Waking up to smell the coffee

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FOR a nation known across the world for its love of tea it is ironic that London now possesses more Starbucks than Manhattan Island. More surprising is that it was only 10 years ago that a little known coffee company named after Seattle opened its first branded shop in the UK.

Since then coffee culture has enveloped the UK like a frothy cappuccino. The endless march of Starbucks, which consumed the Seattle Coffee Company, has been accompanied by a host of other chains including Costa Coffee, Caff Nero and Caff Ritazza. Even Scotland has got in on the act with its own 13-strong coffee chain Beanscene.

The rampant growth of the market has surprised many who saw it as a temporary fad, and five years ago there was talk of saturation. But since then the number of cups bought in coffee chains has doubled to more than 6m, fuelling a market worth an estimated 1.1bn. According to market research group Allegra Strategies, the UK coffee market is forecast to continue growing at nearly 9% a year.

With this growth forecast, shares in coffee chains ought to be going through the roof. Not so. Last November, shares in Caff Nero were hovering around the 255p mark but have since slumped to a low in July of 186p.

A quick analysis of the figures shows there was no good reason why the shares fell. From a trading standpoint Caff Nero has continued to perform very well. Sales growth and profits have climbed substantially.

Now its entrepreneurial Californian chief executive has decided to inject his own shot of espresso into the firm by indicating that he wants to take private the business he founded in 1997 and floated in 2001.

Analysts say that Ford is increasingly frustrated with the share price performance. Yet some argue that given that he and his associates hold about 43% of the shares, they can see an opportunity to acquire a company on the cheap that has the potential to topple Starbucks.

Caff Nero has 250 UK stores and expects to have a further 10 open by the end of this year. But it is the overseas market that really excites Ford. He expects to sign a franchise agreement in the Middle East, but is also considering the possibility of expansion through a joint venture with a local business in northern Europe.

One source close to him says that to achieve his expansion plans he needs to take on more debt - something that is much easier for a private company. The source says: "Ford's ambitions lies overseas. He believes Caff Nero has the capacity to rival Starbucks on the international stage in Europe. By taking it private he has a damned sight more privacy then he does listed on the stock exchange and he can also take on more debt. Private companies tend to have a little bit more room to be entrepreneurial."

The UK remains by far the most important market with more than 2,650 branded coffee shops, but Europe is potentially massive. According to IGD market research, across Europe 190 billion cups of hot beverages are consumed out of the home each year.

A number of countries are poised for substantial growth. In particular, Ireland, Holland, Spain and Sweden. France, Italy and Belgium, despite drinking a lot of coffee, remain underdeveloped in terms of chains relative to their populations.

Outside Europe, India and China have also experienced huge growth with international caf chains entering the market as well as the development of domestic players.

Ford is adamant Caff Nero is ideally placed to beat Starbucks to the punch. When he created the chain in 1997, he positioned Caff Nero as a European-style chain intended to be distinct from Starbucks. This is most notable in its coffee, which is stronger and less milky.

One analyst said: "Nero is a distinct offering and it is feasible that Ford could eclipse Starbucks, especially on the Continent where a more European-friendly brand is more likely to be more successful with the consumer."

But there is, of course, the possibility that Ford's "informal approach" could kick off an auction for Nero, a scenario which would not surprise Mark Brumby, leisure analyst at Oriel Securities,

"Stranger things have happened," he said: "It could be a real possibility and there was some speculation that this is why he made his move in the first place. I suspect his phone is probably ringing out with potential buyers at the moment.

"These would fall into two camps: venture capitalists or a rival chain. If it was a rival chain it would be either Starbucks or Costa Coffee, with Costa Coffee probably being the most likely."

One thing analysts do agree on is that there will have to be consolidation in the UK coffee market. Starbucks, Whitbread owned Costa and Caff Nero accounted for 70% of new openings last year.

But branded food-focused players such as Pret A Manger and EAT have grown rapidly in recent years and are looming in the background waiting to snatch market share.

Allegra Strategies says that these "food-focused" outlets are growing at 6.4% per year and they can certainly compete on price. A quick comparison shows that whereas a cup of coffee costs on average 220p at Caff Nero and 219p at both Costa Coffee and Starbucks, it comes in at only 170p at EAT and 179p at Pret.

Jeffrey Young, managing director of Allegra Strategies, said: "The market has surprised many people with its growth. Our findings show that there is still room for a number of brands in the marketplace, but there will be consolidation. Non-specialist players like Marks & Spencer are also increasing the availability of quality coffee, which will further drive demand."

The market is also going to have to react to a number of differing trends. The availability of fair trade coffee, driven by corporate responsibility, will become more important to consumers, as will healthier eating trends such as the introduction of fruit juice and smoothies.

Food will become increasingly more important. Earlier this year, JD Wetherspoon, the giant pub operator known for its cheap ale, announced it was to roll out a series of stand-alone coffee shops to tap into the lucrative breakfast market.

Breakfast is likely to become a battleground. Croissants and muffins already feature heavily on menus, but this could be complemented by toast, hot breakfasts and cereals, as well as arange of brunch snacks.

Who knows? One day London might boast more delis than New York.