Paul Heeschen never thought the sale of a small but growing coffee products company would trigger drawn-out scrutiny by federal regulators.
“Coffee is the second largest commodity and the second-most consumed beverage in the U.S.,” he said. “How could there be anything anticompetitive about it? Yet people figured out a way to make that allegation.”
In early March, Heeschen’s Irvine-based coffee wholesaler Diedrich Coffee Inc. was acquired for $290 million by Vermont’s Green Mountain Coffee Roasters Inc.
The deal, agreed to in December, took some five months to complete after regulators balked in January.
The Federal Trade Commission took a long look at the impact Diedrich’s sale would have on the market for a new type of single brewing cups known as K-Cups.
“Much of the FTC’s focus was on the K-Cup business,” said John Williams, partner at the Irvine office of Los Angeles-based Gibson, Dunn & Crutcher LLP, which has represented Heeschen and Diedrich since 1992.
K-Cups allow consumers to brew a single cup of coffee in a special machine by putting one of the K-Cups into the slot where coffee grounds and a filter would go on traditional coffee makers.
Green Mountain’s Keurig Inc. unit owns the K-Cup brand and licenses it to others. Diedrich was one of a handful of K-Cup licensees before the sale.
Green Mountain has sought to consolidate production and sales of K-Cups since acquiring Keurig in 2006.
It bought the wholesale coffee business of Seattle’s Tully’s Coffee Corp. in early 2009 and Toronto-based Timothy’s Coffees of the World Inc. in November.
The deals have firmed Green Mountain’s hold on K-Cups, which are more profitable through direct sales than licensing, according to analysts.
First Test
The size of the Diedrich buy triggered an automatic federal review under the Hart-Scott-Rodino Antitrust Improvement Act of 1976.
“Diedrich Coffee constituted the largest acquisition of a licensee by Green Mountain, whose earlier transactions had not been large enough to trigger a Hart-Scott-Rodino filing,” Williams said. “We anticipated there would be some regulatory review, but you never know how deep they are going to go. They went a lot deeper than we anticipated in terms of the level of review.”
Williams, Heeschen and Diedrich President Sean McCarthy flew to Washington, D.C., “to give a presentation to the FTC and effectively walk them through why we did’t think that the transaction with Green Mountain would be anticompetitive,” Williams said.
Much of the review seemed to stem from political pressure by Green Mountain competitors that see K-Cups changing the way people drink coffee, according to Heeschen.
“There certainly were other parties having dialogue with the FTC to exert political pressure on the transaction,” he said.
Many within the coffee industry see the growth of K-Cups as a game changer for coffee roasters that have long wooed consumers with traditional ground beans.
“Our grandparents used to percolate their coffee,” Heeschen said. “Our generation ground and dripped our coffee and made pots of it. But now people are going to make one cup at a time.”
K-Cups proved to be a lifesaver for Diedrich, which at one point was left for dead after a disastrous bid to take on Starbucks Corp. in coffeehouses.
Diedrich sold the last of its namesake coffeehouses in 2006, when it sold 40 of them to Seattle-based Starbucks.
Diedrich got rid of all of its remaining coffeehouses in 2009 when it sold its Gloria Jean’s Gourmet Coffee & Teas in the U.S. to Praise International North America, an affiliate of the Australian group that bought the international Gloria Jean’s a few years earlier.
History
The company’s K-Cup license stemmed from Keurig, a relatively unknown Massachusetts company that developed the product and struck a deal with Diedrich back in 2000.
“At the time it appeared they were trying to promote their potential by entering into license agreements with regional and national brands,” Heeschen said. “Then the roles changed.”
Diedrich’s K-Cups license languished for six years before the product started to become a significant part of the company’s business.
In the past year or so, K-Cup sales have surged thanks to retailers including Wal-Mart Stores Inc. and Bed Bath & Beyond Inc.
Heady growth from K-Cups drove a wild 2009 for Diedrich, which saw its shares soar on Wall Street last year, ending up about some 10,000%.
Bidding War
In late 2009, Emeryville-based Peet’s Coffee & Tea Inc. first offered $213 million in cash and stock for Diedrich, setting off a bidding war that ultimately ended with Green Mountain’s acquisition.
“We knew there was interest in the K-Cups,” Williams said.
The K-Cup “really is a sea change in an industry and part of why Peet’s was so aggressive about finding an entrée to it,” Heeschen said.
Diedrich entered into separate talks with Peet’s and Green Mountain and was bound by confidentiality not to let one know it was talking to the other, according to Williams.
When Peet’s went public with its offer in November, Diedrich then was able to seek bids from other suitors under a “go shop” provision, he said.
The month-long bidding war resulted in some long nights for Heeschen and Williams, who said they often were racing against the clock to get out press releases on the status of negotiations.
Heeschen said the goal wasn’t always to sell the company. A deal came about after the growth of K-Cups, he said.
A venture capitalist, Heeschen now is out of the coffee business and into other investments.
His 58% stake in Diedrich was worth about $170 million in the buyout before factoring in money he spent to exercise warrants or stock options.
He had put in an estimated $9 million into Diedrich since 1992.
