By Martinne Geller and Lisa Baertlein
LONDON/LOS ANGELES (Reuters) - Nestle's (S:NESN) high-priced purchase of a majority stake in California-based coffee bar chain Blue Bottle this week, highlights how big companies are seeking exposure to fast-growing premium brands driven by millenials.
Industry experts are predicting more deals will follow in the highly fragmented coffee market, which provides richer profit margins than mainstream packaged food and drink.
Since 2015 there have been nine coffee deals by JAB Holding Co, owned by Europe's billionaire Reimann family. With brands like Douwe Egberts and Tassimo sitting alongside Blue Bottle rival Intelligentsia, JAB now owns the second-biggest packaged coffee business behind Nestle, owner of Nescafe and Nespresso.
"There are certainly going to be further purchases at all levels of the price tier," said Matthew Barry, beverage analyst at Euromonitor International, adding that any company that is not doing acquisitions risks falling behind.
Earlier this month, Italy's Massimo Zanetti (MI:MZB) bought a majority stake in Indonesian roaster Caswell's and in August, Italy's Lavazza bought a stake in France's Espresso Service Proximite, its third acquisition in less than two years.
In May, Lavazza's chief executive told Reuters the company could put together more than 1.5 billion euros ($1.8 billion) for acquisitions.
THIRD WAVE
Switzerland's Nestle announced its deal with Blue Bottle late on Thursday. Its few dozen coffee bars are part of the so-called third wave coffee movement in the United States, which emphasizes quality beans and expertly-made drinks.
Analysts see the deal as evidence that an energized Nestle, under its new chief executive, is taking steps to reconnect with consumers, particularly young ones.
"It emphasizes the wish to actively work on the portfolio and build on attractive growth areas," said Patrik Schwendimann, analyst at Zuercher Kantonalbank.
The deal gives Nestle entrance to high-end bars that are part refreshment and part theater, with space-age "siphon" or "vacuum" brewers. While niche, these outlets are seen as testing labs for new trends that may eventually go mainstream, such as cold brew, single-origin beans and nitro coffee.
High street chains such as Starbucks (NASDAQ:SBUX) and Costa (L:WTB) are already moving in that direction and a front-row seat could help Nestle innovate more quickly.
Nespresso already has a network of shops but Liberum analyst Robert Waldschmidt sees the Blue Bottle deal as being less about retail and more about Nestle getting a premium brand it may sell in packaged form.
"I don't think they're trying to reinvent themselves as a retailer," Waldschmidt said. "They could be looking at going a bit more multi-brand given that JAB is the epitome of multi-brand."
It remains to be seen if there is enough demand for such exotic drinks outside major urban markets, or whether expanding too much will hurt the Blue Bottle brand's cachet. For now, Nestle said Blue Bottle would continue as a standalone entity.
"At a national level, there is no evidence of a shift toward independent coffee," Bernstein analyst Sara Senatore said in a recent report on third wave coffee. "Independents are largely limited to the largest urban markets, which, while important to both chains (Starbucks and Costa), contribute a fairly small share of revenues or profits."
She estimated that the top third wave players - which include JAB's Stumptown and Intelligentsia, Philz, Counter Culture, Blue Bottle and La Colombe Coffee Roasters - together generate just $126 million in revenue across 123 stores.
By contrast, Starbucks alone generated $21.3 billion in revenue last year from 25,085 stores globally.
BIG MARK-UP
Nestle is the leader in a global packaged food and beverage market that has seen growth slow due to cooling emerging markets, increased competition from upstart brands and changing consumer tastes away from processed food.
The company, which is under pressure to improve returns from activist investor Third Point, has identified coffee as one of its key priorities for investment.
"There's a big markup on coffee shop coffees," Liberum's Waldschmidt said. "Put it all together and you've got growth and margin, and in some areas, barriers to entry. Its fragmented so you can consolidate, which usually leads to margins going up."
Nestle's overall operating margin was 15.3 last year, whereas the margin in its powdered and liquid drinks unit, which includes coffee, was 20.8 percent.
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