The Paul Singer-led insurgent fund is engaging with the coffee chain, which joined our Watch List of possible activist targets after it cut earnings and revenue forecasts.
By Ronald Orol
July 22, 2024 11:42 AM
Elliott Management Corp. has accumulated a large stake in Starbucks Corp. (SBUX) and is agitating to improve the coffee chain’s stock price, The Deal has confirmed.
Consequently, Starbucks becomes a Direct Hit and comes off The Deal’s Watch List of possible activist targets.
The chain joined the list July 12 after it cut fiscal 2024 earnings and revenue forecasts and reported that store traffic slipped 7% during the quarter ended March 31.
Starbucks shares jumped 6% following a Wall Street Journal report issued Friday, July 19, suggesting that Elliott has been engaging with the company. The chain and activist fund could reach an agreement privately soon, the report added.
Even with the spike, however, Starbucks shares are down 23% and 20% over the past 12 months and five years, respectively. Shares dropped significantly after the chain issued its dismal April 30 quarterly report.
It’s unclear whether Elliott, which declined to comment, may seek to shake up Starbucks’ board. The two sides could be negotiating over directorships.
Board Refreshments
There are several red flags associated with Starbucks’ directors.
No director on Starbucks’ 11-person board has direct coffee industry experience and only one, Richard E. Allison Jr., a former Domino’s Pizza Inc. (DPZ) CEO, has direct experience in quick-service restaurants, according to relationship mapping service BoardEx Inc.
Allison joined the board nearly five years ago, making him a newbie relative to board chair Mellody Hobson, who’s been a director for more than 19 years and could be considered overtenured. Hobson, a rare African American board chairman, has served as chair since 2021, and she has been co-CEO of Ariel Investment LLC, an investment management firm, since 2019.
Starbucks’ board could be vulnerable because it doesn’t contain anyone with multi-unit coffee chain or small-box retail experience, explained John Gordon, principal at Pacific Management Consulting Group.
“That isn’t right,” he said. He added that Allison is a positive board member, as he has QSR experience, including supply chain expertise, which is important.
However, Gordon noted that Domino’s and Starbucks are very different. “Domino’s has a supply chain in it, but they are talking about pizza and dough. Coffee is very different,” he said.
Gordon added that Starbucks should be able to find top-level former executives at other key coffee chains, such as Tim Hortons, Costa Coffee or Luckin Coffee Inc., which competes with Starbucks in China. “From a cultural standpoint, it is essential to have someone from China on the board because Starbucks has major competition from Luckin,” Gordon said, noting that China is Starbucks’ largest market outside the U.S.
In addition, a conflict may be emerging between CEO Laxman Narasimhan, who was installed in the top position in March 2023, and the Starbucks founder he replaced, Howard Schultz. A 1.9% holder, Schultz has held the title of chairman emeritus since September, though he noted recently that he doesn’t receive internal financial information about the chain.
The Starbucks founder has made some comments suggesting he could start agitating. Speaking on a June 3 episode of the podcast Acquired, Schultz said he can’t ignore a situation where the “company is doing a drift towards mediocrity,” and if that occurs, he would “hold leadership and the board accountable.” He added that “the company hasn’t executed the way that I think it should have,” though he added that he has no desire to return as Starbucks’ CEO.
Gordon said it’s essential to get Schultz back on the board. He added that perhaps Starbucks could install Schultz in a nonvoting but participatory capacity “where he could have a lot of influence but not overly dominate the board.”
Elliott hasn’t followed through on a director battle at a U.S. corporation since its 2017 contest at Arconic Inc. As a result, one adviser in the activism category said Elliott is “very aware” that it needs to do another serious campaign to keep its “fear factor.” The director nomination deadline for Starbucks’ annual meeting expected in May is Nov. 13. Even so, a contest at Starbucks would be a major undertaking for Elliott, as the chain has a $90 billion market capitalization.
In addition, Elliott hasn’t filed an activist 13D filing, and it’s likely the activist investor has accumulated a large cash-settled equity swaps position, rather than common shares, to back its campaign.
Nevertheless, it’s possible Elliott could be seeking to partner with Schultz to launch a campaign seeking to install the coffee chain’s founder in a full-time director role. Insiders, other than Schultz’s near 2% stake, hold very few shares and Starbucks’ three largest holders are Vanguard Group Inc., BlackRock Inc. (BLK) and State Street Corp. (STT), with a collective 18% stake.
Activists often push retailers to franchise locations, as a means of raising capital for debt reduction or share buybacks. For Starbucks, however, franchising isn’t seen as a viable solution. “There is no question that it would not pencil out,” Gordon said. “[In the U.S.], you cannot take a Starbucks company store now, which is averaging a 20% contribution margin, and make it work with a 5% royalty — which would essentially be the franchise contribution — coming in.”
Elliott Pivots Towards Operational Activism
It’s likely Elliott has privately launched an operationally focused activism campaign at Starbucks, even though the activist fund often encourages M&A as part of its efforts. Elliott appears to have partly pivoted toward operationally focused activism campaigns, as the M&A market has slowed, Barclays plc global head of shareholder activism Jim Rossman said.
“Look at Elliott Management, a bellwether of where activism is heading. Their campaigns in the first half of 2024 are focused on governance, operational and management changes,” Rossman said.
Paul Singer’s activist fund produced 11 campaigns in the U.S. and globally in the first half of 2024. Three of Elliott’s biggest campaigns of 2024 — at Southwest Airlines Co. (LUV), Texas Instruments Inc. (TXN) and SoftBank Group Corp. — have all steered clear of M&A demands.
In June, Elliott launched a campaign urging Southwest to reconstitute its board and bring in new leadership from outside the airline to address share price performance.
At Texas Instruments, Elliott expressed concern that the chipmaker risks building more semiconductor production capacity than it needs if it continues to press ahead with a capital spending plan it announced in 2022. Also in June, Elliott initiated a campaign at SoftBank urging it to authorize a $15 billion share buyback.
Nevertheless, Elliott has kept M&A as part of its agenda in some situations.
Goodyear Tire & Rubber Co. (GT), for instance, on Monday said it will sell its off-the-road tire business to Yokohama Rubber Co. Ltd. for $905 million. The sale comes after Goodyear in January named a new CEO after it launched a strategic review for some noncore assets including the OTR tire business. Two activist portfolio managers at Elliott greeted the M&A review, launched in November, as a “significant step towards a stronger and more profitable” company.
Starbucks declined to comment.