Starbucks Corp and Kraft Foods Inc began airing a messy divorce in public Monday, fighting over the dissolution of their partnership selling bags of Starbucks coffee at supermarkets.
Kraft said it had launched arbitration proceedings to challenge Starbucks' attempt to end the agreement, sending shares of both companies lower.
At stake for Kraft is a partnership with $500 million in annual sales and strong profit margins. Starbucks may have to pay more than $1 billion to buy back the business and run it, a risky move for a company known for operating coffee shops, not selling packaged goods.
News of the breakup surfaced on Nov. 4, when Starbucks Chief Executive Howard Schultz told analysts the company wanted to end its 12-year deal with Kraft, which markets and distributes Starbucks and Seattle's Best coffees to supermarkets and other retailers.
Kraft, which also sells Starbucks discs for its Tassimo brewer and Tazo teas, contends that if Starbucks wants to back out, it must pay the fair market value of the business plus a premium of as much as 35 percent, based on how Starbucks carries the business forward.
Starbucks shares were down 1.5 percent in afternoon trade, while Kraft shares fell 0.8 percent.
Kraft also sells the Maxwell House and Yuban coffee brands but does not discuss individual brands' profits. Analysts have estimated the Starbucks coffee's operating margin at 20 percent or more since it is a premium brand.
Starbucks may have to pay more than $1 billion if forced to compensate Kraft, said Baird analyst David Tarantino. Sources familiar with the business say the figure could be more than $1.5 billion.
Starbucks risks the cost of a dissolution as it seeks growth beyond its cafes. It is looking to the market for consumer packaged goods, which Edward Jones analyst Matt Arnold said offers more stability and higher returns on investment.
Under Kraft's management, Starbucks bagged coffee sales grew from $50 million a year to $500 million.
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.
The company 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.
If Starbucks replaces Kraft with another partner, Kraft would be entitled to the full premium, or 35 percent of the value of the business, said a Kraft spokesman.
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 giant of multiple "material breaches."
Among other allegations, Starbucks said Kraft did not always meet minimum advertising budgets or keep Starbucks involved in major initiatives, violations it said eroded its "brand equity."
Starbucks said it had "raised these issues with Kraft, but there was never any improvement in Kraft's performance."
Kraft in turn said Starbucks was trying to walk away from their partnership.
"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.