5 Reasons Green Mountain Will Bounce Back

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Green Mountain Coffee Roasters (NAS: GMCR) has a problem.

Starbucks (NAS: SBUX) announced its entry into the single-serve coffeemaker market on Thursday night, and Green Mountain's stock took a beating on Friday.

The fears are overblown. Verismo's arrival may not be a positive development for Green Mountain's Keurig, but it isn't curtains for K-Cups. There are a few things that the market is forgetting, so let's dive right into the various reasons that shares of Green Mountain will bounce back.

1. The memo matters
It's been 13 months since Starbucks CEO Howard Schultz sent a memo to key executives that was leaked, perhaps intentionally.

"Green Mountain has done a very fine job introducing single-serve brewer technology to the U.S. market," Schultz wrote. "But as I have said, these are very early days, and history has demonstrated time and again that patents alone do not determine market winners -- deep customer engagement, best-in-class experiences and quality do."

He then went on to point out how a whopping 80% of Starbucks customers do not own a single-cup brewing system. Schultz also hammered home the fact that just 6% of U.S. households had a single-cup brewer at the time, compared to 40% market penetration in Germany.

"The single-serve segment of the coffee industry is poised for a sea change of innovation," he said, tipping his hand as to what would happen 13 months later.

Three weeks later -- after its multiyear exclusivity deal with Kraft's (NYS: KFT) Tassimo ran out --  Starbucks struck a deal with Green Mountain for Starbucks K-Cups.

Why did Starbucks validate what many perceive as a rival? Would it have been better to simply pull out of the single-serve market entirely until last week's announcement? Verismo was already in development, so obviously it's not as if Starbucks felt that one move would trip up the other.

2. Low pressure and high pressure aren't the same thing
There are essentially two types of single-serve brewers on the market. Keurig's low-pressure system makes straight coffee, tea, hot cocoa, and cider. The high-pressure systems also do that to some extent, but their true strength lies in the espresso, cappuccino, and other fancy European coffee beverages that they can whip up.

Verismo is actually competing head-on with Tassimo, Nespresso, CBTL, and the countless other European platforms.

In the United States, consumers have preferred Keurig's low-pressure appliances to provide the caffeinated jolts of premium black coffee. Green Mountain's new Vue introduces adjustable water pressure, timing, and airflow settings, but the standard Keurig machines stand out on their own.

3. Pricing and selection matters
Verismo will roll out offering only Starbucks brews.

The move may seem hypocritical in light of Schultz's memo last year. He took jabs at Keurig, pointing out how Germany's biggest player in single-serve was an open royalty-free platform.

"It would seem self-defeating for Starbucks to create a system -- especially an open royalty platform as it points out is the case with Germany's top dog -- if it's rich with third-party beans," I argued at the time. "If it weans java junkies from its stores through cheaper and more convenient premium single-serve brews and follows that up with a plethora of rival refills, that would be the beverage giant's dumbest move since nixing Chantico."

I miss Chantico.

It's easy to see why Starbucks is doing an about-face with Verismo. If it was to become the Android of java makers, it would soon be flooded with competing products at lower price points. Consumers would love that, but Starbucks would not.

Wait. Isn't that what will happen when Keurig's original K-Cup patents expire later this year? Isn't that why Green Mountain has spent the past few years acquiring the more popular single-serve coffee pod specialists? There are now more than 200 varieties of K-Cups at price points typically well below the price of high-pressure single-serve refills.  The variety will grow -- and the price points should fall -- later this year.

Verismo will naturally have a very limited selection at high price points. If it's been trying to charge a buck for Via instant packets, how expensive will the Verismo pods be?

If you think Starbucks' single-serve brews are a game changer at any price, ask yourself why Starbucks was available as T discs on Kraft's Tassimo for years -- yet you probably never knew about it.

4. Distribution is important
Verismo will hit the market later this year. Where will you be able to buy it? Naturally it will be sold through Starbucks stores, but how long will it take to penetrate the home goods, warehouse club, and office supply stores the way that Keurig has?

You can now even buy Keurig machines at Best Buy. You can also purchase Keurig systems -- along with Dunkin' Donuts K-Cups -- at many of Dunkin' Brands' (NAS: DNKN) doughnut shops. Good luck getting Dunkin' to ever stock Verismo.

As long as Starbucks limits its refills to expensive proprietary blends, it will be hard for mass retailers to devote shelf space to the high-pressure brewer in a niche that has historically been a hard sell in this country. 

5. Starbucks has more to lose than gain
The pro-Starbucks argument here is naturally that Verismo will lead to incremental sales. History bears that out. The booming success of Keurig machines hasn't gotten in the way of Starbucks delivering positive store-level comps in recent years.

However, Starbucks still has to realize that for every Verismo user who makes an espresso at home at a time when trekking out to the neighborhood barista isn't feasible, many more will take advantage of the convenience to substitute Verismo for an in-store visit.

If Verismo's brews are too good -- or too cheap relative to an in-store latte -- it will be doing what digital delivery has done to traditional media.

"Oh, but the aromatic stores are so charming," you say.

Tell that to Borders.

In other words, while I'm sure the product quality will be more than merely good, Starbucks will orchestrate price points that are too high to dissuade its in-store regulars -- yet at the same time not get in the way of Keurig cornering mainstream java junkies.

In the end, it doesn't pay to bet against Green Mountain. We've seen these hits before. It happened when the Starbucks memo leaked last year -- only to surge three weeks later when Starbucks warmed up to Green Mountain. It happened when hedge fund rock star David Einhorn made a strong bearish case against Green Mountain -- only to see the stock surge on a blowout quarterly report.  

Brew ha ha
Shares of Green Mountain have popped nearly sixfold since I originally recommended the java heavy to Rule Breakers subscribers three years ago. It's clearly been a big winner for the growth stock newsletter service, but if you want to discover the newsletter service's next Rule-Breaking multibagger, a free report tells all. Check it out before it's gone.  

At the time this article was published The Motley Fool owns shares of Starbucks.Motley Fool newsletter serviceshave recommended buying shares of Starbucks and Green Mountain Coffee Roasters.Motley Fool newsletter serviceshave recommended writing covered calls on Starbucks and creating a lurking gator position in Green Mountain Coffee Roasters. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story, except for Green Mountain. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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