Green Mountain Coffee Roasters was a scandal waiting to happen. There’s been something fishy about their accounting from the outset. The business strategy it was pursuing was a classic example of front-end loading, where revenues and cash flows today are exaggerated in order to fool the unsuspecting investors into thinking that profitability can be maintained. Specifically, they pursued a highly aggressive acquisition strategy to create an illusion of growth. So the fact that their growth has finally cratered shouldn’t come as a surprise to anyone paying the least attention to the game they’ve been playing.
As I wrote in an article for Acquisitions Monthly in October 201, titled Wake Up And Smell the Coffee: Is Green Mountain Coffee Roaster’s acquisition of Van Houtte a sign of weakness?
There won’t be any meaningful free cashflow until 2012. Perhaps that is why Green Mountain has just hiked prices on all its K-Cup portion packsby 10%–15%, blaming it on a 31% increase in green coffee prices duringthe past quarter.
On top of that, the cost of amortising the goodwill building up on Green Mountain’s balance sheet – the cost of overpaying for its acquisitions – will weigh on earnings for years to come. So if Green Mountain’s present share price is to be justifiable, the manufacturing and distribution synergies that its recent deals promise ought tobe realisable.
Switching royalties for actual revenues has allowed Green Mountain to boast the sort of impressive sales growth – 56% each year for the past three years – that has persuaded the market to give it a premium valuation.
But with close competitor Peet’s Coffee trading on a price-to-sales multiple of 1.4, and having paid close to 2x for Van Houtte and Diedrich, it is questionable Green Mountain deserves to be trading on a price-sales multiple of about 3.5. It might be time for shareholders, dare we say it, to wake up and smell the coffee.