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Non-Tech : Starbucks (SBUX) -- Ignore unavailable to you. Want to Upgrade?

To: Sean Rieber who wrote (767)	7/2/1999 1:52:00 PM
From: Daniel Chisholm	Read Replies (2) \| Respond to of 1506

Actually, I said it would be worth less than $10 per share to someone contemplating (theoretically) buying out the entire company. To promote a discussion not biased by the current price a Starbucks share fetches, I propose to show an analysis not on a per-share basis but rather on an enterprise-wide basis. When all is said and done I'll convert back to a per-share basis, to see how this valuation aligns with the present market price of SBUX shares. Assume that I am the financial adviser to someone who has many billions of dollars of cash to invest (hypothetically speaking, let's call him Dr. Evil), and I must make the case for (or against) him buying Starbucks. Let's say that the entire company (all shares outstanding) are offered to him for $1800M -- is this a good deal for him or not? That $1800M is quite a premium to the (according to Yahoo!) $880M in book value. However some people (e.g., Warren Buffett) have paid impressive premiums to book value and become rich nonetheless, provided that the company they "overpay" (in a conventional accounting sense) is truly wonderful. Starbucks might conceivably be such a company, so at this point I would not necessarily advise Dr. Evil to turn down the offer. Going against the prevailing wisdom and laughing all the way to the bank is just the sort of investment that interests Dr. Evil. And if I were the one responsible for this, it could substantially advance my career with Evil, Inc. This $880M of book value is also known as shareholder's equity. When you compare one year of profits earned to shareholder's equity, the resulting figure is "Return on Equity". It is subject to many possible distortions and illusions, but a good clean ROE figure is an invaluable barometer of the earnings power of a business. SBUX earns no more than 10% ROE. Because Dr. Evil is being offered the corporation at a substantial premium to book value, his return on his $1800M investment will be quite a bit less than 10% in the first year. In fact, in the first year he can expect only a 4.9% return on his investment (caluculated as follows: 10% ROE times book value $880M divided by price paid $1800M) Clearly Dr. Evil is not interested in a 4.9% return on his investments, since he can get substantially more than that simply by buying US bonds. And funneling his ill-gotten gains into instruments (such as bonds) his grandmother would consider conservative and fuddy-duddy would not maintain his Fear and Respect amongst his underworld cohorts and sycophants. To even suggest that he make investments that underperform bonds, well let me just say, as Dr. Evil's financial advisor, I must strive to make sure that he does not underperform bonds, lest I invoke his infamous rage and fury! The only way I could persuade Dr. Evil to accept a 4.9% return in the first year is through the promise af far, far greater profits further down the road. Starbucks must grow earnings, and grow earnings fast, to be worthy of Dr. Evil's investment. The trouble is, same store sales growth is somewhere between 3% and 7% (the numbers tend to be pretty volatile, but are typically in the range of inflation plus a few percentage points). Dr. Evil will take whatever gains are available to him through same store sales growth, however single digit gains like this are not going to be the secret path to incredible riches within the next ten years. The only option left for him to realize spectacular growth in profits is by expansion. That is the path that Starbucks as a publicly traded entity has taken in the past, and since the world is not yet fully saturated with Starbucks store, there is still room for expansion. However, Starbucks is a relatively capital intensive industry -- it takes about half a million dollars to open a new store. In fact, running various spreadsheets I find, as his cunning investment advisor, that the fastest rate that we can grow the business is about 10% per year. Which not surprisingly is exactly equal to the Return on Equity. In order for Dr. Evil's Starbucks to grow the business faster than 10% per year, he must inject more cash into the business. Dr. Evil is not interested in selling any stock in the company, nor is he interested in borrowing money. Such actions are simply not done by Evil Overlords. If the company needs cash for expansion, Dr. Evil will provide it from his massive ill-gotten hoard. Of course Dr. Evil expects any such fresh cash infusions he provide to generate spectacular profits for his empire. Analyzing the return on a "marginal dollar of investment", I find it to be... 10%. Drat! There's that darn ROE figure again! When all is said and done, the best spreadsheet I can provide Dr. Evil shows his initial return on investment at 4.9% per year, eventually growing to 10% per year. Since this would make him appear to be a second rate investor, it is not a course of action I would recommend to him. Oh yeah, $1800M is $10 per share. - Daniel