When Wall Street Hotshots Are Wrong, Your K-Cup Company Tumbles

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Green Mountain Coffee Roasters, David EinhornWords can move the market, especially when the person mouthing those words is legendary hedge fund manager David Einhorn.

Shares of Green Mountain Coffee Roasters (GMCR) tumbled 10% after Einhorn revealed that he was betting against the company. Patent expirations, questionable accounting practices, and a lofty valuation have led the hedge fund manager to short the company behind Keurig single-cup coffee brewers and the K-Cup refills that make them run.

Einhorn is the one who famously bet against Lehman Brothers shortly before the investment banker's collapse a few years ago, so when he's a naysayer people listen.

Let's go over three reasons he may have sipped more than he can slurp here.

1. K-Cup patent concerns are overblown
It's true that two of Green Mountain's dozens of patents -- important ones covering the K-Cup portion packs -- expire next year. If the Vermont-based java heavy can't find a way to extend those patents, anyone would be able to market their own K-Cups -- though likely under generic names.

Green Mountain gets a few pennies for every licensed K-Cup sold, so it's easy to see why this is problematic.

Thankfully, Green Mountain has been readying itself for this day. It has snapped up the regional makers of its most popular K-Cups, assuring itself of continued profitability without the licensing royalties. Green Mountain is also working on a new espresso-making system and an updated Keurig platform, and success with either of these new machines will create new patent gravy years.

2. Green Mountain's potential market is bigger than naysayers think
Green Mountain estimates that K-Cup brewing systems can be found in 8% to 10% of the homes in this country.

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In its recent call it claims that 25% of the coffeemakers sold during this past holiday season were Keurig systems. In other words, the market is growing. Green Mountain is simply at the mercy of joe buffs replacing their makers.

We're not just talking about hot coffee and tea here. Green Mountain recently struck a deal with ConAgra (CAG) for Swiss Miss hot cocoa. It has also been promoting a new line of chilled K-Cup beverages. Brewing the coffees and teas into a cup of ice does the trick.

Where does it go from here? Green Mountain is exploring beverages with functional or wellness benefits. (Vitamin coffee, anyone?) In short, the market for one-off brews at substantially lower price points than barista-poured coffees is just getting started.

3. The company's shares are selling for a reasonable price
Analysts see Green Mountain trading at 31 times this new fiscal year's earnings and 21 times next fiscal year's projected profitability. These valuations may seem to be as rich as a freshly brewed Keurig coffee, but keep in mind that Green Mountain is growing considerably faster. Net sales grew 127% in its latest quarter, and earnings grew at an even headier clip.

Market darling Starbucks (SBUX) is mature and a relative slowpoke, yet it fetches a similar 19 times fiscal 2013's estimated earnings. Frappuccino fans justify Starbucks' market premium by pointing to international expansion, now that stateside growth has all but maxed out. What about Green Mountain's overseas potential?

Einhorn is an investing genius, but this bearish pick is near-sighted and flat-out wrong.

Longtime Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Green Mountain Coffee Roasters and Starbucks. Motley Fool newsletter services have recommended creating a lurking gator position in Green Mountain Coffee Roasters.


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