Happy Anniversary: Teavana’s Tactical IPO

ATLANTA, Ga.

On the anniversary of the tea industry’s first retail IPO, Atlanta-based Teavana Holdings is fast-growing and profitable, has greatly expanded its North American retail presence with the acquisition of Teaopia Ltd. and continues to lead the parade as the flag-bearer among premium tea vendors.

Teavana’s public disclosure of its high earnings last spring drew a lot of attention to the segment, spurring significant private and corporate investment in retail operations as a result.  The company continued to establish enviable benchmarks in the past year including a gross margin of 63.8% and operating margins of 18.8%. Retail sales averaged $980 per sq. ft with an average ticket of $40. Stores earned an average $913,000 in 921 sq. ft. of retail space.

Loose-leaf teas account for 55% of sales, tea-related merchandise 41% with the remainder of sales for teas prepared and served in-store. The company reports that this year customers are buying "significantly higher units per transaction,” according to a June 2012 investor presentation at the William Blair 32nd Annual Growth Stock Conference.

Online sales grew by 46% and now account for 7.6% of all sales. The company’s customer database has grown to include 400,000 email addresses and it plans to build a new marketing organization in the coming year.

There is speculation but no evidence the company is for sale. There is substantial evidence tea retail is getting a long-anticipated infusion of cash. The simple fact that there are now financial analysts following tea invariably piques investor interest.

Wall Street

Analyst reports are mixed. Wall Street insiders rant from time to time about the company’s share price which has fallen from a 52-week high of $29.35 to around $11 after trading in the mid $20s for much of the year. The initial offer price was $17. In May the stock fell to an all-time low of $10.95 which triggered contrarian analysts to recommend buying shares.

Anyone who paid $30 in the frenzy immediately following the July 28, 2011 IPO has their regrets. Dunkin’ Donuts funded its IPO the same week, at an opening price of $19 to generate $425 million. Shares now sell for $34 from a high of $37 giving the company a $4.1 billion capitalization. Teavana, by comparison, is valued at $424 million.

In March, market watcher Frank Voisin, who regularly contributes to the financial advice website Seeking Alpha called Teavana’s metrics “fantastic.”

Nashville“Aggregate sales are up but more importantly comparable store sales are up too. New store growth is robust and there is no sign of market over saturation. Furthermore, these increased sales translated to increased profitability (in other words, the company isn’t sacrificing its margins in order to show top line growth). In fact, gross margins expanded over the period, meaning the company has been able to charge more on average for the same inputs as compared to its results prior to going public,” said Voisin.

But all this good news is bad he concluded. While the company is performing well its valuation makes it “one of the most overpriced companies in America,” he wrote. The market is mistaken in its assessment of the company’s future performance, suggests Voisin, concluding that “unrealistic expectations of future growth” led investors to make Teavana the most heavily shorted stock (76.6%) on the NY Stock Exchange.

A few weeks later Teavana’s stock suffered a sharp decline when the company reported its earnings  May 30. At $10 a share it no longer looks overpriced. Investor’s biggest concern is that comparable store sales were up a meager 1.7% which was far below the 5.5% growth reported in the previous quarter.

Recent analyst reports have been more favorable but Wall Street generally sees Teavana’s tea cup as half empty.

World Tea News views Teavana as fundamentally sound. Here’s why:

First mover advantage: The company is in sync with consumers currently spending at least $8.7 billion annually (according to market researcher Packaged Facts) and possibly as much as $27 billion, according to an analysis by Seattle-based Sage Group.

Andrew Mack
CEO Andrew Mack

"We continue to see people adopting tea into their everyday lifestyles and tea is leading the way in the health and wellness movement," says Founder & CEO Andrew Mack. “Teavana is less about serving cups of tea and more about getting tea into people’s everyday lifestyle,” he explains. “It is the opposite of coffee and soda and higher paced life. We offer an affordable indulgence… somebody can spend $15, $20 or $30 to bring quality tea into their daily lives and afford to do it again next month,” he says. Teavana understands the market and is developing the girth and efficiencies of scale to bring this vision to millions.

Strong Earnings: Net sales rose from $64 million in 2008 to $168 million last year, a compound annual growth rate of 38%. Despite a drop of 17% in the share price on news that its Q1 revenues were slightly below expectations, revenue was up 27% compared to the previous year. Net income for the quarter rose 12% to $3.7 million on $44.3 million, a number well above the $34.9 million earned in the first quarter of fiscal 2011. The company expects to book $208 million this year maintaining an adjusted net income growth rate of 30- to 35%.

Accelerated Expansion: The chain already has opened 23 of 60 new stores this year in addition to acquiring 46 company-owned stores from Teaopia Ltd. This brings its total to 223 mall-based shops. The company will soon be represented in every state and province with franchise activity in Mexico and the Middle East. The company is on track to exceed its goal of operating 300 stores by the end of this year and 500 stores in 2014. Teavana stands to gain $22.9 million a year in additional sales simply by bringing Teaopia’s $435,000 sales average to its own $913,000 average sales per store. Teaopia is expected to add $.03 to $.04 cents per share in 2013. Teavana paid $26.9 million in a cash transaction and will incur an estimated $200,000 to re-brand the stores.

Teavana spent much of the past year perfecting what it does well — breaking preconceived notions about tea one tasting sample at a time.

Increasingly Competitive Marketplace

A far more significant threat than daily stock fluctuations is the changing retail landscape. In the past 12 months:

• Tazo Tea, the $1.4 billion division of Starbucks, announced it is expanding into stand-alone retail. The company will open a single outlet near Seattle in October. This is not viewed as a concept, but an extension of Tazo’s formidable retail operations. Tazo currently earns half its revenue in grocery with $750 million in sales at 18,000 Starbucks and Seattle’s Best Coffee cafes. Tazo will likely focus more on street and neighborhood locations, while Teavana is largely mall based.

• Montreal-based DavidsTea expanded operations to New York City and accepted a major investment of $14 million from the Highland Consumer Fund; beefed up its board of directors to include Chip Wilson, founder and former CEO of Lululemon Athletica and Tom Stemberg, Managing General Partner at Highland and founder and former CEO of Staples. The company, which operates 77 retail stores, will soon open a U.S. based headquarters, likely near Boston, Mass. This company operates a mix mall and urban storefronts.

• Argo Tea, a Chicago-based tea retailer founded in 2003 added Boston to its list of New York and St. Louis locations last year expanding its store count to 25. The $20 million company also introduced its bottled tea concentrates at 10,000 grocery stores and it contracted with Azadea Group to open 100 franchised stores in Abu Dhabi, Dubai and other Middle East locations beginning this fall in Beirut.

• Jamba Juice, a California-based chain of 750 fresh juice bars acquired Talbott Teas this spring and is now rolling out the brand at 450 locations. Look for innovative juice-tea blends as well as hot and iced-tea offerings. Jamba locations are widely dispersed in malls, suburbs, business districts and urban neighborhoods.

Store InteriorThe Year Ahead

Past performance is no guarantee of future earnings. Teavana boasts an impressive history of expansion for a tea company but at its peak Starbucks was opening hundreds of stores a month. Teavana is averaging one a week.

The company's immediate challenge is integration of Teaopia's 46 stores, completion of several Canadian stores (the most recent in St. John, New Brunswick) and the opening of 60 new U.S. stores. The latest to open include St. Petersburg, Fla., Houston and San Antonio, Tex.;  Stamford, Conn., Concord, Calif., Hampton, Va. and Salt Lake City, Utah.

Mack lists four priorities for the year ahead, beginning with the integration of Teaopia to reach a goal of 300 stores. Teavana, which franchised 18 stores in Mexico, will also support its first branded operation in the Middle East. Alshaya, the Middle East franchise holder, is responsible for building all Starbucks in the Middle East.

Same-store growth is the coal that fires the furnace. Demand for tea remains brisk which suggests competition may be eroding Teavana’s market share. It might also be an anomaly. Teavana has not offered an explanation for why growth slowed. Comparable store sales, including e-commerce, increased by 8.6% in FY 2010. Comparable store sales, excluding e-commerce, increased by 5.5%

Competition is heating up. Lipton, Tetley, Twinings all have upgraded their grocery offerings.

“There is no shortage of people willing to chase each new food fad with brick & mortar locations at a minimal up-front investment of $120,000 (think smoothies, frozen yogurt, and bubble tea to name a few). And this is ignoring the fact that it is even cheaper for existing brick & mortar retailers to begin emphasizing premium loose leaf tea,” observes Voisin in his Seeking Alpha column.

Teavana’s most important priority is to regain store-level momentum returning sales growth to 5% for comparable retail operations while continuing to increase the contribution from online sales.

In the end, the company will get hit on all sides, from new entrants both online and in physical form, and from existing retailers with their greater marketing budgets and already loyal customers, writes Voisin.

Motley Fool columnist Alyce Lomax is more optimistic, she writes that “the fact that Starbucks is doing something big and trying out a stand-alone Tazo tea shop this fall could ultimately be good news for tea in general, as well as companies like Teavana. Maybe tea time is coming back to America.

“In a way, it's good news that the U.S. isn't completely amped up on tea at the moment. If specialty tea consumption takes off in a big way, the future growth potential for Teavana is huge. However,  that's easier said than done,” writes Lomax who believes “America tends to be pretty obsessed with coffee.”

Acquisition Target

Teavana is one of two tea firms to make Inc. Magazine’s Fastest 500 list last year. Honest Tea, which was acquired in 2011 by Coca-Cola, is the other. At the William Blair Growth Stock Conference in June CEO Mack painted a rosy picture of the expanding tea market. He described his company “as a little bit of Starbucks and a lot of Williams Sonoma, just for tea.”

It is possible Starbucks holds a similar view.

Analyst Drew Handy sees a clue in the Starbucks’ decision to open only one Tazo retail location. He questioned whether opening new locations is prudent when Starbucks, which has $1.5 billion in the bank, can acquire both Teavana and Peet’s Coffee & Tea or any number of smaller operators across the country such as Argo Tea.

The limited expansion may indicate that Starbucks is testing the waters with its Tazo branded location to determine whether to acquire a competing chain, writes Handy on Seeking Alpha.

“I anticipate that Starbucks will determine that the synergies and competitor reduction benefit will be sufficient to motivate them to acquire either Teavana or Peet’s within the next two years,” he concludes.

Sources: Seeking Alpha, The Motley Fool, Teavana Holdings

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