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Keurig Dr Pepper (KDP) Part II - K-Cups, K-Pods, And The Gourmet Coffee Obsession

by Alex Mason | Companies, Episodes

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Mental Details

Description

  • Nestled in a small Vermont town, entrepreneur Bob Stiller found delicious, gourmet coffee, and he was determined to share it with the world. By joining forces with another up and coming coffee start up, Keurig became a nationwide brand name and coffee makers started showing up in office break rooms and home kitchens everywhere.
  • In today's episode we cover the history of the gourmet coffee business that ultimately became one half of Keurig Dr. Pepper.

Transcripts:

  • Alex Mason: Today, we're going to talk about Keurig Dr. Pepper, and we're going to be continuing our series. This is going to be part two of the series. Last week, we discussed the beverage side of the business, really focusing in on the history of the soda brands. Well, today we're going to talk about the coffee side of the business and understand the history of where Keurig came from.
  • [00:00:21] I'm Alex Mason, host of stock stories. This is the podcast where we decode investing principles by analyzing the business behind the stock, as well as learning about mental models in order to help you become a better investor. You ready? Let's go.
  • [00:01:05] All right. All right. All right. All right. Welcome. Welcome to the show. This is the stock stories podcast. My name is Alex Mason, and yes, I am your host and stock storyteller. Thank you so much for joining me today. It's a beautiful, lovely day. Definitely a cold day up here in Chicago, Illinois, but Hey, it's winter.
  • [00:01:28] So that's what That's what you expect. Right? Hope you're having a wonderful day yourself. And thanks for joining me again. This is the podcast where we decode the business behind the stock, and we also look at mental models. Now, one of the goals of the show is to cover the entire and yes, I meant entire S&P 500.
  • [00:01:53] That's a lot of companies, but we're going through them one by one. And I hope that you learn. Just as much as I'm learning as I go through these companies and share everything that I learned with you and the company that we're talking about today is Keurig Dr. Pepper. If you were with us last week, you know that we talked about the beverage side of the business, and now we're going to talk about the coffee side.
  • [00:02:17] And so let's just get into it because we've got some things to talk about, talking about Keurig. Let's do it.
  • [00:02:37] All right. Let's talk about Keurig green mountain. So just to reiterate, we talked about the beverage side last week. This episode will be focused exclusively on the coffee side of the business. And then next week we're going to look at. The current business today, the combined business and the financials, and looking ahead toward the future.
  • [00:02:58] But this week's episode is exclusively focused on coffee. So let's talk about coffee. So first let's talk about the beginning of green mountain coffee. Our story begins actually not too long ago, back in the 1980s, less than 40 years ago. And there was an entrepreneur. His name was Bob Stiller. And he was going on a ski trip up in the Hills of Vermont.
  • [00:03:25] Now in 1981, he got coffee at a ski resort. He was, he was skiing at, and he took a sip of that coffee. And man, he was blown away by how good it tasted. Have you ever tasted something? It, maybe it was coffee or maybe it was some other drink and you were just blown away by how good it was. Right. Yeah. I definitely had that experience myself too.
  • [00:03:49] Now, most people would simply be satisfied with that and want to come back again for a second couple later, but Bob was not content. He tracked down the original roaster of the coffee. He just had to know where it came from. It was that good to him. And in his search, it brought him to this little small town in Vermont called Waitsfield.
  • [00:04:13] And there's a company there called green mountain coffee to set the context of this time. Gourmet coffee was not a thing. It was not a popular product in the United States, but Bob Stiller, he wanted it to be, he saw this vision for creating gourmet coffee and making it available to everyone. So he saw that potential, now he ended up buying the company after talking with the owners.
  • [00:04:42] And then eventually he began to market it. And as he got into marketing, marketing, it, he got very aggressive. He started using mail order as one of his tactics. And he started finding success because just like he had experienced that amazing taste. Other people started finding out, wow, this is really good coffee.
  • [00:05:03] And they would come back for more. Now, eventually he worked his way up to getting a few wholesale accounts. And that's when he started making more money and news of his delicious coffee spread. So this is interesting because Bob Stiller, he didn't invent the product. Right. All he did was find it and take action in order to acquire ownership.
  • [00:05:27] I think that's an important lesson. There was already a company in existence, green mountain coffee already existed. They already had amazing coffee. But green mountain coffee without Bob Stiller, wasn't going to grow the way that it grew. And that's because it's not good enough to have a great product is not good enough to make something of value.
  • [00:05:49] You have to sell it. You have to market it. You have to let people know about it. And it's that combination of the salesmanship of the founder, the founders, right with the salesperson Bob Stiller. That made this business very successful. Now by 1991, just 10 years after Bob Stiller took his first sip, the business had grown to over 1000 wholesale contracts.
  • [00:06:18] And in fact, they had over $11 million in sales. So this was pretty good growth. They were starting to grow. Definitely well-known locally. Now, meanwhile, while green mountain coffee was growing, there's another parallel story here. There's a small coffee maker, upstart that was just getting off the ground.
  • [00:06:40] There were two engineers by the name of John Sylvan and Peter Dragone and they wanted to create a machine that made better coffee. That's all they wanted to do. We just want to make a machine that makes better coffee. And the reason that they want to do this was working in their offices. They had these typical coffee machines that, you know, existed in most corporate offices.
  • [00:07:04] And in fact, to this day, I've seen, I've seen very old coffee machines and some offices in the past, and they were just so downtrodden with just how bad the coffee was. They thought, you know, we could do better than this. So they partnered with a friend of theirs. His name would, was Dick Sweeney and the three of them began to design and build a concept.
  • [00:07:27] They built prototypes, they experimented with different designs and eventually they created a machine that served a single cup of coffee and they named it Keurig. Now the reason they need that Keurig is they named it after what they thought was the Dutch word for excellence. And I think if I'm not mistaken, the exact pronunciation or translation rather is something more like neat or a different word other than excellence.
  • [00:07:56] But nonetheless Keurig really stuck. And that became the name of the machine and the name of the company. And the way that this machine worked is it accepted these little pods of coffee. In order to create each cup and they dubbed these pods K cup pods. Now one aspect of the pods that was really important was the fact that it would fit into competing coffee makers and still work.
  • [00:08:22] So people would be able to buy the K-cup pods and drink them out of other brands. For example, some of their competitors were. The Mr. Coffee brand or the cuisine art brand of coffee maker. So they were able to be compatible with competitors and what's allowed them to expand their potential market because people would know, okay, if I buy this it's okay.
  • [00:08:45] Maybe I'll just like the coffee and use my existing machine. But of course they wanted people to buy their machines as well. Now with their machine ready to go, they knew it would be a natural fit if they partnered with. People who produce great coffee, right? And that is what led them to green mountain.
  • [00:09:04] So they came knocking to green mountain and they sat down with Bob Stiller and Bob was impressed. He thought they were very bold for what they were doing. He liked it. And after some time he decided, Hey, I'm going to invest in this company. So he bought a stake in Keurig and the partners partner together.
  • [00:09:26] To make both great coffee and great coffee machines. Now, as the 1990s progressed, they decided to refine their product even further. And they started selling their first commercial brewers in 1998. Now they wanted to first target the market that they initially thought of. Right. Which were large offices.
  • [00:09:47] They didn't want other people like them who had to suffer through these. These coffee machines that were not up to par in their opinion. So that was the first sales target and they were succeeding with these customers. It made sense for corporations to buy convenient, quick coffee for their office workers that still tasted good.
  • [00:10:09] So it made a lot of sense and it started to catch on. Now eventually the green mountain and the Keurig team decided to expand and they made a bold attempt to break into the at home. Market. So they had this individual consumer friendly Keurig machine that they wanted people to buy and put on their kitchen, kitchen, counter, and use.
  • [00:10:31] So they started marketing themselves in high-end department stores in the early two thousands. And this is really when Keurig started to really take off now seeing the success of the Keurig system, the companies. Went all in and green mountain acquired the business outright in 2006. So the companies were finally United.
  • [00:10:55] You had the part of the business that was making the Keurig machine. And then you had the part of the business that was sourcing the coffee itself, which was a pretty good combination. Okay. Let's talk about the second part of the story. Keurig green mountain. Now it was at this point that some massive growth began in 2007 green mountain made $13 million in net income by 2013, that profit figure expanded to over $480 million.
  • [00:11:33] That's a growth rate of 82%. Annually. Oh my gosh. Like, hold up, we got to go over that again. In 2007, green mountain made 13 million and then in 2013 they made over 480 million. That's only six years in order to get that level of growth. How did, how in the world did they do that? Well looking into it. This is what I found out it has to do with profit margins.
  • [00:12:03] You see, in the late 1990s green mountain, they were making almost all of their revenue by selling coffee to wholesalers. And that's really low margin because you're sourcing the coffee beans, you're processing it. And then you're selling these big packages to wholesalers so that they can then resell it to consumers.
  • [00:12:24] But by the mid two thousands with the growth of the K-cup a lot more coffee was now being sold in these super small cup size packages. Now, if you have smaller package sizes, that means that you can increase your margin because you can charge more for a single. Little pod or a single little package. So overall the company started making all of its money from these products.
  • [00:12:51] They started making more and more money catering to the end consumer with high margin products, as opposed to catering to businesses, selling wholesale products. So that was a secret sauce that led to this incredible growth rate in the late two thousands and early 2000 and tens. So the name ended up getting changed to Keurig green mountain officially in 2014, because Keurigs growth that was really driving the profits.
  • [00:13:20] And then during the course of this decade, other brands started getting acquired or were made licensed partners. And part of what legitimized the growth of this business is that in the same year, Coca-Cola actually bought a 10% stake in the company. And they actually increased their state to 16% pretty quickly thereafter.
  • [00:13:42] So they also worked with Dr. Pepper Snapple group, but Dr. Pepper Snapple group, they didn't get any equity there. But the biggest thing with the history of this company in recent years is in 2015. There is a Luxembourg based conglomerate and it's called jab holdings, J a B, and it's a private company, so you can't invest in them directly, but they decided to make an offer to buy out Keurig green mountain and after offering almost $14 billion, the offer was accepted and all of the shareholders, including Coca-Cola got a nice, nearly 78% premium.
  • [00:14:25] In cash above the market price of the stock. Now I want to pause here for a moment because I want to point out that buyouts of stock can be extremely lucrative. Existing large shareholders typically are not willing to sell large blocks of stock for the existing price that their stock is trading at in the market.
  • [00:14:44] So they require a premium to be bought out. So that is something that can work out very well for you and I as individual investors, maybe we own a company and it's taking off and the share price is going up and that's great. And then we get bought out and then all of a sudden we just opened our account and we see a bunch of cash sitting there.
  • [00:15:04] And so that can be a good thing. Right. But it's, it's just part of the nature of investing. Sometimes private companies buy out public companies and sometimes public companies buy out other public companies. It just, there's all sorts of different things that can happen. So just a few years after that in 2018, the Keurig green mountain subsidiary ended up buying out Dr.
  • [00:15:29] Pepper Snapple group for over $18 billion. And that is what formed the third largest beverage company in North America. And then as part of that, the Dr. Pepper Snapple shareholders received a really big cash dividend of over $103 per share. So that's kind of how the story merged at the end. Now I want to take a few minutes to touch on another point regarding the coffee side of the business.
  • [00:15:58] So specifically I want to talk about Keurig green mountain, the stock, and it's rated as ticker symbol, G M C R for green mountain coffee roasters for a long time. So although Keurig the company was very successful for many years, particularly. Throughout the early two thousands. If you go back and look at a historical stock chart of its stock, it's been a really wild ride for shareholders after reaching a peak in 2011 of around $105 a share or so, the shares ended up plummeting to Amir $18 per share just one year later.
  • [00:16:39] And they eventually came back up a little bit before the merger, but. Geez what happened, right? I mean, $105 to $18. If things are firing on all cylinders, like what happened? Well, it was the perfect storm of bad news for Keurig green mountain. And here's what happened. Well, number one, there was a lot of competition.
  • [00:17:01] Competition began to increase as Keurig started showing up in more and more households. Other companies took notice, notably Starbucks took notice. And of course Starbucks was also growing rapidly around this time, but they were already a big company for sure, in the early to mid two thousands. And they made an announcement that they would make a competing machine to the Keurig.
  • [00:17:24] So that brought shares down a little bit. Right. Then there were also just some bad quarters. They just had some bad results of sometimes. And for a very high growth company, there tends to be really, really high expectations tied to that company. And that's usually baked into the valuation of smaller growth stocks like green mountain coffee roasters was back in the day.
  • [00:17:50] And the thing is with these types of stocks, when there's a miss, even if it's a small miss. The share price, usually plummets and that's because those expectations are not met. And so just as quickly as it rises, it falls just as quickly. And that's exactly what happened here with green mountain coffee roasters, there were some poor quarters, there was competition and things were not looking good for at least some period of time, even though there was a strong period of growth on the backend.
  • [00:18:21] In addition to this, there were some questionable accounting practices and some would say questionable growth strategies. According to some investors, notably David Einhorn, who was a famous investor. Now he and other investors ended up shorting the stock. And that also helped to drag down the momentum and if you don't know what shorting a stock means, that means you're effectively betting that the stock is going to go down instead of up, when you buy a stock, normally it's called a long position.
  • [00:18:53] You are believing that the stock will eventually rise in value, but if you short a stock, you are basically saying that you believe the stock's value is going to decrease, usually because of some kind of fundamental issues with the company. So when you have big investors with lots of money who are shorting your stock, that's, that's usually bad news for you as the company, because that means that other people lack faith in your ability to make the company successful and have that share price rise.
  • [00:19:24] So that was another thing that was a negative to add insult to injury. When the stock price fell, remember Bob Stiller, who was. The entrepreneur who really got this whole thing going, he was forced to sell over 5 million shares. That was over 70% of his ownership. He was forced to sell it because he had put it up for collateral for some loans that he had with his bank.
  • [00:19:49] And this is what's called a margin call. When a broker sees that the value of your collateral is sinking. That is exactly the time that they want to reduce their risk. And then call in there loan. And that can force a sale of shares for the investor. So Bob Stiller, he, he just got taken basically because he chose to put his shares up for collateral and he chose to put a lot of it up for collateral and it went against him at exactly the wrong time.
  • [00:20:21] Now, this big selling action that brought the selling momentum of the shares down even further, because. As you can imagine if 5,000 shares flood the market, all of a sudden as available the supply and demand relationship becomes imbalanced and share prices, go down. There's a lot of selling action. It actually accelerates.
  • [00:20:43] The share price decreasing in value. And if that wasn't enough, the triggered margin call meant that Stiller sold shares during a time that as the chairman of the board, as a director of the company, and he was prohibited from doing so based on. Based on the law because of insider trading rules. So things were just not good for Bob Stiller during this time.
  • [00:21:06] And it was really unfortunate because other shareholders got pummeled as a result of all of these things getting triggered all at once. It really was the perfect storm of just bad things happening one after another. And subsequently Bob Stiller was dismissed from his role as chairman of the board. So after Keurig's great rise, it had a great fall.
  • [00:21:28] But the thing is it eventually Rose again because the underlying business was indeed good and management kind of righted the ship and then eventually it was snapped up by J a B holdings. So just some lessons there, I think are important to note the way that management runs the company, the way that they steward.
  • [00:21:56] The capital that you entrusted them as an investor is critically important. And I mean, critically important, especially if you're talking about a smaller company, a growth company, a company that doesn't have tons of huge institutional shareholders watching over it all the time. Yet it's incredibly dependent on the actions of.
  • [00:22:21] The chairman of the board and the directors. And of course any company is right, but especially smaller companies. And also another lesson here is like, don't put all of your stock of, for collateral, for loans. Like don't do that. That's a huge, that's a huge risk. Another lesson is if you're going to invest in small, fast growing growth companies, be aware that there can be really big price swings.
  • [00:22:49] Even if expectations are missed just a little bit, that's the way that the market tends to work. So just be aware of that if you're investing in high growth companies. So that is, is going to wrap it up for today. That was the history of the coffee side of the business of Keurig Dr. Pepper. I really hope you enjoyed this episode now next week, we're going to be talking about.
  • [00:23:18] The business itself, we're going to be talking about Keurig Dr. Pepper in its present form going over the business overview, the current business model financials, the things we normally go over on the show. And so I hope that you join me next week for part three. Thank you so much for listening to stock stories.
  • [00:23:37] If you enjoyed this episode, it would help me out so much. If you just shared it with a friend, share it with another investor who you think would benefit from this knowledge, from these stories. And let me know, send me a note about it. Send me a direct message @stockstoryteller and that's on Instagram or on Twitter at stock storyteller.
  • [00:23:59] Or you can send me an email at Alex at stock stories, podcast.com. So thanks again so much for listening. I really appreciate you going through these stock stories with me and I hope you're having just as much fun as I'm having. All right. I'll see you in part three next week.
  • [00:24:39] The information presented here on stock stories is informational educational and entertainment purposes only you and you alone are responsible for your investment and financial decisions. Please consult an appropriate tax legal or financial advisor that analyze your specific situation in the context of your goals and circumstances.

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