.19 on the New York Stock Exchange.

Starbucks has accused Kraft of contract breaches including not always meeting minimum advertising budgets or keeping Starbucks involved in major initiatives, thereby eroding its "brand equity."

The two sides informed investors of their fight in statements released simultaneously on Monday morning. On Sunday Reuters obtained letters from a Starbucks attorney to Kraft, accusing the packaged food company of multiple "material breaches."

If the companies do not settle on their own, the matter will go to arbitration, handled by dispute resolution firm JAMS in Chicago. Starbucks said it planned to defend its position at arbitration.

Brand Control

Starbucks is looking to market consumer packaged goods as it seeks growth beyond its cafes, which Edward Jones analyst Matt Arnold said offers more stability and higher returns on investment.

Starbucks is also pushing sales of its new Via instant coffee in what it hopes will become a billion-dollar brand. Via had sales of about $135 million in its first year and is sold in about 55,000 outlets globally, including Starbucks cafes.

"What they want is to manage their brand. They're trying to regain control of that," said Oppenheimer analyst Matthew DiFrisco.

Under Kraft's management, Starbucks bagged coffee sales grew to $500 million a year from $50 million a year. Kraft buys the coffee from Starbucks, sells it to stores and then pays Starbucks a royalty fee, based in part on the product's sales and profits.

Kraft also sells Maxwell House and Yuban coffee.

If Starbucks replaces Kraft with another partner, Kraft would be entitled to the full premium, or 35 percent of the value of the business, a Kraft spokesman said.

Starbucks told Reuters it plans to work with privately held Acosta Inc, which handles Via, to manage Starbucks coffee at stores after ending its ties to Kraft on March 1, 2011.

"In effect, Starbucks is trying to walk away from a 12-year strategic partnership, from which it has greatly benefited, without abiding by contractual conditions," said Marc Firestone, Kraft's general counsel.

Starbucks disputed Kraft's assertion that the deal was in effect indefinitely, saying it was set to expire in 2014 unless one of the parties decided to end it early.

Additional reporting by Phil Wahba in New York; editing by Michele Gershberg, Matthew Lewis and John Wallace

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