CHAPTER 13
Wall Street Measures a Company’s Price, Not Its Value

There are only two guidelines. One, what’s
in the long-term best interests of the
enterprise and its stakeholders, supplemented
by the dominant concern of doing what’s right.

—ROBERT D. HAAS , PRESIDENT,

LEVI STRAUSS & CO.,

AS QUOTED IN THE CORPORATE CONSCIENCE

More than most managers, I rely heavily on my instincts about people. Whether I’m hiring a key executive, selecting an investment banker, or assessing a partner in a joint venture, I look for the same kind of qualities most look for in choosing a spouse: integrity and passion. To me, that’s just as important as experience and abilities. I want to work with people who don’t leave their values at home but bring them to work, people whose principles match my own. If I see a mismatch, or a vacuum where values should be, I prefer to keep looking.

THE VALUE OF VALUES

When Starbucks finally decided to go public, we could have hired any investment bank in the country. Many of the biggest national investment banks, as well as a number of smaller, local ones, sought us out in our roasting plant/offices on Airport Way South in Seattle.

At the time, in 1991, we were still a relatively modest-sized, regional company. We ended fiscal 1991 with just over a hundred stores, all of them in the Northwest and Chicago, and $57 million in sales. But the major investment banks were looking for just the sort of promising, high-growth profile we had. They liked our financial projections and our plans for aggressive national expansion. When they examined our books, they were impressed with our unit economics—sales per store, average cost, return on investment.

It was flattering to be the object of so much attention, and I met with more than twenty suitors over the course of six months or so. But to my dismay, I found that most of the investment bankers I talked to viewed Starbucks as simply one of many options on a long list of potential IPOs—companies planning their first stock market listing, or Initial Public Offering. I began to get the feeling they were playing the odds: doing their due diligence to make sure there were no obvious errors of judgment and then backing a certain number of candidates, fully aware that some would fail and some would succeed.

Almost all of them seemed to tune out when I started discussing our company’s Mission Statement. If they were taking notes, their pens stopped moving when I brought up values, as if I were indulging in rhetoric unrelated to Starbucks’ financial performance. Experience has taught me that it’s easy to talk about values, hard to implement them, and even harder for an outsider to determine which values are heartfelt and which are window-dressing. Wall Street cannot place a value on values.

I began to get discouraged. I knew Starbucks could carry off a successful IPO, but I wanted to work with investment bankers who got it, professionals who understood that Starbucks was more than another retail/restaurant play, more than a chain of cafés, more than just the latest transaction. These people were from a different world, where everything was weighted by its financial value; if you couldn’t put a number on it, it didn’t show up in the equation. They wanted to know what we could deliver to shareholders, not how we treated our employees.

One day in August of 1991, another investment banker showed up for an appointment. Dan Levitan was from Wertheim Schroder, a firm more experienced working with large, well-established companies than with small ones like ours. He had flown from Los Angeles to Seattle and joined up with a colleague from New York. They were probably about the tenth set of investment bankers to approach us. Neither had ever been in a Starbucks store, so they stopped by one that morning before coming to my office.

At that time, my office had a huge glass window, covering an entire wall, through which I could see the plant and the roasters. I pointed out to them our three big Probat roasting machines, with a combined capacity of 7 million pounds per year per shift. As we took our places at a small conference table I once again tried to explain. Starbucks is fast-growing and profitable, I told them. Overall, the U.S. gourmet coffee market had risen by 18 percent a year, from $270 million in 1984 to $750 million in 1991, and it was expected to reach $1 billion by 1994.

But, I told them, Starbucks was attempting to accomplish something more ambitious than just grow a profitable enterprise. We had a mission, to educate consumers everywhere about fine coffee. We had a vision, to create an atmosphere in our stores that drew people in and gave them a sense of wonder and romance in the midst of their harried lives. We had an idealistic dream, that our company could be far more than the paradigm defined by corporate America in the past. I told them about Bean Stock, our revolutionary new program of granting stock options to all employees. Our first priority was to take care of our people, because they were the ones responsible for communicating our passion to our customers. If we did that well, we’d accomplish our second priority, taking care of our customers. And only if we achieved both of those goals would we be able to provide long-term value for our shareholders.

I waited for their eyes to glaze over.

But this time, they didn’t. These guys seemed to get it—at least more so than many of the others—and they immediately started asking some good questions.

After the meeting ended, I walked them out. As we headed down a long hall toward the front stairs, I said something to Dan Levitan that took him aback.

“Do you know what the problem with your business is?” I asked.

Dan braced himself for a major indictment of the investment banking industry. “No, what?” he said warily.

“There are not enough mensches.”

I assumed Dan would know the word mensch, a Yiddish way of describing someone who is basically decent, honest, and full of integrity.

Dan jerked his head up and looked me directly in the eye. I could see that he took my point, instantly. My guess had been right: Dan was a mensch.

He later told me that he got on the plane that day, completely hyperactive, and used the in-flight telephone to call his colleagues in New York, telling them he had just discovered an amazing company.

He found it to be a hard sell. Starbucks didn’t have any stores in New York then, and most New Yorkers thought of coffee shops as bland, purely functional places, not as fast-growing enterprises. In an era when biotechnology and fiber optics were the hottest investments, coffee didn’t strike Dan’s colleagues as an obvious moneymaker. Even when they came to understand and appreciate the business, they figured that Starbucks couldn’t maintain such rapid growth, that it would spin out of control, or self-destruct, or quickly saturate the market. Ironically, Dan got to experience firsthand what I had been going through in Seattle, learning how tough it was to communicate intangibles like passion and values to hard-bitten skeptics. He got a lot of grief from his colleagues before he convinced them Starbucks was worth the risk.

Dan kept in touch with me by phone, and we had dinner together the next time I went to Los Angeles.

In early April of 1992, we had our “Beauty Contest”—a parade of seven investment banks, the finalists we invited to formally pitch for the business of handling our IPO. The contenders included some of the biggest names in the business, and the process took two intense days. We were rigorous and demanding, asking each group to fill out and submit a five-page questionnaire before its two-hour session. We wanted to see who cared enough to devote the most care and thought to the presentation. Laura Moix, who had advanced from being my trusted assistant to a marketing position, gave them all a tour of the roasting plant and reported back to us how much interest each of them showed. Professional and personable, a true believer in the company and its dream, Laura was the perfect person to take the pulse of those investment bankers.

One of our key goals was to find out who was genuinely passionate about both our product and our company. Some of the bankers all too clearly had the attitude that we at tiny Starbucks were lucky such a huge, successful investment firm had taken the trouble to pitch for our business. One such crew showed up in a big limousine but had never bothered to visit our stores.

Dan Levitan poured his heart into his presentation, and the effort showed. He brought along his chairman, Jim Harmon, and they lingered longer than anyone in our roasting plant, showing a sincere interest in the coffee. Laura reported back that they understood our passion. That put them a point ahead.

After the bankers left, Orin Smith and I had long discussions with Craig Foley and Jamie Shennan of the board, who had guided our IPO process from the beginning. Our plan was to pick two of the seven. We already had close ties with several of the investment banks, including some top-rated ones, so it would be hard to break ranks with them. But I had a gut instinct about Dan and his company, and the others agreed.

We selected two firms: Alex. Brown & Sons, which had many years of experience in taking companies like ours public, and Dan’s firm, Wertheim Schroder & Co. (now Schroder Wertheim).

Dan called me that Sunday from Minnesota, where he was watching his alma mater Duke play in the Final Four basketball games. I couldn’t tell him of our decision yet, because I hadn’t yet informed the unsuccessful candidates. I tried to reassure him to be patient.

Finally, I phoned him on Monday morning. “Congratulations. You got the business.” He was overjoyed.

Our choice of Alex. Brown as lead underwriter was not a surprise, since they specialized in working with smaller companies like ours. Alex. Brown had three great people, who, not unlike Dan, understood our mission and viewed our IPO as far more than just another transaction: Mayo Shattuck, the president, Peter Breck and David DiPeitro, in capital markets. But some people didn’t expect us to pick Wertheim Schroder since it was not on the A list of pedigree firms for our type of business. Time has proven that we made the right choice, and we still work closely with both firms. As time went on, I developed close working relationships with all of them, as well as with Robert Fisher, another managing director at Schroder Wertheim.

In my experience, relationships and loyalty have become undervalued commodities at many American companies. So many of us have lost sight of the vital importance of dealing with people we can trust. Adversarial or distant relationships are not inevitable—nor are they the best way of doing business. There is much to be gained by enlisting partners and colleagues who are committed to the same goals.

Any of the seven finalist investment banks could have done the job we needed. They were all first rate. For me personally, what made the difference in the winners was their obvious commitment and passion. They both brought an intangible something extra that I knew would take us over the top.

DON’T GET DIZZY ON WALL STREET’S

EMOTIONAL ROLLER COASTER

If I had to pick the happiest day of my business career, it would have to be June 26, 1992. That was the date we went public, when Starbucks stock was listed on NASDAQ.

Our target range was $14 to $16 per share, a figure considered high at more than sixty times the previous year’s earnings. Some worried about whether we could sustain that high a price, since the market for IPOs, hot in March, suddenly went soft, and most new issues started selling at prices below projections. Our advisers recommended the low end of that range. Local newspaper articles warned small investors to be wary of buying our stock since prices of most new issues drop after the initial offering. Once again, we defied conventional wisdom. We priced Starbucks stock at $17 a share, just above the initial range.

On the big day, several of us in the senior management team went to a brokerage office in downtown Seattle and huddled around a terminal, watching as the name SBUX came up on the screen, open for trading. At the opening bell, the stock price immediately jumped to $21. We cheered.

Starbucks was the second most active stock traded on NASDAQ that day. The IPO raised $29 million for the company, $5 million more than we had expected. By the closing bell, Starbucks’ market capitalization stood at $273 million—just five years after I bought it for slightly under $4 million.

The IPO was one of the most successful of the year—one that made Wall Street brokers search eagerly for “the next Starbucks.” Our share price maintained its strength far longer than Wall Street pundits had predicted. It never fell significantly below the opening price, and within three months, it reached as high as $33 a share, making Starbucks worth nearly $420 million.

Being a public company has lent Starbucks a certain patina, taking it to the big leagues. Our stock market listing provided the liquidity that has allowed many people at Starbucks, including me, to cash in stock options and buy things we need or have long wished for. It has likewise served as a great incentive to attract talented people, who join us not only because of the excitement of building a fast-growing company but also because of the value we are creating.

Our success on Wall Street also added dimension to the brand. It allowed us to go back to the market almost every year and ask investors for more money to underwrite our growth. We’ve raised close to $500 million since going public, by issuing new stock or selling bonds that convert into stock if the price goes above a certain level. I personally enjoy the intellectual stimulation of interacting with the bright people I’ve met on Wall Street, people who have done their homework and understand the company. I also like the challenge of formulating a strategy for Starbucks to finance its growth.

But becoming a public company has its downside, too. It exposes your business to a high degree of scrutiny and your personal life to a sudden lack of privacy. Most importantly, it increases the weight of responsibility to shareholders and imposes a burden of meeting Wall Street’s expectations.

Around the time we went public, one newspaper report appeared that really irked me. A Wall Street pundit who often forecasts disaster and sells stock short predicted that Starbucks would stumble. He believed we were way overvalued and said the stock would fall to $8 by the end of the year. The piece cast a shadow over the glory of the moment. I cut it out and stuck it in a drawer in my office. Every morning for the next six months, I pulled out that clipping and re-read its gloomy prediction. Fortunately, the pundit was wrong: We didn’t stumble, and our stock price continued to rise, albeit with some dramatic ups and downs along the way. His forecast reminded me, every day, of the cost of even a minor trip-up.

Alongside the exhilaration of being a public company is the humbling realization, every quarter, every month, and every day, that you’re a servant to the stock market. That perception changes the way you live, and you can never go back to being a simple business again. We began to report our sales monthly, including comps—“comparable” growth of sales at stores that have been open at least a year, also called same-store sales growth. When there are surprises, the stock reacts instantly. I think comps are not the best measure to analyze and judge the success of Starbucks. For example, when lines get too long at one store, we’ll occasionally open a second store nearby. Our customers appreciate the convenience and the shorter lines. But if, as often happens, the new store cannibalizes sales from the older store, it shows up as lower comps, and Wall Street punishes us for it.

Over the past few years, we’ve faced many a skeptic in the financial community. Starbucks’ stock has always traded at a high multiple to earnings, which has made it a favorite for short-sellers, who bet against it because they are convinced that our company is overvalued. Since 1992, we’ve had the dubious honor of consistently being one of the top names on the short-sellers’ list. But so far, most of our steadfast believers have been rewarded, and the skeptics have been proven wrong. Investors in every new Starbucks stock issue have seen the price go up. But when your stock is trading high, you become familiar with the business version of vertigo: It’s a long way down.

While Wall Street has taught me a lot, its most enduring lesson is an understanding of just how artificial a stock price is. It’s all too easy to regard it as the true value of your company, and even the value of yourself.

In early December 1995, Starbucks’ stock price reached a record high—the sort of news that normally lifts moods around the office. But in fact, we had just learned that our Christmas merchandise was not selling as well as we had predicted, and tension ran high as we waited for the final results of the critical holiday selling season.

In early January, when we announced December comps of only 1 percent, the stock fell dramatically, from $21 to $16. In just a few days, we lost $300 million in market value, even though we had announced only a $5 million shortfall in sales. Concerned investors called me up, asking: “Why is the company performing so poorly?” The Wall Street Journal declared that we were a “shining light” that “may now be fading.” Analysts seemed sure that our growth days were over, that the bloom was off the rose.

In fact, Starbucks hadn’t changed in that month. Although our sales were lower than expected, our overall annual sales growth was nearly 50 percent. We were still buying and roasting coffee. We were opening a store a day. We continued with our plans to enter new cities and introduce new products.

Three months later, the stock rose to another all-time high. Comps were healthy again for the first three months of the year. Goldman Sachs, one of the pedigree bankers on the Street, with no vested interest in Starbucks, predicted even higher profit margins and a higher stock price.

Investors were now phoning to congratulate me—some of them the same people who had called with serious concerns during the Christmas season.

What had changed? Again, nothing substantial. Starbucks was the same company in April that it was in January. The difference was that Wall Street suddenly decided the company was worth a lot more.

Running a public company is an emotional roller coaster. In the beginning, you accept the congratulations as if you really deserve them. Then, when the stock price falls, you feel you have failed. When it bounces back, it leaves you dizzy.

At some point, you have to divorce yourself from the stock price and just focus on running the business. You need to maintain a controlled calm throughout both the heady highs and the sickening lows. That sort of composure comes hard for me, because normally I respond very emotionally. But I’ve discovered how critical it is to exert strong, consistent leadership through both good and bad times, to be able to temper the morale swings of those around you. Most importantly, I’ve tried to make decisions based on what’s right for the company, not what’s right for the stock price. That’s one of the achievements I’m proudest of at Starbucks.

Every entrepreneur dreams of building a public company. But how many of us really know what we’re getting into? Not every company leads as charmed a public life as Starbucks has. If it’s been a wild ride for us, what must it be like for those whose companies do stumble?

Another old saying rings true here: Be careful what you wish for. You might get it.