Downmarket, Downgraded: Starbucks as Metaphor

Perhaps 15 years ago, my wife commented that she had gotten into spending $3 for a morning coffee at a new shop called Starbucks. I said what, she said yes, I said you can do what you want wife but . . . I'll stick with free joe at the doctors' lounge.

Well, by the time our Era of Prosperity peaked around 2000, I had also learned what espresso was and was happy to pay $4 to have it mixed with milk or soy. I was also happy to give SBUX an interest-free loan of $25-50 to avoid having to take up the barista's time each time I bought something (thus also forgoing AAdvantage miles).

So far as the stock went, the recession of 2001 just presented buy points on the chart. Up, up and away went SBUX (what a great stock symbol!).

But concomitant with the rise in the stock and in the false prosperity of the post-9/11 era, there was falsity at Starbucks. In order to meet the perceived need for endless growth and efficiency, the geniuses in management eliminated hand-pressed espresso and went with automated espresso machines. I cannot imagine on whom they test-marketed this concoction, but I have not found one devotee of Starbucks espresso-based drinks who does not believe wholeheartedly that the automated stuff was not nearly as good as the prior drink. Also, all of a sudden, the coffee shops smelled like . . . wait . . . there was no smell anymore. They had created a coffee shop with no coffee odor. Brilliant!

But no matter- they could conquer China! The world at their feet.

And there were breakfast foods and more and more sweet stuff. What they may or may not have realized is that they were quickly becoming McDonald's for the rich, the quasi-rich and the wannabes. Now we see in Starbucks what is happening all over America (AP/Yahoo):

Starbucks to sell value-meal pairings for $3.95

The gourmet coffee chain said it will introduce value-meal type options for $3.95 each in its U.S. company-owned stores. Customers can order a tall latte and an oatmeal or a slice of reduced-fat cinnamon swirl coffee cake. Drip coffee drinkers can get a tall brewed coffee with a breakfast sandwich at the same price.

Starbucks said it will also launch two new breakfast sandwiches — a bacon sandwich with egg and gouda cheese and a ham sandwich made with egg and cheddar.

Regular prices for the drinks and food items vary depending on the location of the store but a tall latte and an oatmeal can cost as much as $5. Starbucks said the pairings will provide customers with an average savings of as much as $1.20.

What's happening, of course, is that if they act like McDonald's, people will just go to McDonald's.

Along with price cuts comes another unkind cut (MarketWatch/Yahoo):

S&P lowers Starbucks' short-term rating to 'A-3'

Standard & Poor's Ratings Services on Monday lowered Starbucks Corp outlook to negative from stable and also downgraded its short-term rating to A-3 from A-2. At the same time, S&P affirmed its corporate credit rating of BBB. "While Starbucks has announced cost-cutting initiatives and a further reduction of unprofitable stores, we do not expect meaningful improvement in credit metrics during fiscal 2009 due to market conditions that we believe will continue to hurt top-line growth," said Jackie Oberoi, an S&P credit analyst.

The previously debt-free company has taken on lots of debt: over half a billion dollars in 2007, and has added other liabilities. The stock is down almost 80% from its all-time high but still sells for about 4 times tangible book value and about 15 times estimated 2009 earnings (but who knows). It has never paid a dividend. In fiscal 2005, it repurchased 27 million shares of stock, thus bringing its working capital from $582 million to negative $18 million. More shrinkage of shares outstanding were engineered after 2005, financed by the above-mentioned debt. Net working capital is now about negative $400 million.

Starbucks has been a symbol of consumerism. It contributed to the obesity epidemic. It got fat and arrogant itself. It larded itself up with debt at the height of the debt-mortgage mania. It forgot about quality and changed its focus to the stock price rather than the core business.

Now Starbucks is reaping what it has sown. It has severely harmed its image. It is surviving on short-term borrowings. It resorted to financial engineering for all the wrong reasons. Its stock remains arguably quite overvalued. It changed management with, to date, no benefit.

Does this sad story remind you of any particular country?

Copyright (C) Long Lake LLC 2009