STRATEGY

Did Seth Go to the Dark Side?

Another natural foods guy sells out. Seth Goldman, founder of Honest Tea, says his deal with Coke is all part of staying true to his mission.
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For 10 years, since he founded Honest Tea, in 1998, Seth Goldman has been among the heroes of the natural foods movement. Even as his company took off, Goldman held true to his socially responsible ways. Honest Tea still buys its ingredients at fair-trade prices from small organic farms around the globe; its lightly sweetened drinks for kids are sold in pouches that can be recycled into pencil cases. In 2007, with Honest Tea's sales up 70 percent, to $23 million, Goldman enjoyed poster-boy status among the organic foods crowd.

But that was before his deal in February to sell 40 percent of his company to Coca-Cola (NYSE:KO) for an estimated $43 million. For many in the natural foods world, that's tantamount to selling out to the Evil Empire. Natural foods activists have excoriated Coca-Cola for peddling unhealthful soft drinks and tolerating environmental and labor abuses by its overseas bottlers. "You just signed a deal with the devil," one former fan vented on Goldman's Honest Tea blog. Goldman is responding to his critics on his Inc.com blog, where he is also getting his share of praise from those who support the Coke deal. (Goldman's blog is at blog.inc.com/the-mission-driven-business.)

Goldman argues that his decision to team with Coke isn't just good business but good natural foods policy. Like many niche products, Honest Tea has struggled to find its way into mainstream outlets such as supermarkets and convenience stores. Goldman says the company's patchwork of distributors wasn't enough to get it on such shelves outside of a few major cities. Convinced that Honest Tea had to go for a national presence to be successful (despite its sales, the company isn't profitable), Goldman began talking with suitors in mid-2006. In the end, Goldman figured, what better partner than Coke to help Honest Tea take its products to the masses?

Just as important, says Goldman, teaming up with a big corporation is the only way Honest Tea and companies like it can have the impact on society they desire. If Coke can get it in front of more consumers, Honest Tea will not only grow but also will amplify the good it does in the world, through such practices as sourcing ingredients from sustainable farms and encouraging consumers to be healthy and recycle. "Our mission is to democratize organics," says Goldman. "The best way to protect what we've done is to make it big."

That's what the natural products guys always say when they sell. But the organic foods movement sees the entrance of the mega-corporations differently. "They're here because organics have proven to be the fastest-growing segment of the market," says Craig Minowa, an environmental scientist with the Organic Consumers Association. "As they step into it, the organic market is literally getting trashed." And boy, are they stepping into it. Last fall, Clorox paid $913 million for Burt's Bees, maker of beeswax-based lip balms and lotions, and Kellogg picked up a pair of natural foods brands, Bear Naked granola and Wholesome & Hearty Foods, for a combined $122 million.

The buying frenzy has many in the natural foods movement feeling glum. "The club of people who haven't sold their business is getting smaller and smaller," says Jeffrey Hollender, president of Seventh Generation, which makes environmentally friendly household and personal care products and which remains independent. "What I worry about is bolting on a green, natural, responsible business to a larger company that is fraught with problems. Quite honestly, I think the best you can hope for is that the larger company doesn't screw the smaller one up."

Goldman is betting he can do far better than not get screwed up. His deal began last August with a call from Coca-Cola, which, he says, was interested in buying the company outright. Goldman and Coke agreed to a 40 percent stake and "a path to control" for Coke. In three years, Coke will have the option of buying the rest of the company. Until then, Honest Tea will remain independent while gaining access to Coke's mammoth network of distributors as well as its relationships with restaurants, schools, and other institutions. The two companies are already testing Honest Tea in Subway outlets in California.

Keeping control of the company for three more years and then selling to Coke will also allow Goldman to make more for his investors, assuming he can, as he expects, rapidly expand the brand. That would increase the sale price of the remaining 60 percent of the company. "We think there's still a lot of value to build," says Goldman, who predicts Honest Tea sales will hit $100 million by 2011.

Goldman compares his pact with Coke to the French conglomerate Groupe Danone's purchase of 80 percent of organic yogurt maker Stonyfield Farm, whose CEO, Gary Hirshberg, sits on Honest Tea's board. Hirshberg endorses the comparison. "Coke is most interested at this point in Seth growing a substantial brand," says Hirshberg. "They recognized that he's got a heck of a long way to go, and they're willing to underwrite that."

But unlike Goldman, Hirshberg will keep control of his company and can't be replaced as CEO as long as he meets performance targets. "The reality is, after three years, Coke owns Honest Tea," says Steve Demos, who sold White Wave, maker of Silk Soymilk, to Dean Foods for $204 million and was forced out three years later. "That business is only safe as long as the senior management permits it to be so. It's my experience that he who owns the equity rules the day."

If Coca-Cola does acquire the rest of Honest Tea, it will be able to do whatever it wants with the brand. For starters, it could put pressure on the company to cut costs. In a worst-case scenario, says Phil Howard, a professor at Michigan State University and an expert on the organic foods industry, such cost reductions could include substituting cheaper ingredients, such as high-fructose corn syrup, or boosting the number of ingredients that don't meet organic standards.

That would be bad news for all the Honest Tea fans who expect natural foods companies to operate in keeping with their personal values. Many already see the writing on the wall. "I understand that it is their business, and money does rule the world," says Anne Axelrod, a Chicago telecommunications consultant who has expressed her disappointment with Honest Tea on its website. "But I was hoping for something better. I've decided not to buy any more." Goldman says not to worry, but he feels his consumers' angst. "Before I got into all this," he allows, "I might have been that same consumer."

Andrew Park is a writer based in Chapel Hill, North Carolina.
Last updated: May 1, 2008




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