1. Starbucks : Long-Term Financing Policy and Capital Structure, Risk Management Policy, and Acquisition Analysis Debbie Pryer University of Phoenix Advanced Problems in Finance: FIN 545

2. Background  WHAT:  Starbucks Corporation purchases and roasts high-quality whole bean coffees and sells them, along with beverages food items, coffee-related accessories and equipment, a selection of premium teas and a line of compact discs, primarily through Company-operated retail stores.  Starbucks also sells coffee, tea, and ice cream products through other channels and, through certain of its equity investees. These nonretail channels are collectively known as “Specialty Operations.”  HOW:  The Company’s objective is to establish Starbucks as the most recognized and respected brand in the world.  To achieve this goal, the Company plans to continue rapid expansion of its retail operations, to grow its Specialty Operations and to selectively pursue other opportunities to leverage the Starbucks brand through the introduction of new products and the development of new channels of distribution. The Company has two operating segments, United States and International, each of which includes Company-operated retail stores and Specialty Operations.

3. Growth Strategy  Plans to open over 1,500 stores in 2005 globally

4. Long Term Financing

5. Long-Term Financing  Starbucks disdains debt, instead relies on cash flow for growth  Most recent long-term financing occurred in 1999  Purchased roasting plant and distribution facility  Cost $12.9 million  Paid $5.2 million in cash  Financed $7.7 million with city-financed bonds  Interest rates between 0% - 2%)  Debt will be retired in 2007

6. Stock Repurchase Plan  The company is cash rich  Repurchasing $15.7 million approved by Board in May 2005  Company believes stock is under-valued

7. Capital Structure  Near zero debt in light of company size  Increasing leverage via stock repurchase

8. Company Values  Book Value = $2.3 billion  Market Value = $2.995 billion (market multiples approach)  Levered Value = $48.865 (M&M approach)  WACC = 9.52% (CAPM method)

9. Optimal Capital Structure  Maintain current strategy of focusing on sales and store growth utilizing free cash flow  Starbucks’ cost of capital is 9.52%, price per share is $59  (based on P/E, DCF and ROIC methods from Goldman Sachs’ Kron, 2005),  and market value is $17.5 billion  (based on fiscal year-end 2004 market value and attainable 30% growth with recommended acquisition)

10. International Investments  Starbucks should consider fully utilizing swap contracts to hedge a major portion of coffee and milk purchases  (currently the company uses this strategy for a very small portion of only their milk purchases and this opportunity should be exploited and include coffee beans)

11. Risk Management Policy

12.  Use risk management tools to measure uncertainty of opportunities and hazards  Starbucks is risk averse and focuses heavily on sales growth

13. Black-Scholes Option Pricing  Starbucks could use the Black-Scholes Option Pricing Model in managing many of their global business risks, particularly their foreign currency hedging investment policy  after a put or call option decision has been made, they could use Black- Scholes to eliminate risk

14. Decision Tree Analysis (DTA)  Starbucks could utilize DTA:  in its current endeavor to introduce food items at its stores, or  to determine whether or not a particular acquisition or store opening in a particular location would be the right strategic move

15. Simulation Analysis  Using simulation analysis, Starbucks could utilize an interest rate scenario and see what would happen (and what risk it could face) if interest rates declined or increased 100 (or any number) basis points

16. Hedging  Starbucks hedging policy is quite conservative (monthly valuations), considering that the company has a tremendous amount of cash that is exposed to various prices, including but not limited to  foreign exchange rates,  interest rate,  commodity prices, and  equity prices.  When these prices change, it can have an overwhelming impact on Starbucks’ reported earnings

17. Acquisition Policy

18.  Starbucks acquisition policy is to not acquire companies simply for growth’s sake, but to acquire companies that provide value to Starbucks and its customers  Most recent acquisition: Hear Music (allows in-store customers to create personalized CDs of music)

19. Where to Look?  Starbucks is currently testing hot food sales at 80 stores  Spinach-Chicken Sandwiches  Egg-Sausage Muffins  Top 10 Global Trends prove that customers want healthy, low-fat, quick- easy foods, and that fruit is now 2 nd favorite snack worldwide

20. Synergistic Acquisition Candidate  Chiquita International Brands, Inc.  leading international marketer, producer, and distributor of high quality bananas and other fresh produce  distributes and markets fresh-cut fruit and other branded, value-added fruit products  Meets the food demands of our global customers  Capitalizes on global food trends

21. Chiquita Shares & Ratios  Chiquita has 41.7 million shares outstanding and was trading at $27.31 as of August 5, 2005 with a market cap of $1.14 billion  PEG ratio of 1.00  Price/Sales of 0.38  Price/Book of 1.27  Total Debt/Equity of 0.359  Profit Margin of 3.80%  ROA of 5.77%  ROE of 13.90%

22. Chiquita Value  Book Value = $954 million  Market Value = $148 million  Liquidation Value = $516 million  NPV = $5.06 per share  IRR = 4.97%  Profitability Index = 1.1  MIRR = 3.07%

23. Acquisition Terms  Offer Chiquita shareholders $31.00 per share, or a 15% premium over its current trading price of $27.31  At $31.00 per share, the acquisition cost would be $1.293 billion  Stock is undervalued  Current R&D efforts to create and sell a new sweeter, smaller banana that is currently commanding a 100% premium price in Japan

24. Risk Factors  Specific risk factors inherent in the Chiquita acquisition include  natural disasters and unusual weather conditions;  fluctuating prices for Chiquita products;  availability and costs of products and raw materials;  the Company’s ability to realize its announced productivity improvements;  risks inherent in operating in foreign countries, including government regulation, currency restrictions and other restraints, burdensome taxes, expropriation, threats to employees, political instability and terrorist activities, including extortion, and risks of U.S. and foreign governmental action in relation to the Company;  the outcome of the Department of Justice investigation related to the Company’s Colombian subsidiary sold in June 2004;  labor relations;  actions of governmental bodies;  the continuing availability of financing; and  other market and competitive conditions

25. Conclusion  Starbucks is in the enviable position of having very little debt and expansive growth opportunities, coupled with strong brand recognition, customer loyalty, and limited competition