Starbucks’ Under Fire: Impact of a Hypothetical Terrorist Attack on Starbucks’ Financial State

There are several regions with incredibly tense and unstable political situations and high anti-American sentiment. The probability of escalation in some of those regions is relatively high, and there is possibility of terrorist attacks on American companies. Starbucks is known as a supporter of the U.S. Military (Starbucks Stories, 2005) and an iconic American brand, so it could become one of the targets. In the following paragraphs, the hypothetical terrorist attack’s impact on Starbucks’ performance (immediate and 12-month effect) will be analysed.

Case Scenario

In this paper, we analyse a bad scenario: three synchronous attacks with bomb explosions at Starbucks coffee shops in three different locations across North America and Europe, so it is obvious that the terrorists’ aim was not just a random café but specifically Starbucks.

Assumptions:

• The hypothetical attack happened in October 2020 (the first month of Starbucks’ fiscal year 2021);
• After the initial attacks, no further attacks followed;
• Without the attack, Starbucks’ financial statements for 2021 fiscal year would have been identical to that for 2020 fiscal year;
• After the attack, Starbucks implemented improved security systems (it would be a logical step).

Besides the assumptions above, there are also several logical expectations regarding the behaviour of the company, its clients, and investors. First, as for the immediate reaction for stocks – a deep fall (more than 10%) in the first day or two; for clients — a drop in the number of daily visitors for several weeks; also, Starbucks very possibly would temporarily close some cafes for safety reasons and many employees would likely resign or start to miss their shifts. Everything affected by these changes would come back to a normal state within less than one year. Secondly, there are long-term changes expected for the business model in order to get customers to return: additional costs for security standards improvement, higher staff rewards, additional promotion in media, more discounts, and investments in delivery systems.

Financial Impact

Financial Statement

Balance Sheet

For the Asset part, the effect would most likely be expressed in Goodwill and other intangibles decline (as the reputation for investors would be hurt), and a decline in Cash and equivalents (as borrowing would be more expensive the company probably would issue less debt). Also, a slight increase in Property, plant, and equipment is expected due to the security system implementation. This increase counterbalances the damage to the cafes themselves and associated property repair costs.
In Liabilities, we probably would see an increase in Accounts payable and Operating liabilities (for flattening unexpected cash outflows). Operating lease liability would stay relatively stable, because they most likely utilise multi-year lease contracts, and the same for Deferred revenue; however, Long-term debt would increase as it did for the last many years (possible reasons will be discussed under CEO-compensation).

Income Statement

The drop in the annual Total revenues is not expected to be very high – not more than 8-10% as we expect the Starbucks’ client traffic would fully recover within several months. The after-attack additional costs, mentioned in the Case scenario, would lead to higher Store operating expenses (increased security) and Product and distribution costs (more discounts, more delivery). Store operating expenses as a percentage of company-operated store revenues would also increase. The Goodwill decline would reflect in higher Restructuring and impairment expenses.

As a result, the decline in operating revenue and raising of expenses would result in a double strike to Operating income and overall Net income.

Cash Flow Statement

As mentioned above, a decline in net earnings is expected, however, the company may afford one or two billion USD increase in payables, which can improve the picture for Cash from operation activities.

Considering that we expect investments in security systems, they will be reflected as an increased Additions to property, plant and equipment. Other cash flows in investment and financing activities are strongly dependent on management’s tactics (the more effective choices are not obvious, so different combinations are possible): for example, would Starbucks issue a new debt and how much? Would they repurchase dropped stocks and how much dividends to pay?

Cash Flow Statement

As was mentioned in the paragraphs above, a decline in net earnings is expected, however, the company probably may afford one or two billion USD increase in payables, which can improve the picture for Cash from operating activities.
Considering that we expect investments in security systems, they will be reflected in increased Additions to property, plant and equipment. Other cash flows in the investment and financing activities part are strongly depended on management’s tactics.

Financial Performance

The most evident statement about the financial performance is that it would be worse than the industry average. Given the aforementioned changes, Starbucks’ Net revenues, Net earnings and EBITDA would decrease (and the company maybe would not increase dividends). This decrease, however, is expected to be not higher than the 2020-to-2019 COVID-related decline of ~11% for revenue and ~45% for EBITDA.
With its negative shareholders' equity (the deficit persisted since 2019), Starbucks already looks unhealthy: in the 2020 annual report, liabilities were almost $8 billion higher than assets, and this gulf would increase in the after-attack annual report. This fact may cause concern to investors and lead to higher stock volatility.

Intangible Assets

Besides Goodwill, there are other intangibles which would suffer from the terrorist attack. One of those is Starbucks’ trademark — it may lose value if Starbucks’ name is associated with explosions and deaths (but a long-term decline in trademark price is not expected).

The trademark value changes can be tracked by several metrics such as: how much partners are ready to pay for the company license, how much Starbucks merch people buy, or how much customers are ready to overpay for a Starbucks’ product compared to the same no-name or other-brand product.

To tackle this issue, Starbucks would need to invest in promotion and advertising.

CEO Compensation

The CEO Kevin Johnson at-risk bonus makes up 96% of his total compensation.

The target annual incentive is 7% of the maximum compensation and is based on Adjusted Net Revenue and Adjusted Operating Income (also, there is an individual performance factor, assessed by the Compensation Committee but we’ll not focus on it). To increase these metrics given the circumstances, the CEO could push the company to expand and open new cafes during the year; and, to do so, Starbucks would have to take on significant additional long-term debt.
The main 89% of the maximum compensation is the long-term Leadership Stock Plan, 60% of which is performance-driven: based on 3-year changes in Earnings per share (EPS) and Total return to shareholders (TRS) measures. Again, the CEO would promote the issuance of long-term debt in order to pay high dividends (for TRS) and repurchase stock — it usually leads to increasing of stock prices (good for TRS), and it reduces the amount of stock (so EPS grows). In fact, it is exactly what we see in Starbucks’ annual reports for the last few years. 

Considering this context, the long-term debt taking and stock repurchasing most likely would continue even after the attack. 

Immediate Effect on Main Financial Ratios

The strongest changes in the financial statements are expected in the first after-attack quarter report. The most-affected financial ratios for that quarterly report would be those linked to earnings and cash from operations (the first month would be the worst for sales), and assets (decline in Goodwill and intangibles, and decline in cash if the company does not issue new debt during that short period):

Conclusion and Additional Info for More Precise Assessment

Overall, Starbucks, with its huge leverage, is already not in the best financial state: falling into long-term debt to repurchase stocks and pay dividends. Terrorists would make it worse, mostly by reducing the revenue and increasing the operating costs, leading to an even higher debt and leverage ratio as a long-term effect (as top management is interested in long-term borrowing).

In order to make a more precise assessment, additional analysis would be needed, and also it would be helpful to know/assume several additional factors, such as: where the attacked cafes are located, what the habits and the brand loyalty in those countries are, if there are threats of new attacks (and how long they are would continue), how advanced the current delivery system is, what methodologies the company uses to assess intangible assets and Goodwill, and what the company long-term plan of expansion is.