TABLE OF CONTENTS

INTRODUCTION .......................................................................................................................... 4
HISTORY ....................................................................................................................................... 5
GLOBAL PRESENCE ................................................................................................................... 6
FUTURE GLOBAL EXPANSION PLANS ............................................................................... 9
 INNOVATION TO IMPROVE CUSTOMER EXPERIENCE IN CHINA .................... 9
 TAPPING THE GROWING INDIAN MARKET ........................................................... 9
THE STRATEGIES FOR SUCCESS ............................................................................................. 9
GROWING THE NUMBER OF STORES .................................................................................. 10
ELEVATING THE COFFEE EXPERIENCE .............................................................................. 10
CREATING NEW CUSTOMER OCCASIONS .......................................................................... 11
DRIVING AT HOME COFFEE SHARE & OCCASIONS ......................................................... 11
BUILDING TEAVANA ............................................................................................................... 11
ESTABLISHING NEW PARTNERSHIPS .................................................................................. 11
EXTENDING DIGITAL ENGAGEMENT .............................................................................. 12
A SOCIALLY RESPONSIBLE CORPORATE EMPIRE .................................................... 12
STARBUCKS’ SUPPLY CHAIN STRATEGY .......................................................................... 13

 SOURCING ....................................................................................................................... 13

 MAINTAINING SUPPLIER RELATIONS...................................................................... 14

 STRICT SUPPLIER VETTING ........................................................................................ 14

 MANUFACTURING AND DISTRIBUTION .................................................................. 14

 A CENTRALIZED SYSTEM ........................................................................................... 15

 LEVERAGING DIGITAL TECHNOLOGIES ................................................................. 16

 INNOVATIONS ................................................................................................................ 16

 ZERO WASTE & INEFFICIENCY .................................................................................. 17

 FLOW CHART: SUPPLY CHAIN NETWORK OF STARBUCKS ............................ 17
THE MARKETING STRATEGY ................................................................................................ 18
  FOCUS ON PRODUCT AND PLACE ELEMENTS OF THE MARKETING MIX ...... 18

 CUSTOMER SEGMENTATION AND TARGETING PREMIUM CUSTOMER

SEGMENT ................................................................................................................................ 18

 INTEGRATED APPLICATION OF MULTIPLE MARKETING COMMUNICATION

CHANNELS.............................................................................................................................. 18

 CONSISTENT INCREASE OF THE MARKETING BUDGET TO IMPLEMENT THE

ABOVE MEASURES AND INITIATIVES............................................................................. 18
STARBUCKS STOCK: CAPITAL STRUCTURE ANALYSIS ................................................. 19

 EQUITY CAPITALIZATION........................................................................................... 19

 DEBT CAPITALIZATION ............................................................................................... 20

 STARBUCKS IS EXPANDING BY TAKING ON DEBT .......................................... 20
 STARBUCKS RAISES $500 MILLION WITH ITS FIRST SUSTAINABILITY BOND
21
 ‘SIGNIFICANTLY OVERSUBSCRIBED’ .................................................................. 21

 WHY STARBUCKS ISSUED ITS FIRST 'SUSTAINABILITY' BOND? ...................... 22

 INTEREST AND TAX EXPENSE ................................................................................... 24

 ENTERPRISE VALUE ANALYSIS ................................................................................ 24

DIVIDENT POLICY .................................................................................................................... 25

 STARBUCKS' RECENT DIVIDEND GROWTH............................................................ 25

 WHERE IS STARBUCKS' DIVIDEND HEADED NEXT? ............................................ 26

 VALUATION .................................................................................................................... 27

 STARBUCKS VS MCDONALD ...................................................................................... 28

 VALUATION AND STOCK PERFORMANCE .......................................................... 28
 DIVIDENDS COMPARISON ....................................................................................... 29
 GROWTH PROSPECTS AND RISKS ......................................................................... 29
THE COMPETITION ................................................................................................................... 30

 PRIMARY COMPETITORS ............................................................................................ 30

 STARBUCKS VS DUNKIN DONUTS ............................................................................ 30

  FRANCHISING ............................................................................................................. 31
 FOCUS AND BRANDING ........................................................................................... 31
 QUALITY ...................................................................................................................... 32
 FINANCIALS ................................................................................................................ 32
FINANCIAL MANIPULATIONS ............................................................................................... 34

 WAS THE TAX UNPAID LEGAL OR ILLEGAL? ........................................................ 34

 STARBUCKS EMEA OVERVIEW ................................................................................. 34

 THE CLAIM BY UK UNCUT .......................................................................................... 35

 STARBUCKS RESPONSES ............................................................................................. 36

 BACKGROUND OF THE CASE ..................................................................................... 39

 THE CONTESTED MEASURE ....................................................................................... 39

 The SMBV APA ................................................................................................................ 40

 ROYALTY FEE ISSUE................................................................................................. 42
 PRICING OF GREEN COFFEE BEANS BY SCTC .................................................... 46
 LOSS GENERATED AT SMBV .................................................................................. 47
INTRODUCTION
Starbucks is a well-known chain of coffee stores founded in Seattle in 1971. Along with coffee,
Starbucks sells hot and cold drinks which can be made to custom order, such as the trademarked
Frappuccino drinks with different flavors and syrups. Starbucks brands itself as a very hip and
very modern coffee store. It is very brand-conscious, with a social media presence that spans the
web.

Starbucks locations serve hot and cold drinks, whole-bean coffee, microground instant coffee
known as VIA, espresso, caffe latte, full- and loose-leaf teas including Teavana tea
products, Evolution Fresh juices, Frappuccino beverages, La Boulange pastries, and snacks
including items such as chips and crackers; some offerings (including their annual fall launch of
the Pumpkin Spice Latte) are seasonal or specific to the locality of the store. Many stores sell pre-
packaged food items, hot and cold sandwiches, and drinkware including mugs and tumblers; select
"Starbucks Evenings" locations offer beer, wine, and appetizers. Starbucks-brand coffee, ice
cream, and bottled cold coffee drinks are also sold at grocery stores.
HISTORY
The first Starbucks opened in Seattle’s Pike Place Market, Washington, on March 31, 1971, by
three partners who met while they were students at the University of San Francisco:

 Jerry Baldwin – The English Teacher

 Zev Siegl – The History Teacher
 Gordon Bowker – The Writer

BALDWIN – BOWKER – SIEGL

They were inspired to sell high-quality coffee beans and equipment by coffee roasting entrepreneur
Alfred Peet after he taught them his style of roasting beans. The company grew to be the largest
roaster in Washington with multiple locations until the early 1980’s.

In 1982, Howard Schultz joins Starbucks as director of retail operations and marketing.
Starbucks begins providing coffee to fine restaurants and espresso bars.

In 1983, Schultz travels to Italy, where he’s impressed with the popularity of espresso bars in
Milan. He sees the potential to develop a similar coffeehouse culture in Seattle.

In 1984, Schultz convinces the founders of Starbucks to test the coffeehouse concept in downtown
Seattle, where the first Starbucks Caffè Latte is served. This successful experiment is the genesis
for a new company Il Giornale that Schultz founds in 1985. It was offering brewed coffee and
espresso beverages made from Starbucks® coffee beans.
In 1987, the original owners sold the Starbucks chain to their former manager Howard Schultz,
who rebranded his ‘Il Giornale’ coffee outlets as Starbucks and quickly began to expand. He
continues to serve Starbucks as a CEO till 2016.

On December 1, 2016, Howard Schultz announced he would resign as CEO effective in April
2017 and will be replaced by Kevin Johnson. Johnson assumed the role of CEO on April 3, 2017.

Howard Schultz

GLOBAL PRESENCE
Today Starbucks is the largest coffeehouse company in the world, with 24395 retail locations as
of the first quarter of 2016, followed distantly by such coffee shop chains as Dunkin Donuts with
about 10,000 restaurants, Tim Horton’s with 4,300 outlets with 4,300 outlets, and Costa Coffee
with nearly 1,700 stores worldwide. Based on the company’s positive sustained operating results,
it is ranked among Forbes’ top-500 world’s biggest public companies.
 NUMBER OF STARBUCKS STORES WORLDWIDE FROM 2003 TO 2016

While Starbucks initially focused on the domestic US market, in 1996 the company opened its first
stores outside the US. Since then, Starbucks’ international footprint has expanded to 11,266 stores
in the three main markets: America which includes Canada, Latin America and US; China and
Asia Pacific (CAP); and Middle East and Africa (EMEA). The domestic market still represents
more than half of all Starbucks stores; California with 1,836 locations, has more stores than any
other state.
 STARBUCKS PRESENCE IN THE AMERCAS, CAP AND EMEA COUNTRIES

TOP -15 COUNTRIES BY NO. OF LICENSED STORES

Starbucks operates two types of stores: company-operated and licensed. Currently, the store count
is almost equally distributed between these two types – 51 percent of stores are company operated
and the other 49 percent are licensed – even under continuous expansion. During the third quarter
of 2016, Starbucks launched 474 new stores, including the first stores in Andorra and Slovakia.
The company’s growth is bolstered by low turnover of its stores. Only 443 Starbucks stores have
closed throughout the company’s history: 240 stores in 2009, the year of global financial crisis; 42
in 2010; and 161 in 2011.
FUTURE GLOBAL EXPANSION PLANS

With a goal to open 500 new stores in China in 2016-17, bringing its specialty tea brand Teavana
to India, and entering the China ecommerce market, Starbucks Corporation seems to have a
strategy in place to expand its international operations.

 INNOVATION TO IMPROVE CUSTOMER EXPERIENCE IN CHINA

Since its launch in China, Starbucks SBUX +1.79% has ensured that it adapts itself to the local
environment and this strategy has been instrumental to its growth in the region. The company
continues to do so as part of its ambitious expansion plans in China. Given the popularity of digital
technology and ecommerce in China, the company plans to build locally relevant Starbucks 4th-
place Experience that seamlessly blends its store experience with the digital space. It aims to
capture a higher market share in the region and the company appears to be on target to reach 3,400
stores in China by 2019.

 TAPPING THE GROWING INDIAN MARKET

As the Indian economy witnessing high single digit growth, Starbucks sees a huge opportunity in
the growing middle class with higher disposable income in the country. While the company faces
intense competition in India from coffee chains such as Café Coffee Day, which had nearly 1,500
stores in December 2014, the overall café market in India is valued at $1.1 billion of which the
chain café market is worth nearly $300 million. Although it operates only 75 stores in India in
partnership with a local player, Tata Global Beverages, Starbucks believes that India is its fastest
growing market.

THE STRATEGIES FOR SUCCESS

A cup of coffee; that’s all it is, or is it? One company has taken a simple product and turned it into
a lifestyle. People no longer only drink coffee in the mornings to get the caffeine they need for
the day, but drink coffee at all times of the day just for the fun of it. Coffee is now an enjoyable
experience that anyone can have at any time of the day. Why the drastic change? One word:
Starbucks.
As such, the Seattle-based coffeehouse chain is arguably the most prominent of its kind. Yet,
within the context of coffee connoisseurship, or for that matter, mass beverage consumption,
Starbucks has received its fair share of criticism.
Coffee enthusiasts, from renowned chef Wolfgang Puck to aspiring baristas, have labelled
Starbucks’ beverages as deceivingly mediocre. The caffeine empire has also been criticized
for cultural commodification and appropriation, global corporate megalomania, and unethical
sourcing methods.
Nevertheless, such incidents have failed to reduce the phenomenal appeal of Starbucks. The
emerald mermaid remains beloved by millions, and is deservedly credited, by both its fans and
detractors, with revolutionizing the modern cafe experience.
Unsurprisingly, Starbucks sustains its popularity through shrewd and unconventional marketing
strategies. Here, we take a look at some of these successful strategies.

GROWING THE NUMBER OF STORES

Not only is Starbucks concentrating on expanding its footprint, but also changing its store mix.
Instead of opening more dine-in restaurants, the coffee giant is concentrating on drive-thrus in the
outer edges of urban and suburban areas. In addition, Starbucks is opening up express stores which
essentially function as walk-thrus in New York, Boston, and Seattle. This strategy is aimed at
increasing the company’s store penetration. However, a force that may counter the incremental
growth from the new store openings is cannibalization. That said, Starbucks remains confident that
it will see a minimum 5% comparable sales growth in the U.S.

ELEVATING THE COFFEE EXPERIENCE

With the coffee market set to grow multi-fold in the next few years, the company is pulling all
stops to position itself as the most preferred coffee shop. The following picture gives a glimpse of
Starbucks’ expanded store portfolio, offering highly customized and elevated experiences.
CREATING NEW CUSTOMER OCCASIONS

Lunch hours, for the company, have been the fastest growing day part for a number of years now.
This was driven by improved food offering, more fresh food items around bistro boxes and
sandwiches, and strength in its tea platform. Furthermore, Starbucks is launching nitro cold brew
in 500 stores by the end of December. All of this is aimed at enticing a greater number of customers
to its stores, by offering new and innovative food and beverage options.

DRIVING AT HOME COFFEE SHARE & OCCASIONS

Driving the demand for at-home coffee entails growing the consumer product goods department.
CPG mainly consists of packaged coffee and K-Cups. Starbucks is the leader in K-Cups, even
though the industry has slowed down significantly from its peak.

BUILDING TEAVANA

Teavana, since its launch, has become one of the biggest growth drivers for the company. It has
contributed one percentage point in comparable sales growth for seven consecutive quarters. Its
successful launch has led to Starbucks rolling out Teavana in China and Europe.

ESTABLISHING NEW PARTNERSHIPS

Food sales now represent 20% of Starbucks’ revenue and has been consistently contributing almost
a percentage point to comps. Further, the company has found that each day part is far below its
saturation level in terms of food offerings. To fully leverage off the gaining popularity of its
complementary coffee and food menu, the company is working towards establishing partnerships
and making food one of its major future growth drivers.
 EXTENDING DIGITAL ENGAGEMENT

Mobile payments comprise of one-fourth of all transactions in the U.S. for Starbucks. The
company’s latest endeavor at driving digital engagement, Mobile Go and Pay, is at 20% of all
mobile transactions. The initiative, which is only one year old, is Starbucks’ path towards
promoting a truly seamless, digital experience.

A SOCIALLY RESPONSIBLE CORPORATE EMPIRE

It is a well-documented fact that businesses with social causes tend to garner greater brand loyalty
and financial gains. A 2013 marketing study revealed that 90% of Americans were likely to trust
socially responsible companies, and advocate for them. In terms of social advocacy, Starbucks has
certainly made its mark at both local and global levels. For example, Starbucks has a history of
supporting LGBT rights, from rebuking its homophobic investors to turning its stores into LGBT
safe spaces. In addition to LGBT issues, Starbucks has championed refugee welfare and rights. In
2015, it launched a humanitarian donation drive for Syrian refugees and migrants. In 2017, the
company announced that it would hire 10,000 refugees in all the countries it does business with
by the year 2022, much to the chagrin of President Trump’s offended followers. This policy would
join another similar Starbucks initiative: the recruitment of 10,000 military veterans by the year
2018.

As expected, Starbucks’ social advocacy has triggered some backlash. At the same time however,
the coffee chain’s hiring campaigns have largely been praised across social media.
STARBUCKS’ SUPPLY CHAIN STRATEGY
Did you ever wonder what journey coffee goes through before ending up in your cup? Well, getting
the coffee from Latin America or Africa surely can’t be an easy task. But imagine adding on top
of this – 22,000 retail stores across 6 continents that must be supplied with various coffee blends
at all times to satisfy your coffee needs every morning. Yes, Starbucks can make it all happen.
The scale and efficiency of Starbucks supply chain is impressive. Consider this – they process
70,000 deliveries a week, supplying their 22,000 retail stores across 65 countries. What is even
more impressive is that Starbucks controls every function of their upstream logistics starting from
coffee plantations, to coffee processing and manufacturing, and finally delivering. They are
involved in every single step and process from growing coffee to serving coffee to their clients.
This even includes manufacturing of their cups and paper. So how do they achieve these impressive
results? No matter the country, at Starbucks you always get the same coffee experience and fast.
Let’s break down their supply-chain and the design of their distribution network.

SOURCING
The magic starts right from the source of Starbucks – their coffee beans. Starbucks sources their
coffee beans directly from the farmers, without any intermediaries in between. Their premium
coffee is sourced from 8 coffee plantations around the world including Brazil, Columbia,
Guatemala, Mexico, Hawaii, Tanzania, Kenya and Saudi Arabia. Starbucks tries to be quiet
selective of it’s suppliers, and follow Coffee Sourcing Guidelines (CSG) as set of standards to
select their suppliers. Only if the suppliers meets these requirements, will Starbucks source coffee
beans from these plantations.

MAINTAINING SUPPLIER RELATIONS

Starbucks continuously works with their suppliers to ensure every coffee bean meets required
standards. Since their plantation are located in developing countries, their strategy must be
innovative and make local people feel they are making a difference (Prahalad, 2005). In 2004,
Starbucks introduces Coffee and Farmer Equity (CAFE) sustainability standards and even provide
farmers with special training programs to ensure high-quality coffee beans (Hoban, 2016).
Starbucks even went beyond this dedication to coffee bean production. In 2013 Starbucks acquired
a coffee plantation in Costa Rica. This move gives them a competitive edge over competitors but
also reduces risk of coffee supply shortage. Research anticipates coffee deficit, with 3.5 million
coffee bean bags shortage in the coming year. Owing their own supply point of coffee, Starbucks
is secured against possible coffee deficit (Hoban, 2016).
With the majority of its suppliers in isolated, rural locations, this approach to Supplier Relationship
Management also enables Starbucks to make its suppliers feel like an integral part of its operations.
This SRM strategy also allows for better collaboration and communication with its suppliers,
which is critical given many suppliers’ isolated positioning.

STRICT SUPPLIER VETTING

Starbucks has strict supplier-vetting guidelines in place to ensure that every supplier is in line with
the company’s sustainable, green and efficient approach to business operations.
The company’s Coffee Sourcing Guidelines (CSG) sets standards for its coffee-producing
suppliers, and only when these strict guidelines are met will a producer be approved as a supplier.
And only when these guidelines are met will a formal buyer-vendor relationship be formed.
In addition, suppliers must meet Starbucks’s social responsibility standards which, like its CSG
policy, are highly detailed. For example, the company states a Zero Tolerance policy regarding
working with suppliers who employ anyone under the age of 14.
The combination of these strict supplier vetting and social responsibility guidelines allow
Starbucks to ensure a “green and sustainable supply chain” according to USFCA.
MANUFACTURING AND DISTRIBUTION
When it comes to processing and manufacturing of coffee Starbucks developed a highly
centralized system that enables them to streamline logistic operations across 6 continents. They
currently have 6 Central Distribution Centers where their coffee is roasted, prepared and packaged
(Boyer, 2013). Their manufacturing process follows strict procedures to ensure it delivers high-
quality coffee blends to their consumers. These are then transported to their large, regional or small
warehouses from where they get delivered to the final retail stores.

Starbucks’ delivery process is even more demanding. Coffee beans travel from plantations all way
to their DC centers and then to their retail stores worldwide. Starbucks must process 70,000 global
deliveries every week ensuring adequate amount of coffee is timely delivered to each of their retail
points across 69 countries! Of course, they didn’t achieve such efficiency right from the start. Back
in 2008, Starbucks transportation expenses were fast increasing as their supply chain and logistic
system was not able to keep up with their global growth (Cooke, 2016).

In United States alone transportation related expenses increased almost by 75 million. They went
through large scale reorganization, where every transport carrier was analyzed and their
performance assessed. This way they cut out many of their logistic carriers, leaving only their best
and most efficient partners.
The latest news is that Starbucks is buying coffee beans from Yunnan province in China, to supply
their retail stores located across the country. They really try to discover new ways to optimize the
logistic processes and shorten distance between plantations and distribution points. It is also a
strategy to build coffee trend in China, who is more known for it’s tea traditions and culture.

A CENTRALIZED SYSTEM
Starbucks uses one centralized system to manage its supply chain and logistics network across six
continents. By doing so, Starbucks is able to operate and manage multiple global distribution
centers centrally with complete control: five in the United States, two in Europe and two in Asia.
Starbucks also uses one, simple “scorecard system” to evaluate its supply chain efficiency. The
four high-level categories Starbucks assesses are:

 Safety in operations
 On-time delivery and order fill rates
 Total end-to-end supply chain costs
 Enterprise savings

LEVERAGING DIGITAL TECHNOLOGIES

Starbucks makes use of digital technology to ensure its supply chain is efficient and can cope with
the growing demand for high-quality coffee globally. Using an automated information system, the
company is able to monitor this demand in real-time.
By doing so, production and distribution plans & schedules can be developed and modified as and
when needed, giving Starbucks’s supply chain added flexibility and allowing the company to
address peaks in demand with agility.
Through digital technologies, Starbucks also has on-demand access to constantly-updated
information on things like stock inventory, transport scheduling and storage capacity, allowing the
company’s supply chain to operate at maximum efficiency at all times.
According to Computer Weekly, Starbucks has also been leveraging cloud technology like
Enterprise Resource Planning (ERP) systems for “a long time”.

INNOVATIONS
Faced with a decline in production of its main coffee blend due to a fungus, Starbucks decided to
address the serious threat to its supply chain by purchasing a farm in Costa Rica.
Although the farm will initially be used for research to learn more about this dangerous fungus,
the company has visions to create its own coffee blends, which could result in full-scale coffee
production in the future.
This move could end up being a huge coup for Starbucks, as it would allow the company to gain
a massive advantage over its competitors, by having greater control over its ability to meet
increased demand as the industry itself faces a decline in global production.
Just this week, The Telegraph reported how a “coffee crisis” could hit Europe in the next 3-5 years,
as consumer thirst for high-quality coffee continues its unprecedented upwards trajectory.
Such is the demand for high-quality coffee that the industry is at serious risk of a supply shortage.
This risk is already becoming something of a reality, with an anticipated deficit of 3.5 million bags
of coffee beans for the current production year.
Such is Starbucks’s commitment to innovation that as much as one fifth of its annual income is
spent on innovative strategies.

ZERO WASTE & INEFFICIENCY

Starbucks’s efficient and sustainable operations go far beyond its supply chain. blur CEO Philip
Letts highlighted in an article last year how Starbucks’s UK arm is the embodiment of a Size Zero
Enterprise.
After 17 loss-making years, Starbucks UK reported a profit of £1.05 million ($1.54 million) in
2014. For a global enterprise operating in 50 countries, this profit may seem nominal. But when
you consider that Starbucks UK’s previous year’s (2013) results reported a loss of £20 million
($29.2 million), the feat appears all the more impressive.

 FLOW CHART: SUPPLY CHAIN NETWORK OF STARBUCKS

THE MARKETING STRATEGY

Starbucks marketing strategy is based on the following principles:

FOCUS ON PRODUCT AND PLACE ELEMENTS OF

THE MARKETING MIX
Marketing mix comprises 7 elements – product, place, price, promotion, process, people and
physical evidence. Businesses choose to concentrate on one or two elements as their sources of
competitive advantage according to their business strategy. Accordingly, Starbucks marketing mix
focuses on product element through offering foods and beverages of high quality and providing
respective level of service. Place element of the marketing mix represents an additional source of
Starbucks competitive advantage in a way that stores are usually located at high-traffic, high-
visibility locations.

CUSTOMER SEGMENTATION AND TARGETING

PREMIUM CUSTOMER SEGMENT
The world’s largest coffee retailer targets males and females from middle and upper class who can
afford expensive prices of Starbuck products for regular consumption. The company uses mono-
segment, adaptive and standby product positioning techniques in order to appeal to the needs and
wants of the target customer segment.

INTEGRATED APPLICATION OF MULTIPLE

MARKETING COMMUNICATION CHANNELS
Starbucks marketing communications mix utilizes a number of marketing communications
channels such as print and media advertising, sales promotions, events and experiences, public
relations and direct marketing in an integrated manner to communicate the marketing message to
the target customer segment.

CONSISTENT INCREASE OF THE MARKETING

BUDGET TO IMPLEMENT THE ABOVE
MEASURES AND INITIATIVES
Starbucks has been consistently increasing its marketing budget for a number of years. Starbucks
marketing expenses totalled USD378.7 million, USD351.5 million and USD315.5 million in fiscal
2016, 2015, and 2014, respectively. These include advertising expenses which totalled USD248.6
million, USD227.9 million and USD198.9 million in fiscal 2016, 2015, and 2014, respectively.[1]

STARBUCKS STOCK: CAPITAL

STRUCTURE ANALYSIS
Starbucks Corporation (NASDAQ: SBUX) was launched as a single store offering coffee beans
and coffeemakers in 1971. Howard Schultz joined the company in 1982 and expanded distribution
to include restaurants, coffee bars and various retail outlets. Schultz left Starbucks in 1985 after
failing to persuade owners to serve coffee and related beverages rather than supplies. He formed a
chain of coffee bars called Il Giornale throughout Seattle. In 1987, Schultz purchased Starbucks
and renamed all of his locations under the Starbucks banner. The company popularized the
specialty coffee genre. It expanded into licensing, distribution and product brands, including
Teavana, Tazo, Ethos, Frappuccino and La Boulange. Starbucks has grown into a global brand
operating in over 23,900 stores throughout more than over 65 countries worldwide, and generated
full-year 2015 annual revenues of $19.70 billion. The following is an analysis of the capital
structure for Starbucks Corporation for the year-over-year (YOY) period from December 2014 to
December 2015.

EQUITY CAPITALIZATION
Starbucks had 1.51 billion fully diluted shares outstanding, with a market cap of $61.88 billion on
Dec. 31, 2014. The company implemented a two-for-one stock split for shareholders on record as
of March 30, 2015. The shares began trading split-adjusted on April 9, 2015. This caused the
market cap to spike to $143.77 billion at the end of the first quarter. The diluted share count
representing stock compensation nearly doubled from 11.3 million to 22 million shares at the end
of the second quarter. The total equity market cap fell to $82.67 billion.
Third-quarter diluted shares reached 30.5 million, representing $1.76 billion in stock
compensation, at the end of September 2015. This raised the total equity market cap to $87.88
billion. The fourth-quarter diluted share count dropped to 9.4 million valued at $567 million by
the end of December 2015, closing out the year with 1.49 billion total fully diluted
shares outstanding valued at a $90.17 market cap, for a 45.7% YOY rise. Shares of Starbucks
gained 47.98% for full-year 2015 compared to 1.38% for the Standard and Poor's (S&P 500) Index
performance.
 DEBT CAPITALIZATION
The company debt load increased by net $299.2 million to a total of $2.34 billion at the end of
2015, which was up 14.2% YOY. In the third quarter, Starbucks issued $850 million in additional
long-term debt, which was composed of $350 million in 30-year 4.300% senior notes due June
2045 and $500 million in seven-year 2.700% senior notes due June 2022. It used the proceeds to
redeem $550 million of the 6.250% senior notes due August 2017. This transaction essentially
transferred the $549.8 million short-term debt into long-term debt, as cited on the consolidated
balance sheets. At year-end 2015, Starbucks had $2.34 billion in total debt divided by $12.44
billion in total assets for a debt-to-equity ratio of 18.7%. Considering the industry average is near
40%, Starbucks is an extremely well-managed cash flow machine with access to cheap rates due
to the solid stability of its balance sheet.

 STARBUCKS IS EXPANDING BY TAKING ON DEBT

In the last part of this series, we saw that Starbucks (SBUX) is aggressively growing its units.
Now, we’ll look at how SBUX is funding its unit growth. Starbucks sources its capital
requirements for new restaurant construction. SBUX sources its cash and investment balance as
well as cash flows from operations and debts.
In the above chart, we can see that SBUX’s net income and net profit margins have been on an
uptrend since 2010. At the end of fiscal year 2014, SBUX’s adjusted net income was $2.05
billion—compared to $1.7 billion in 2013. The net profit margin also increased to 12.4% in 2014—
from 11.2% in 2013.
Keep in mind that this is the adjusted net income. It doesn’t include the one-time litigation charge.
The charge was related to the settlement with Kraft Foods. We discussed this in the last part of this
series.
Dunkin’ Brands (DNKN) had a net profit margin of 20.5%. McDonald’s (MCD) had a net profit
margin of 19.8%. Tim Hortons (THI) had a net profit margin of 13%.
Some of the restaurants mentioned above are also included in the SPDR S&P 500 ETF (SPY).

 STARBUCKS RAISES $500 MILLION WITH ITS FIRST

SUSTAINABILITY BOND
Starbucks Corp. is turning to the bond market to fund its sustainable-coffee efforts.
The Seattle-based chain has issued a first-of-its-kind $500 million U.S. corporate sustainability
bond, according to a statement Monday. The 10-year, 2.45 percent senior notes will fund programs
that ensure coffee is grown and distributed in a way that can be maintained over the long run, such
as providing fair pay for workers and protection for wildlife. Out of the 551 million pounds of
coffee Starbucks purchased last year, 99 percent met its ethical sourcing standards, the company
said.
“It’s really the only way we source coffee and we thought financing that supported and encouraged
that core practice of ours would be helpful,” Scott Maw, chief financial officer of Starbucks, said
in an interview.
Sustainability bonds are used to fund projects with a social impact, but they differ from the more
prevalent “green bonds,” which fund environmental projects. Since 2012, 21 bonds have been
issued globally to fund social projects. They’ve raised $4.6 billion, including the new Starbucks
bonds, according to data tracked by Bloomberg. Most of the issuers in the past have been
development banks and financial services firms, rather than corporations.

 ‘SIGNIFICANTLY OVERSUBSCRIBED’
Starbucks had initially looked into issuing a green bond to support some of its environmental and
eco-friendly retailing projects. But in the process of speaking with banks, the company learned
about the option to issue a sustainability bond, Maw said. The sustainability bond issue was
“significantly oversubscribed” and attracted interest from a diverse group of socially focused
investors outside its normal investor base, Maw said.
In addition to financing coffee purchases, the bond will support a $50 million loan program that
helps farmers rotate their crops and fund a network of eight farmer-support centers for suppliers
in Rwanda, Tanzania, Colombia, China, Costa Rica and other countries. Proceeds also will go
toward maintaining crop stability and sustainable-farming practices.
In addition, bond proceeds could support the company’s efforts to develop coffee plants resistant
to drought and a fungus that causes coffee leaf rust, Maw said. Coffee prices, which fell 24 percent
last year, have been among the most volatile commodities this year. Dry weather across coffee-
producing regions has tightened supply, and the U.S. Department of Agriculture is forecasting
record demand this year. Starbucks, which uses a set of standards called “CAFE” -- short for coffee
and farmer equity -- pays a premium to futures-market prices for coffee.
Starbucks will publish annual updates on the use of the sustainability bonds’ proceeds until they
have been fully allocated to projects. The company’s coffee standards include 140 different
requirements for sustainable sourcing, Maw said. Conservation International then verifies that its
coffee has been grown and delivered sustainably, he said.
Sustainable sourcing is “inseparable from what we do,” Maw said.

WHY STARBUCKS ISSUED ITS FIRST

'SUSTAINABILITY' BOND?
Starbucks is using its sustainability bond proceeds to train farmers in places such as Costa
Rica and Mexico how to grow coffee more sustainably.

Slowly but surely, U.S. companies are waking up to the notion that bonds can be a useful financing
mechanism for all manner of corporate sustainability projects.
In February, Apple shook up the market with a $1.5 billion green bond issue — the largest
undertaken by any U.S. tech company — that will pay for a range of environmental initiatives.
More recently, Starbucks issued $500 million in debt that will be used for several purposes,
including underwriting programs for farmers that adhere to the Coffee and Farmer Equity
(C.A.F.E.) Practices, a set of guidelines Starbucks adopted roughly 15 years ago for growing and
harvesting crops more sustainably.
In disclosing the offering, Starbucks CFO Scott Maw declared, "Issuing a bond focused on
sustainable sourcing demonstrates that sustainability is not just an add-on, but an integral part of
Starbucks including our strategy and finances."
Aside from the size of the offerings, there’s one big difference between them — the sorts of
programs that will benefit from the money raised.
Apple is using its proceeds to fund solar and wind projects, energy storage installations, energy
efficiency upgrades, water conservation measures, 'greener materials' research and recycling
initiatives.
Apple’s debt falls under the category of green bonds, generally used to fund projects specifically
meant to mitigate the negative effects of climate change. Some forecasts suggest that up to $1
trillion will be issued annually by 2020. Apple is using its proceeds to fund solar and wind projects,
energy storage installations, energy efficiency upgrades, water conservation measures, "greener
materials" research and recycling initiatives.
Starbucks has earmarked the money from its bond issue for projects that fall under the broader
umbrella of corporate social responsibility (CSR) and sustainable agriculture initiatives,
particularly those focused on ethical sourcing of coffee, said Drew Wolff, the vice president and
treasurer of Starbucks responsible for arranging for the new debt.
The Starbucks’ senior notes offering was "significantly oversubscribed" and took about a month
to pull together, he said. "We talked to a whole new set of investors that we didn’t know and hadn’t
talked to before."
The bonds will finance resources at the company’s network of eight farmer support centers in
Rwanda, Tanzania, Colombia, China, Costa Rica, Indonesia, Guatemala and Ethiopia, where
communities are trained in sustainable crop growing and harvesting practices.
Starbucks also supports a $50 million fund for short-term and long-term loans, and it also owns a
farm in Costa Rica. Among other things, it’s supporting a program to replace trees affected with
the coffee rust fungus. "A little bit of money goes a long way in this program," Wolff said.
Improving the efficiency and effectiveness of coffee farming practices helps to strengthen the
overall sustainability of the coffee supply chain while advancing the socioeconomic conditions of
coffee farmers.
As of last year, the company said almost all of the 551 million pounds of coffee it purchased were
"ethically" sourced according to the C.A.F.E. practices.
The bond proceeds also may be used to support some of Starbucks’ green retail initiatives,
including certifications under the Leadership in Energy and Environmental Design (LEED)
process, as well as CSR efforts such as training and placements for veterans and disadvantaged
youth, Wolff said.
The Starbucks bonds were rated by consulting firm Sustainalytics, which also reviewed Apple’s
bonds.
"Improving the efficiency and effectiveness of coffee farming practices helps to strengthen the
overall sustainability of the coffee supply chain while advancing the socioeconomic conditions of
coffee farmers," said Simon McMahon, executive president of advisory services for Sustainalytics,
in a statement.
More people in this country are realizing that they can steer their investment dollars the same way
that consumers can steer their purchases.
Wolff said he expects to know very quickly whether there will be an appetite for future Starbucks
corporate sustainability or green bonds, an instrument he thinks will become more commonplace
over the next several years. "More people in this country are realizing that they can steer their
investment dollars the same way that consumers can steer their purchases," he said. "Over time,
you should get better pricing for instruments like these."
Other U.S companies using green bonds include data center developers and operator Digital Realty
Trust, which raised about $493 million from an issue back in June 2015. It allocated the money to
supporting nine projects that have earned green building certifications. The rating systems that
Digital Realty supports include LEED, the Building Research Establishment Environmental
Assessment Methodology (BREEAM) and the Certified Energy Efficient Datacenter Award.
About $118 billion "labelled" green bonds are outstanding, according to data released in early July
by the Climate Bonds Initiative. The larger universe of bonds related to financing low-carbon or
carbon-resilient infrastructure projects is valued at close to $694 billion, the organization
estimated. The country supporting the most "climate-aligned" bonds is China, followed by the
United States, the United Kingdom and France.
"The growth in size and depth of both the climate aligned and labelled green bonds is a positive
for potential investors looking to lift their green exposure post the COP21 at Paris," said Zoe
Knight, managing director of the Climate Change Center of Excellence for financial services giant
HSBC, commenting on the data. "It’s a sign of the scale and liquidity in the market and
demonstrates the potential for future green investment."

INTEREST AND TAX EXPENSE

Interest expense increased to $64 million in 2014—from $28 million in 2013. This was a result of
an increase in long-term debts to $2.04 billion in 2014—from $1.3 billion in 2013. This debt will
be used to expand stores. It will also be used for other expenses.
In 2008, SBUX started reducing its capital expenditure due to a slowdown in the US economy. As
the economy gets better, the company is starting to expand. As a result, more capital is required.
In 2014, SBUX’s effective tax rate was 34%.

ENTERPRISE VALUE ANALYSIS

Starbucks started 2015 with $61.57 billion in enterprise value (EV). The company completed the
acquisition of the remaining 60.5% interest in Starbucks Japan in July 2015. For full-year 2015,
Starbucks saw global comparable same-store sales grow 7% YOY on a 3% YOY increase in store
traffic. Full-year revenues climbed 17% YOY to $19.2 billion, with GAAP operating profits
growing 17% YOY to $3.6 billion. Full-year earnings grew 35% YOY to $1.82 per share. The
company also bought back 29 million shares in 2015. Starbucks paid out a 20-cent period share
dividend on Nov. 27, 2015. These are all components that contributed to the 47.8% annual
performance return on shares. This resulted in a year-end 2015 EV of $90.56 billion, which was
up 47% from 2014.
DIVIDENT POLICY

STARBUCKS' RECENT DIVIDEND GROWTH

Starbucks began paying dividends in 2010 and has increased its payout every year since. Until that
time, Starbucks had retained all the earnings for its substantial global expansion. Starbucks had
declared their first dividend of $0.05 per share in Apr 2010. They most recent dividend the
Starbucks has declared is $0.25 per share recently, in Feb 2017. The trend of dividend paid out by
Starbucks is illustrated in the below charts:

Two things in particular stand out about the charts above. First, if you purchased Starbucks stock
on April 7, 2010, the record date for its first dividend payout, your dividend yield based on what
you paid that day would now be 6.4% -- much better than most dividend stocks offer today.
The second is that Starbucks' earnings have risen in tandem with its dividend increases. The gains
over the last six years are almost identical. That means that the company's dividend hikes are
funded by growing profits and not by debt or cash on hand. If Starbucks' profits continue to grow
at the same pace, its dividend can follow suit endlessly. Also of note is that the company's payout
ratio, or the percentage of profits devoted to dividends, is still under 50% -- much less than the
typical dividend stock, which might spend around 80% of profits on dividends. That means
Starbucks has room to hike its dividend even if profit growth slows.

During the past five years, the coffee giant has increased its dividend at an average annualized rate
of 24.9%. And this dividend growth hasn't slowed recently. Over the last three years, Starbucks’
dividend has grown by 23.6% per year.

Source: Simply Safe Dividends

WHERE IS STARBUCKS' DIVIDEND HEADED

NEXT?
Starbucks' strong dividend growth during this period has been enabled by the company's equally
impressive earnings-per-share growth. During the past five years, Starbucks' EPS has increased at
an impressive average rate of 18.6%, even as Starbucks' capital spending during this period
increased at about 22% annually. Further, like its recent dividend hike, the company's EPS growth
remains high today. In the company's most recent quarter, EPS increased 26% year over year.
Starbucks can continue growing its dividend at a rapid pace going forward, but a dividend growth
rate closer to 13-17% seems more likely. The company is still in investment mode, and
management likely wants to keep the payout ratio not much higher than 40%, which is about where
it sits today.
Therefore, future dividend growth will be driven by underlying earnings growth, which is expected
to average about 15% annually over the next few years.
Given the company’s opportunities for expansion in international markets, continued share
repurchases, expanding free cash flow margins (due to scale and technology advancements), and
management’s long-term guidance below, the growth forecast doesn’t seem unreasonable.
 Source: Starbucks Investor Presentation

Looking forward, there's good reason to expect Starbucks' dividend to continue increasing at rapid
rates.
Perhaps the most notable reason to expect robust dividend growth in the coming years is the
company's low payout ratio, or dividend payments as a percentage of earnings. Currently,
Starbucks' payout ratio is just 42%. In other words, only 42% of Starbucks annual earnings is
currently going toward dividend payments. This leaves plenty of room for dividend increases in
the future.
Starbucks' room for dividend growth is just as evident by looking at the company's dividends paid
in the trailing 12 months compared with its free cash flow, or cash from operations less capital
expenditures, during this same period. Of Starbucks' $3.1 billion in free cash flow, the coffee
retailer paid out just $1.2 billion in dividends.
But more than Starbucks' current financial situation makes a case for expected dividend growth.
Investors should also note management's forecast for earnings growth over the next five years. In
the company's recently updated five-year plan, management said it expected EPS to increase
between 15% and 20% annually during the next five years. And analysts seem to -- almost -- agree;
the consensus estimate for Starbucks' average annualized growth during this period is 15.7%, or
the low end of Starbucks' guidance range.
Combing Starbucks' impressive dividend performance during the past five years with good reasons
for this growth to continue, it would arguably be conservative to forecast Starbucks' dividend to
increase at an average rate of about 20% during the next five years. Highlighting just how much
of a difference dividend growth can make over time, such a heady growth rate would essentially
double Starbucks' dividend in less than four years.
So Starbucks' 1.8% dividend yield may be unimpressive today. But income investors who buy
today and hold for the long haul will probably see their annual dividend payments from Starbucks
increase at rapid rates.

VALUATION
Despite falling 12% over the past year, from just looking at the forward P/E ratio (28x) or dividend
yield (1.5%), you might not think that Starbucks looks undervalued.
After all, the current share price still represents a substantially higher valuation metric than the
market’s P/E, and even accounting for the company’s excellent long-term growth investors can be
forgiven for thinking that Starbucks is trading at lofty levels.
However, there are two things to consider. First, Starbucks has historically traded at a high
premium due to the strength of its brand, the quality of its management, and its long growth
runway. In fact, the stock’s average P/E over the past 20 years has been over 40, implying that
today’s valuation might not be as high as it seems.
As we’ve seen, Starbucks’ growth runway is still very long and, equally importantly for us, it has
the potential for some truly sensational dividend growth in the coming years.
Growing dividends over time is very powerful. For example, Starbuck’s split adjusted cost basis
20 years ago was $2.06. This means that the current dividend represents a 31.6% yield on invested
capital. Even adjusting for inflation that still comes to 20.5% and will only grow exponentially
over time as Starbucks continues to reward patient, long-term investors.
In other words, while Starbucks may not seem like a screaming buy at today’s price, based on its
historical valuations, and more importantly, its realistic forward earnings growth potential, the
stock seems like a solid long-term core holding for any diversified dividend growth portfolio.
Even as large as Starbucks is today, it still has the potential to become one of the best performing
dividend growth stocks of the next decade if it can achieve its long-term guidance. Essentially,
owning Starbucks is a bet that the company’s store concept is not yet saturated but rather has a
long runway for growth. If correct, the stock should deliver double-digit annual returns over time.

STARBUCKS VS MCDONALD
Competition within the restaurant world often comes from unexpected quarters. One might think
that the clientele that fast-food giant McDonald's (MCD) serves would be far different from the
coffee-guzzling customers that Starbucks (SBUX) woos.
But over time, both companies have moved into each other's territory, with McDonald's offering
its McCafe drinks while Starbucks aims at delivering breakfast and other food options.
Many investors see both companies as having considerable strengths and want to know which one
is the more promising stock right now. Let's look at how McDonald's and Starbucks compare on
some key metrics to see which one might be a smarter pick for investors.

 VALUATION AND STOCK PERFORMANCE

Neither Starbucks nor McDonald's has blown out the stock market in terms of performance, but
the fast-food company has a clear lead. Starbucks is roughly flat since December 2015, but
McDonald's is up about 8% over the same time period.
Even though the two stocks haven't climbed very far over the past year, both have valuations that
are somewhat high. Looking at simple valuation methods based on trailing earnings, McDonald's
current stock price works out to an earnings multiple of about 23. That's higher than the broader
market. Starbucks gets an even bigger premium to the market earnings multiple than McDonald's,
with its stock trading at 31 times trailing earnings. Those levels have fallen slightly during 2016,
but they still point to the premium that investors are putting on their performance.
Valuations look a little more attractive when you incorporate future earnings projections.
Starbucks carries a forward earnings multiple of 24, while McDonald's trades at roughly 20 times
forward earnings. Both are somewhat expensive, but McDonald's offers a slightly better value in
terms of simple valuation.

 DIVIDENDS COMPARISON
McDonald's also looks more attractive from a dividend standpoint. The fast-food giant's current
dividend yield is 3.1%, and that compares extremely favorably with the 1.7% yield that Starbucks
offers right now.
McDonald's has a long history of returning money to shareholders through dividends. You'll find
the company on the list of elite Dividend Aristocrats, thanks to its 41-year history of consecutive
annual dividend increases. The most recent raise came just last month, with a 6% boost taking
McDonald's quarterly payout to $0.94 per share. Starbucks, by contrast, has only a seven-year
streak of rising payouts, but it has been more aggressive in its recent growth, pushing its quarterly
payout up by 25% last month to $0.25 per share. For now, that gives McDonald's the proven edge
in terms of shareholder friendliness in its dividend policy.

 GROWTH PROSPECTS AND RISKS

Given the advantages that McDonald's has shown in valuation and dividends, Starbucks needs to
distinguish itself on the growth front. Yet McDonald's has worked hard to foster rising sales, with
the decision to serve breakfast all day having proven to be a popular choice that gets more
customers in the doors and spending more when they do. After several years of sluggishness,
McDonald's has returned to a sustainable growth trajectory. The fast-food company's most recent
results showed a 3.5% rise in sales globally, and that helped boost its bottom line by nearly a tenth.
McDonald's is also learning from its peers in the restaurant space, looking toward offering a wider
array of food offerings and automating certain work functions to improve efficiency. The company
has put together more than a year's worth of rising comparable restaurant sales, and that bodes well
for its future.
Meanwhile, Starbucks is going through a transformation, with CEO Howard Schultz deciding to
give up his leadership role next year. The coffee giant's five-year plan includes double-digit
percentage growth projections for sales and earnings per share, with a rising presence in China
playing a key role in driving expansion. Perhaps most interesting is the opportunity that Starbucks
sees in the ultra-premium space, with its Reserve Roastery concept potentially appealing to high-
end customers wanting a luxury experience while also promoting innovation that could filter down
to Starbucks' conventional stores. Combine that with opportunities for greater penetration in
grocery-sold consumer products, and Starbucks' growth prospects look very promising.
Both McDonald's and Starbucks have points in their favor. For high-growth investors, Starbucks'
opportunity looks bigger than McDonald's. Yet with better value, solid dividend income, and
reasonable chances for long-term growth, McDonald's will appeal to many value and income
investors who appreciate the heritage that the fast-food giant brings to the table.

THE COMPETITION
PRIMARY COMPETITORS
The main competitors of Starbucks are:
o Dunkin' Donuts.

o Costa Coffee

o The Coffee Bean.

Out of these three competitors, the dominant competitor for Starbucks is Dunkin Donuts.

Stores Countries Revenue

Starbucks 20,890 62 13.3 billion US $
Dunkin' Donats 10,083 36 0.54 billion US $
Costa Coffee 1,700 28 1.4 billion US $
The Coffee Bean 900 23 0.45 billion US $

STARBUCKS VS DUNKIN DONUTS

Starbucks Corporation and Dunkin' Brands Group, Inc.are the two largest eatery chains in the
United States that specialize in coffee. While both companies maintain similar menus and overall
strategies, there are key differences in their business models related to scale, store ownership and
branding. Despite being founded 20 years after Dunkin' Donuts, Starbucks grew aggressively and
is a substantially larger company. In 2016, Starbucks generated $16.8 billion in revenue while
Dunkin' Brands reported sales of $828.9 million. Starbucks has a larger footprint, with 22,519
stores to Dunkin' Donuts' 11,500 points of distribution. Starbucks has also expanded beyond the
U.S. more extensively, with locations in 70 different countries. Dunkin' Brands has a substantial
international presence, though many of its international locations are Baskin Robbins ice cream
stores rather than Dunkin' Donuts stores.
In 2015, nearly 79% of Dunkin's consolidated revenue was generated by Dunkin' Donuts locations
in the U.S., while international revenue contributed less than 4% to Dunkin' Donuts' branded stores
revenue. Just under 20% of Starbucks' consolidated revenues were attributed to markets outside of
the Americas in 2015. Dunkin' has announced aggressive international and domestic expansion
plans with the hope to challenge its main competitor's footprint, but the difference in scale stems
from variations in expansion strategy.

 FRANCHISING
Nearly all of Dunkin' Brands' locations are franchises while over 51% of Starbucks locations were
company operated as of October, 2016. Licensed Starbucks stores are disproportionately located
outside of the United States, and the company is not accepting applications for any new franchises
as of March 2016. Over 75% of Dunkin Donuts' revenue came from franchise fees, royalties and
rental income in 2015, whereas only 10% of Starbucks revenues were derived from licensed
locations.
Dunkin' Donuts' higher exposure to franchise and rental income leads to a fundamentally different
business from Starbucks' largely owner-operator model. This has major implications for revenue
streams, cost structure and capital spending. Company-operated stores have different operational
and capital expense structures from franchised locations. Cost of goods sold (COGS) and
store operating expenses are a much larger percentage of sales for Starbucks than Dunkin' Donuts.
Because COGS is so much more prominent in Starbucks' expense structure, its profits are more
severely impacted by changes in coffee bean prices. Starbucks also has a higher capital expense
burden than Dunkin' Donuts, which is not obligated to purchase kitchen equipment for franchise
locations.

 FOCUS AND BRANDING

Dunkin' Donuts markets itself primarily as a coffee seller that also offers donuts and foods, a fact
made apparent by a coffee cup prominently featured on the company's logo and executive
management's explicit assertion that Dunkin' Donuts is a beverage company. Despite building an
identity as a coffee seller, food is still an important element of Dunkin' Donuts' offering. In recent
years, Dunkin' Donuts has focused increasingly on nontraditional food options with the hopes of
attracting customers outside of breakfast hours. The introduction of steak to its menu in 2014 was
a step toward incorporating heartier food items alongside a growing number of sandwich options.
Dunkin' Donuts' interiors are designed differently from Starbucks stores, with the former often
resembling fast food stores in furnishings and decor.

Starbucks brands itself primarily as a beverage provider that offers a more typical coffee house
dining experience. Starbucks locations are designed with the comfort of their customers in mind.
Free Internet access and inviting decor offer a more enticing option for those looking for a place
to read, relax or speak with friends. This also makes going to Starbucks a potential social activity,
turning the stores into a destination rather than a simple distribution location. This appeals to
customers seeking a premium experience. Typically, these customers have higher disposable
incomes and are more willing to pay extra for higher quality materials. In economic downturns,
people with lower disposable incomes are more likely to alter their consumption habits than people
with larger financial cushions. While Starbucks is undeniably impacted by the macroeconomic
environment, it is firmly established with a more resilient and less price-sensitive customer base,
which helps to dampen the blows brought on by economic cycles. Like Dunkin' Donuts, Starbucks
has also shifted focus to include more products aimed at afternoon and evening customers. These
include small plates and sandwiches as well as wine and beer.

 QUALITY
Starbucks has built a more premium brand than Dunkin' Donuts. Starbucks offers a more extensive
menu and more product customization, which is reinforced by writing each customer's name on
the side of his cup. The company offers a comfortable and quiet environment with free wireless
Internet access, encouraging customers to stay to socialize, work, study, browse media or listen to
music while consuming their Starbucks product. Taken together, these factors form a more
premium experience and command a higher price point. Dunkin' Donuts has more competitive
pricing, focusing on the middle class. In company filings and earnings conference calls, Dunkin'
Donuts' management has described its intent to be the lowest cost provider in the market while
maintaining quality above an acceptable minimum.

 FINANCIALS
Because Starbucks operates its own stores, it has tighter margins than Dunkin' Donuts. Profit after
cost of sales, which includes product expenses and occupancy costs, was 83% for Dunkin' Brands
during the quarter ending June 2015. Starbucks only had 60% gross margin during this period.

There is a similar divergence in operating margin with Starbucks posting 17.5% operating margin,
which is more than 26 percentage points below that of Dunkin' Brands. As mentioned earlier,
Dunkin' Donuts has a lower capital expense burden than Starbucks. Dunkin' Donuts' $14.4 million
in capital expense in the second quarter of 2015 was 31% of net cash flow from operations and 7%
of revenue. Starbucks' $944 million of capital expenses was 34% of net cash flow from operations
and 19% of revenue.

This discrepancy is a consequence of the different store ownership structures for the two
companies, and it has material consequences for the fundamentals available to investors.
Investors should also note the difference in capital structure between the two companies. Dunkin'
Donuts carries $2.5 billion of long-term debt, which is 74% of total assets. Starbucks' $2.4
billion of debt is only 18% of total assets.
FINANCIAL MANIPULATIONS

WAS THE TAX UNPAID LEGAL OR ILLEGAL?

The EU Commission has concluded that the Netherlands has granted selective tax advantages to
Starbucks' coffee roasting company. A tax ruling issued by the Netherlands tax authority
artificially lowered the tax paid by the company. This was illegal under EU state aid rules.
Commissioner Margrethe Vestager, in charge of competition policy, stated: "Tax rulings that
artificially reduce a company's tax burden are not in line with EU state aid rules. They are illegal.
I hope that, with today's decisions, this message will be heard by Member State governments and
companies alike. All companies, big or small, multinational or not, should pay their fair share of
tax."
This is illegal under EU state aid rules: Tax rulings cannot use methodologies, no matter how
complex, to establish transfer prices with no economic justification and which unduly shift profits
to reduce the taxes paid by the company. It would give that company an unfair competitive
advantage over other companies (typically SMEs) that are taxed on their actual profits because
they pay market prices for the goods and services they use.

STARBUCKS EMEA OVERVIEW

Starbucks Manufacturing EMEA BV ("Starbucks manufacturing"), based in the Netherlands, is
the only coffee roasting company in the Starbucks group in Europe. It sells and distributes roasted
coffee and coffee-related products (e.g. cups, packaged food, pastries) to Starbucks outlets in
Europe, the Middle East and Africa. The Commission's investigation showed that a tax ruling
issued by the Dutch authorities in 2008 gave a selective advantage to Starbucks Manufacturing,
which has unduly reduced Starbucks Manufacturing's tax burden since 2008 by €20 - €30 million.
In particular, the ruling artificially lowered taxes paid by Starbucks Manufacturing in two ways:
Starbucks Manufacturing pays a very substantial royalty to Alki (a UK-based company in the
Starbucks group) for coffee-roasting know-how. - It also pays an inflated price for green coffee
beans to Switzerland-based Starbucks Coffee Trading SARL. - The Commission's investigation
established that the royalty paid by Starbucks Manufacturing to Alki cannot be justified as it does
not adequately reflect market value. In fact, only Starbucks Manufacturing is required to pay for
using this know-how – no other Starbucks group company nor independent roasters to which
roasting is outsourced are required to pay a royalty for using the same know-how in essentially the
same situation. In the case of Starbucks Manufacturing, however, the existence and level of the
royalty means that a large part of its taxable profits are unduly shifted to Alki, which is neither
liable to pay corporate tax in the UK, nor in the Netherlands. Furthermore, the investigation
revealed that Starbucks Manufacturing's tax base is also unduly reduced by the highly inflated
price it pays for green coffee beans to a Swiss company, Starbucks Coffee Trading SARL. In fact,
the margin on the beans has more than tripled since 2011. Due to this high key cost factor in coffee
roasting, Starbucks Manufacturing's coffee roasting activities alone would not actually generate
sufficient profits to pay the royalty for coffee-roasting know-how to Alki. The royalty therefore
mainly shifts to Alki profits generated from sales of other products sold to the Starbucks

THE CLAIM BY UK UNCUT

If the government took strong action to stop tax dodging by companies like Starbucks- who
haven’t paid any income tax for the last three years- we could easily afford to prevent the £5.6m
being cut from violence against women services, the 25% cut to funding for Sure Start centers and
the further £10 billion benefit cuts.

It was, in a way, rather unfortunate that UK Uncut still went ahead with their protests at Starbucks
branches on Saturday, December 8th. A number of companies have come under scrutiny for their
tax arrangements (see above t-shirt for reference) and the Starbucks did make quite aggressive
voluntary concessions in response to the furor. Little wonder why, of course:
 STARBUCKS RESPONSES
The reporting last week of Starbucks’ concession to (try to) pay more tax in the UK focused on
the company’s estimate of how much they might pay — some £10m in each of 2013 and 2014.
But what exactly has Starbucks offered?

For two years, or until we make a profit, Starbucks UK will not claim deductions:
a) For the royalties, it pays
b) For the coffee, it purchases
c) For interest paid on intercompany loans
d) For capital allowance deductions nor our carry-forward losses
Starbucks is going further than just reversing the items in the picture. Concerning the coffee
purchases from the Switzerland office (point 2), Starbucks is saying that they won’t just take out
the mark-up on the coffee (of 20 per cent) but the entire cost of the coffee. A friend of FT Alpha
Ville, familiar with the coffee trade, got in touch with us on Wednesday and said person reckoned
coffee cost is 4 to 6 per cent of sales. For Starbucks UK, that would make the above concession
worth £16-24m.

Tallying up, that’s £16m of coffee (at the low end), £26m of royalties, and £2m of interest
payments, when using last year’s accounts as a guideline. Removing those for 2011 would have
gotten Starbucks UK to a £11m profit before tax.

This, however, is from the financial accounts, not the tax accounts. Important when one considers
that none of the first three concessions would count for anything were it not for the fourth. Context
from the 2011 accounts:
As Starbucks UK is loss-making (for UK tax purposes) it could pile up deferred tax assets (DTAs)
to use in a profitable year — should it ever get there. DTAs are recognized in the balance sheet
when “it can be regarded as more likely than not that there will be suitable taxable profits” in the
future. In other words, the company must think that it will make profits in the future, and hence it
will be able use the DTAs to lower tax liabilities.

For additional context, the stack of losses Starbucks has made in the UK since it came to these
shores:

Anyhow, what the recent note on DTAs reveals is that Starbucks didn’t recognize the amount it
could have gotten for things like capital allowance deductions (on investments it made,
presumably). If it does do so in 2013, then all its efforts to try to pay tax could go to waste. And
they wanted to pay tax due to huge uproar and reputational loss so Starbucks declared:
“For two years, or until we make a profit, Starbucks UK will not claim deductions for capital
allowance deductions nor our carry-forward losses”
Starbucks branches look kind of the same everywhere in the world. The implication being that a
hell of a lot of Starbucks UK’s stuff is likely to be sourced from outside the country (from other
Starbucks units, that is, in the US or elsewhere). Those characteristic chairs and couches, the
Frappuccino, the mugs, and so on. All of which will involve some transfer pricing and end up in
the UK unit’s cost of sales, thus reducing tax liability.

In other words, the costs Starbucks is offering not to recognize in its 2013 and 2014 UK tax
accounts are, well, kind of arbitrary in a way. They are the items mentioned in the press, plus an
extra one that has to go in lest the first three get negated by it.

Which brings us back to the global point about transfer pricing. Ultimately, there need to be tax
laws that are coordinated and that work for society as a whole. To those who argue that Starbucks
shouldn’t have volunteered to pay tax in advance of a change in law to recover it’
But also to the populists — note that this tax payment will ultimately hurt shareholders of
Starbucks, and then note that Starbucks UK staff are entitled to “Bean Stock”.

BACKGROUND OF THE CASE

The beneficiary of the whole scenario was SMBV. SMBV is a subsidiary incorporated in the
Netherlands of the Starbucks group. The Starbucks group is composed of the Starbucks
Corporation and all the companies controlled by that corporation. The Starbucks Corporation is
headquartered in Seattle, United States of America (hereinafter “US”). Starbucks is a roaster,
marketer and retailer of specialty coffee, operating in 65 countries. It purchases and roasts coffees
that are sold, along with handcrafted coffee, tea and other beverages and fresh food items, through
company-operated stores. It also sells a variety of coffee and tea products and licenses its
trademark through other channels, such as licensed stores, grocery and national foodservices
accounts. In 2014, the Starbucks group had worldwide net revenues of USD 16 448 million and
post-tax earnings of USD 2 067 million. SMBV is the only wholly controlled Starbucks group
entity outside of the US which roasts coffee.

THE CONTESTED MEASURE

This Decision concerns the SMBV APA, an advance pricing agreement concluded by the Dutch
tax administration with SMBV on 28 April 2008 (APA). The SMBV APA is binding for 10 years,
from 1 October 2007 to 31 December 2017 11 . (41) An APA is an agreement between a tax
administration and a taxpayer on the application of tax law regarding (future) transactions, i.e. it
determines the amount of profit that the taxpayer generates from its activities that are taken into
account in that tax jurisdiction. An APA determines, in advance of intra-group transactions, an
appropriate set of criteria (e.g. method, comparable and appropriate adjustments thereto, critical
assumptions as to future events) for the determination of an arm’s length pricing for those
transactions over a fixed period of time. An APA is formally initiated by a taxpayer.

The SMBV APA

By concluding the SMBV APA, the Dutch tax administration accepted that the remuneration
determined by Starbucks’ tax advisor in the transfer pricing report for the functions performed by
SMBV in the Netherlands (including risk assumed and assets used) constitutes an arm’s length
remuneration

That remuneration consists of a mark-up of [9-12] % of the relevant cost base. The relevant cost
base used to calculate that remuneration includes all personnel costs engaged in both
manufacturing and supply chain activities, the cost of production equipment (i.e. depreciation) and
plant overheads. It does not include the costs of the Starbucks cups, paper napkins, etc., the costs
of green coffee beans (cost of raw materials), the logistics and distribution cost for services
provided by third parties, the remuneration for activities provided by third parties under so-called
“consignment manufacturing contracts” and the royalty payments to Alki LP.In the SMBV APA,
the Dutch tax administration further accepted that the level of the royalty payment from SMBV to
Alki LP would be determined at the end of each year as the difference between the realised
operating profit before royalty expenses and the aforementioned [9-12] % mark-up on operating
expenses. The SMBV APA further provides that “this royalty payment is deductible for corporate
income tax purposes and is not subject to Dutch withholding tax” 13 . (45) The SMBV APA thus
endorses a profit allocation to SMBV within the Starbucks group that enables it to determine its
corporate income tax liability to the Netherlands on a yearly basis for 10 years. Since the APA
entered into force on 1 October 2007, this Decision analyses the SMBV APA under the State aid
rules as from that date. The remuneration accepted by the Dutch tax administration in the SMBV
APA is based on the transfer pricing analysis prepared by Starbucks’ tax advisor in the transfer
pricing report, which forms an integral part of that APA. The objective of the transfer pricing
report is to support the proposed profit allocation to SMBV within the Starbucks group as being
based on an arm’s length pricing of intra-group transactions. The transfer pricing report presents a
company overview, a functional analysis and a selection of transfer pricing methods. The report
presents the following relevant information about Starbucks Coffee BV and SMBV14

Starbucks Coffee BV:

Starbucks Coffee BV functions as the Starbucks group’s head office for the Europe Middle-East
and Africa (“EMEA”) region, supporting the group’s EMEA business operations. Starbucks
Coffee BV assists with identifying developers to develop and operate Starbucks retail stores in the
EMEA territories. In its capacity as head office, Starbucks Coffee BV licenses certain Starbucks
trademarks, technology and knowhow from its shareholder, Alki LP, in return for a royalty
payment. Starbucks Coffee BV enters into what is referred to as an “Area Development and
Operation Agreement” (hereinafter: “ADOA”) with related and unrelated operators of Starbucks
shops in the EMEA region. Those operators are called Developers, also referred to hereinafter as
“Shops”. Starbucks Coffee BV sub-licenses intellectual property (hereinafter: “IP”) rights to the
Developers to enable them to develop and operate their shops as Starbucks Shops. For the use of
the IP, the Developers pay a royalty and other fees to Starbucks Coffee BV based on a percentage
of turnover. According to the submission of the Netherlands of 2 October 2013, both related and
unrelated Developers pay the same percentage of turnover as a royalty to Starbucks Coffee BV.
Therefore, Starbucks’ tax advisor considers that a comparable uncontrolled price method16 is
applied to determine the arm’s length price of intragroup royalty payments to the EMEA head
office Starbucks Coffee BV17 . 2.2.2.2. SMBV (49) Starbucks’ tax advisor, when presenting the
most important transactions and intercompany flows for SMBV in the transfer pricing report18,
limits itself to describing that SMBV primarily processes green coffee and sells roasted coffee to
affiliated and non-affiliated parties. It also explains that the green coffee beans sourced by SMBV
are sourced from an affiliated Starbucks’ subsidiary in Switzerland (SCTC). Furthermore, it
explains that SMBV operates as an intermediary distribution entity for a variety of non-coffee
items. In addition to the supply chain function for its own manufacturing activities, the tax advisor
further explains that certain markets also receive some supply chain support from SMBV. The tax
advisor does not describe the roasting IP licencing arrangement under which SMBV pays royalties
to Alki LP for licensed IP among the most important transactions and inter-company flows, but
only shows it in a graph and describes it in a separate section in the transfer pricing report
describing the EMEA market and Netherlands operations19 . (50) According to the functional
analysis provided in the transfer pricing report20, the focus of SMBV’s activities is its Amsterdam-
based roasting facility. The main raw material component of that roasting process is green coffee
beans. The actual roasting process for a particular coffee blend depends on the particular type of
green coffee bean used in the recipe and the desired flavour profile. SMBV is responsible for
executing roasting forecasts provided by Starbucks US and ensuring that the resulting product
meets the quality standards of Starbucks US. SMBV buys the green coffee beans from SCTC, a
designated supplier21. The beans for the EMEA market are roasted and packaged in the
Netherlands by SMBV. (51) SMBV licenses a sub-set of IP from Alki LP, which is not mentioned
in the functional analysis, but described in a separate section on the EMEA market and Netherlands
operations as “necessary to utilize the coffee roasting manufacturing process and the right to
supply coffee to [D]evelopers. In return [SMBV] remits a royalty to Alki LP for the licensed IP”
22 . That coffee roasting related IP consists, in particular, of roasting curves, which according to
the transfer pricing report dictates the temperature and the length of time required to complete the
roasting process. (52) According to the transfer pricing report, SMBV employed [40-60] people,
of which [20-30] perform supply chain operations including procurement, planning, logistics and
distribution planning23 . SMBV has a distribution centre in the United Kingdom (hereinafter:
“UK”) operated under contract by a third party24. SMBV has a supply and logistics agreement
with a third party in the Netherlands, whereby the third party purchases inventory for resale to
developers at arranged prices. SMBV also engaged another third party to open a distribution centre
in Germany during 2006.
SMBV also has a relationship with a consignment manufacturer, [unaffiliated manufacturing
company 1]. [Unaffiliated manufacturing company 1] mainly produces [a trademark registered
coffee product] powder for the Starbucks [trademark registered coffee] product. SMBV is
responsible26 for managing this toll manufacturing relationship27 and sells the majority of the
product produced by [unaffiliated manufacturing company 1] to Starbucks’ US resident
companies.

 ROYALTY FEE ISSUE

The taxable profits of SMBV in the Netherlands, which are determined based on the SMBV APA
in reference to the operating expense of the company, are reduced by a royalty paid to Alki LP.
The Commission requested further information from the Netherlands and Starbucks on the amount
of the royalty payment and the exact calculation of the tax base.

Under the notes to the financial statements, the position “Other expenses” in Table 3 is defined as
follows: “Other expenses relate to a royalty agreement held with the affiliated company [CV 1],
which was assigned to Alki LP on December 13, 2006 and is based on a tax ruling with the Dutch
tax authorities”. The APA to which this footnote relates is the SMBV APA and thus indicates that
SMBV’s auditor interpreted the SMBV APA to determine the royalty payments by SMBV to Alki
LP.

The pre-tax profit before the royalty payment is equal to “Sales” minus “Direct Costs of Sales”
(which represent the costs of raw material consumed in the production process), minus “General
and Administrative expenses”, minus “Foreign currency exchange”, plus “Interest income”, minus
“Interest expense” in Figure 2. For example, for the year 2010/2011, the pre-tax profit before
payment of royalty would be equal to EUR 13 783 458. In order to lower the pre-tax to the level
agreed in the SMBV APA of around [9-12] % of agreed costs, a tax-deductible royalty of EUR 12
352 838 is paid out to Alki LP, as recorded in the position “Other expenses”.

For each period of the application of the SMBV APA, the costs taken into account for the
calculation of the tax base are lower but close to the amounts reported as “General and
administrative expense”. For example, for the period 2012/2013 those costs are EUR 15 694 137
and for the period 2007/2008 those costs are EUR 15 055 253. In the periods preceding the
application of the SMBV APA, the costs taken into account for the calculation of the tax base are
much higher, as they would, according to Starbucks, also include the costs charged by [unaffiliated
manufacturing company 1]. For example, for the period 2006/2007, the costs used to calculate the
tax base were EUR [30-40 million]. This explains why the corporate tax liability decreased by
more than half when the SMBV APA entered into force51, i.e. from EUR 844 309 in 2006/2007
to EUR 383 909 in 2007/2008, as shown in Table below:

SMBV’S PROFIT AND LOSS ACCOUNTS 2001 - 2014

Further, the royalty payment varies between [1-10] % to [30-40] % of SMBV’s revenues from
sales of coffee over the life of the SMBV APA, confirming the Commission’s doubts about the
fluctuation of the royalty146. Moreover, for three of those years the resulting levels were above
[30-40] %,

FLUCTUATION OF ROYALTY PAYMENT OVER THE LIFE OF SMBV

APA
In this specific context, the variable nature of the royalty payment gives a first indication that the
level of that payment bears no relation to the value of the IP for which it is being paid. The
Commission rejected the claims that any effective risk transfer takes place from SMBV to Alki LP
through contractual arrangements. Therefore, any component of the royalty meant to compensate
for an entrepreneurial risk transfer cannot be justified.

PRICING OF GREEN COFFEE BEANS BY SCTC

According to the ad-hoc transfer pricing report provided, SCTC determines the prices to its
affiliates by applying a mark-up to the product costs associated with the green coffee beans sourced
by it.
In addition, to determine a current arm’s-length mark-up on product costs for SCTC for green
coffee beans procurement, three separate components were identified:
– Intellectual Property - C.A.F.E. Practices Program: SCTC manages the C.A.F.E. Practices
Program and uses valuable know-how that, when incorporated into Starbucks’ business operations,
ensures consistent supply and supports the Starbucks brand for sustainability. Starbucks analysed
this transaction using comparable licensing agreements relating to food and agricultural
technologies.
– Procurement: SCTC provides procurement functions for green coffee beans. Starbucks analysed
this transaction using comparable sourcing agreements between third parties.
– Financing: SCTC should generate a return for financing costs it incurs when holding unsold
inventory and net receivables for green coffee beans. Starbucks analysed an appropriate return for
financing that should be returned to SCTC.

Combining the results for each separate component analysed by SCTC would yield a combined
result for green coffee beans overall from 2005 through 2014 as demonstrated in below Table:
The breakdown by Starbucks of the mark-up of green coffee beans purchased by SCTC charged
to SMBV is given below:

According to Starbucks, the mark-up of [around 3 %] applicable on average for the period 2005 to
2010, corresponds to an arm’s length mark-up. However, since Starbucks did not provide any valid
justification for the increase in the average mark-up to [around 18 %] from 2011 onwards.
Starbucks claims that the increase of that mark-up in 2011 was due to the growing importance of
SCTC’s operations, particularly the increased expertise in coffee procurement and, more
important, its ownership and operation of the evolving C.A.F.E. Practices Program.

 LOSS GENERATED AT SMBV

Based on the financial information provided, below graph presents SMBV’s profit margin on its
coffee roasting activities, which is obtained by subtracting the price paid by SMBV to SCTC for
green coffee beans from the revenues of roasted coffee recorded under the description “REV
PACKAGED COFFEE” for each year.
This graph demonstrates that, since 2010, SMBV is loss-making on its roasting activities, when the
margin on green coffee beans required by SCTC increased. Taking that fact into account, along with
increase in royalty paid by SMBV to Alki LP over the revenue from sales of coffee, the roasting
know-how and curves do not appear to create positive value for SMBV. On the other hand, below
shows the impact on SCTC’s profit in Swiss Francs (CHF) from the increase of the mark-up in 2011.
Figure 4 also presents the operating expense of SCTC, which did not demonstrate any such increase
that could have been expected from an increased importance of SCTC as claimed by Starbucks. The
operating expense in percentage of total costs remained stable and the operating costs would therefore
have been covered through a remuneration linked to COGS. The increase in the mark-up from [around
3 %] to [around 18 %] on average for 2005 to 2010 and from 2011 to 2014, respectively, resulted in a
quadrupling of SCTC profits.