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Looking for new growth avenues beyond coffee, Starbucks Corporation (SBUX - Analyst Report) has entered into a definitive agreement to acquire Atlanta-based Teavana Holdings, Inc. , a specialty retailer of tea for approximately $620 million in cash.

Teavana operates through 300 mall-based stores, which Starbucks plans to expand as well as establish new stand-alone Teavana neighborhood stores domestically as well as internationally. Moreover, Starbucks plans to open tea bars (which will make customized tea beverages) inside these stores, which presently sell only loose-leaf teas and related merchandise.

We believe that the coming together of Starbucks and Teavana provides the former a global opportunity to create a unique retail experience in the $40 billion tea category. Starbucks claims that tea is the world’s second largest beverage category with huge scope for innovation, which it plans to exploit. Management stressed though that the push into tea does not signal a slowdown in its core coffee business.

The acquisition is complementary with Starbucks’ already existing core tea business of Tazo tea. Starbucks sells Tazo tea in stores as well as across foodservice channels. Over time, Starbucks plans to create a two-tiered business where both the Tazo and Teavana branded products will co-exist.

Starbucks is constantly on the lookout for new businesses, which complement its core coffee offerings. Six months ago, Starbucks acquired bakery chain La Boulange and a year back it bought Evolution Fresh juice stores to expand its footprint beyond coffee. Teavana is another step in that direction.

Teavana shareholders will receive $15.50 per share in cash for the merger, which has already been approved by 70% of Teavana shareholders through written consent. Per the agreement, which is expected to complete by calendar year end, Teavana will become a wholly-owned subsidiary of Starbucks. The acquisition is expected to add a penny to 2013 earnings.

Our Recommendation

We currently have a long-term Neutral recommendation on Starbucks. However, the stock carries a Zacks #2 Rank (a short-term Hold rating) which implies a short term buy rating. Starbucks is gaining momentum with solid results in fiscal 2012; regular product innovations like the recently launched at-home coffee machine, Verismo; and great strategic deals like La Boulange, Evolution Fresh and now Teavana.

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