Foaming At the Mouth: Einhorn Negative on Green Mountain

David Einhorn of Greenlight Capital spoke at the Value Investing Congress earlier and he was negative on Green Mountain Coffee Roasters GMCR. He believes that Green Mountain is much more likely to earn $3.50 per share, as opposed to $9 per share that the bull case is based on. The bulls believe the growth story is still in the early innings. Company management believes it is only one-third of the way there, and it has room to expand distribution. The company is adding additional infrastructure in 2012, which is key for greater k-cup expansion. The bull case for $9 per share in earnings a few years out is the potential to capture one-third of the 64 million "target households." He believes that Green Mountain is more likely to be called a manufacturing company, as opposed to a technology company. He mentioned that CNBC's Jim Cramer said Green Mountain is "an ETF on the rapidly growing single serve market." The company calls itself "the iPod of coffee." Einhorn said that he thinks Apple (NASDAQ: AAPl) and Green Mountain's earnings multiples should be reversed. Einhorn reached out to company management for fact checking, but management declined to speak due to the quiet period. Mr. Einhorn believes that the current market is much smaller than the bulls think, and that Green Mountain has penetrated most of it. He cited the fact that K-cup consumption is declining. Keurig is the very expensive way to drink coffee at home, with brewer prices starting at $80. Einhorn mentioned the lower end players, such as Folgers and Maxwell House. The total estimated market for coffee households is around 90 million, with 70% of those drinking coffee on a daily basis. Contrary to the bull case, Einhorn thinks that the base case for Green Mountain is more like 21 million, not the 90 million. If that's the case, then Green Mountain has 50% of the market. One major factor is the attachment rate, which is important because it speaks to the addressable market. He believes the early adapters are the biggest users, and that the attachment rate has fallen. With regards to the company's deal with Starbucks SBUX, it does not apply to Green Mountain's next generation brewer, and it is a non-exclusive and a multi-year deal, which Einhorn suggests means it will end after Green Mountain's patents expire in 2012. He suggested Green Mountain is likely to earn one-third of the 22 cents per K-cup profit margin from the deal, as Starbucks has historically earned the other two-thirds in previous deals. Green Mountain said the Starbucks deal was similar to the deal that Starbucks had with J.M. Smuckers SJM. He also mentioned the negative bias he has towards the cash flow from operations, and that it will actually get worse before it gets better. The return on invested capital is 16.3%, and he believes it is difficult to justify the high earnings multiple Green Mountain has been afforded. The company's' acquisition policy has been poor, with GMCR paying high prices to limit competition of the K-Cup and to buy its partners. The company is attempting to make improvements on existing patents for the K-Cup, but Einhorn believes getting the customer to switch to this would be difficult, given their affinity for the Keuring brewing system. The company has also talked about a next generation brewer, which uses a new different patented K-Cup. Einhorn believes that Green Mountain will lose its ability to have monopoly pricing in September 2012, and that many private labels have expressed desire to compete. Sturm TH can already produce K-Cups and enter the market with no investment because it makes Crystal Light packs. Others like Kraft KFT, Nestle, Mars, Maxwell House and Sara Lee SLE can also make cups starting in 2012. Einhorn did not really go in depth on the company's questionable accounting methods, but did mention the several questions Green Mountains' accounting has raised, including the Van Houtte acquisition. When the CFO was questioned about Van Houtte's accounting when it was implemented into Green Mountain, she refused to to disclose operating expenses, and simply said Van Houtte spent less than we thought. He also questioned the recent June quarter, which had a 19.3% K-Cup beat. Historically, the projections for K-Cup sales has been able to be predicted within a few percentage points, but this was a tremendous outlier. Whitney Tilson of T2 Parnters also disclosed that he is short Green Mountain, but that was coincidental. The stock is currently down 9% on the news, and has come off the lows.