WSJ Report

Starbucks Corp. is betting its future on its coffee shops.

To do that, the Seattle-based company has removed a distraction by selling the rights to offer its coffee and tea in grocery and retail stores to Nestle SA for more than $7 billion.

Coffee sellers from Dunkin' Brands Group Inc. to McDonald's Corp. have crowded supermarket shelves with branded bags of ground and roasted beans. Starbucks products will give Switzerland-based Nestle a bigger stake in that fight without having to introduce a new brand to U.S. consumers.

For Starbucks, the consumer packaged-goods business generated $1.8 billion in revenue in fiscal 2017, just 8% of Starbucks's total.

"While consumer packaged goods is an important and highly profitable business, it's small," said Michael Schaefer, head of Euromonitor's global food and beverage practice.

Sales have been slowing at Starbucks coffee shops in the U.S. as mall traffic declines and competition increases. Starbucks has opened higher-end stores under brands called Roastery and Reserve to compete with independent coffee shops and small chains that have grabbed sales from customers willing to pay more for specialty drinks and pastries. There are nearly 33,000 coffee shops in the U.S., according to market-research firm Mintel, up 16% from five years ago.

Starbucks also wants to open more coffee shops in China, a market the Seattle-based company said will eventually overtake the U.S. as its largest. The company recently opened its first Roastery store in Shanghai.

Retail operations in the U.S. and China "are our two big growth engines," Starbucks Chief Executive Kevin Johnson told investors on a call about the deal Monday.

Starbucks has dropped other ancillary businesses recently to focus on its coffee shops. Last fall, Starbucks sold its Tazo tea brand to Unilever for $384 million. The company recently closed its mall-based Teavana tea stores because of weak traffic.

Starbucks shares fell 23 cents to $57.45 on Monday. Nestle stock rose 1.6%.

The deal gives Starbucks an upfront infusion of cash that it plans to return to shareholders through share buybacks. Starbucks said it planned to give $20 billion to shareholders over three years in buybacks and dividends. That might assuage some shareholder concerns as Starbucks works to boost sales growth.

Nestle said it would pay Starbucks $7.15 billion as well as continuing royalties on all sales. Mr. Johnson said the partnership will raise familiarity with the Starbucks brand by getting its ground and whole bean coffee into international markets where it isn't currently sold.

Nestle hopes more coffee sales can offset flagging sales of some of its other packaged-food businesses. As part of the Starbucks deal, Nestle will add Starbucks Reserve, Seattle's Best Coffee and Teavana to a portfolio that includes the Nescafe and Nespresso brands. Nestle will also manage the business of distributing Starbucks K-Cups, the single-serve coffee pods used in Keurig brewers in North America.

Mr. Johnson said Starbucks is the No. 1 coffee brand on the Keurig system. "We intend to keep that," he said.

The transaction doesn't include any fixed assets and excludes Starbucks's ready-to-drink products. Starbucks has partnerships with PepsiCo Inc. and Anheuser-Busch InBev SA to produce, bottle and distribute its ready-to-drink coffee and Teavana teas. The deal also doesn't include sales of products at Starbucks coffee shops.

About 500 Starbucks employees will join Nestle.

Starbucks must approve any new products to be sold under the label.

The deal comes as JAB, a European holding company, has moved aggressively into the American coffee business. The company considers the U.S. to be poised for breakneck growth as consumers shift away from soft drinks. JAB and Nestle view each other as top competitors.

"The coffee market is huge and growing and offers lots of space" for competition, Nestle Chief Executive Mark Schneider said in an interview.

Nestle has highlighted coffee as a priority, along with bottled water, pet care and infant nutrition. Nescafe generates about 10 billion Swiss francs, or roughly $10 billion, of Nestle's nearly 90 billion francs in annual sales. Nespresso's annual sales are more than five billion francs. Last September, Nestle bought a majority stake in specialty U.S. roaster and retailer Blue Bottle Coffee.

Nestle has been shaking up a product mix that stretches from DiGiorno frozen pizza and Perrier bottled water to Maggi noodles and medicinal foods. That has taken on more urgency since American activist investor Dan Loeb took a big stake in Nestle.

In addition to the Blue Bottle deal, Nestle last year bought California-based Sweet Earth, which makes vegan and vegetarian products.

Earlier this year, Nestle sold its U.S. confectionery business, which includes the Butterfinger and Baby Ruth brands, to Italian candy maker Ferrero International SA for $2.8 billion in cash.

Like other large consumer-goods companies, Nestle has struggled with competition from local upstarts and a rapid shift in consumer tastes toward locally grown, organic food. The company has also had trouble raising its prices.