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Krispy Kreme Doughnuts, Inc. Message Board

  • zipperdydoodah zipperdydoodah Jun 16, 2005 11:23 PM Flag

    Stephen Cooper's strategy

    I have spent some time puzzling over this - and I have wondered what Cooper's strategy really is. And I think I have it.

    But lets spell out the material as we know it.

    1). The business is loss making at the moment - we do not know whether it is loss making in an absolute sense - or whether it is only loss making after you run through the legal fees etc associated with the current uncertainty. But it is loss making after legal fees etc - and it is probably not very profitable net of those fees in the best case.

    2). There may be a profitable core. That is if you close down say 200 out of 400 stores you will wind up with a profitable 200 store franchise. It may be that you need to close 100 stores or 300 stores. There is SOMETHING there though - the brand is worth something and the way to extract that value is close unprofitable stores. As bulls are quick to remind you on this site - some stores are staggeringly unprofitable. This is the good news - because it means some stores are profitable. It would be bad news if all the stores were bad.

    3). So far Cooper has not closed many stores.

    4). Krispy Kreme has guaranteed many of the franchisees. KKD does not control all of the stores - and some of the franchisees are staggeringly unprofitable - noted by the fact they are breaching their debt covenants and KremeCo is bankrupt.

    5). There have been NO financial statement - and yet none of the accounting looks too hard. It simply does not look hard to account for a donut store. You might have problems because previous management stole the files regarding purchase of franchises - but there are even rules for "fresh start" accounting in these circumstances. If this were a case of stolen files we would be told that by now. So I am assuming that the filings have not been made because it is not in Krispy Kreme's interest to make them.

    So what is going on.

    Bears would say that he is not closing any stores because he can disavow leases in bankruptcy.

    But this is too simplistic. If that were the case he would just file bankruptcy now.

    Bulls would say he is not closing many stores because they can work it off. But that is implausible. Many of these leases are long dated.

    I got another hypothesis.

    If KKD files bankruptcy now then KKD only owns about 100 stores. Most of the rest are in the franchises who will file bankruptcy separately where necessary. So KKD does not want to file bankruptcy now. If they do they can't achieve the real objective here - which is to shrink this to the profitable 100 or 200 store franchise.

    But KKD can wait and wait (with Silverpoint's money bankrolling them). As they do the franchisees will one-by-one give up the ghost. KKD can't honour the debt but it can ASSUME OWNERSHIP OF THE FRANCHISEE - which is more or less what will happen with KremeCo.

    When it assumes ownership of the franchisees it winds up controlling all 400 stores. Only then does it file bankruptcy. Then KKD can shrink from 400 unprofitable stores to 100-200 profitable ones.

    Silverpoint will own it.

    There is NO POINT filing bankruptcy until the franchisees fold it.

    And there is no point filing the accounts until you have assumed the franchisees - because if you do that the gig is up.

    Its the only hypothesis I can think of that fits all the facts.

    Zipper

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    • I have spent some time puzzling over this - and I have wondered what Cooper's strategy really is. And I think I have it.

      But lets spell out the material as we know it.

      1). The business is loss making at the moment - we do not know whether it is loss making in an absolute sense - or whether it is only loss making after you run through the legal fees etc associated with the current uncertainty. But it is loss making after legal fees etc - and it is probably not very profitable net of those fees in the best case.

      2). There may be a profitable core. That is if you close down say 200 out of 400 stores you will wind up with a profitable 200 store franchise. It may be that you need to close 100 stores or 300 stores. There is SOMETHING there though - the brand is worth something and the way to extract that value is close unprofitable stores. As bulls are quick to remind you on this site - some stores are staggeringly unprofitable. This is the good news - because it means some stores are profitable. It would be bad news if all the stores were bad.

      3). So far Cooper has not closed many stores.

      4). Krispy Kreme has guaranteed many of the franchisees. KKD does not control all of the stores - and some of the franchisees are staggeringly unprofitable - noted by the fact they are breaching their debt covenants and KremeCo is bankrupt.

      5). There have been NO financial statement - and yet none of the accounting looks too hard. It simply does not look hard to account for a donut store. You might have problems because previous management stole the files regarding purchase of franchises - but there are even rules for "fresh start" accounting in these circumstances. If this were a case of stolen files we would be told that by now. So I am assuming that the filings have not been made because it is not in Krispy Kreme's interest to make them.

      So what is going on.

      Bears would say that he is not closing any stores because he can disavow leases in bankruptcy.

      But this is too simplistic. If that were the case he would just file bankruptcy now.

      Bulls would say he is not closing many stores because they can work it off. But that is implausible. Many of these leases are long dated.

      I got another hypothesis.

      If KKD files bankruptcy now then KKD only owns about 100 stores. Most of the rest are in the franchises who will file bankruptcy separately where necessary. So KKD does not want to file bankruptcy now. If they do they can't achieve the real objective here - which is to shrink this to the profitable 100 or 200 store franchise.

      But KKD can wait and wait (with Silverpoint's money bankrolling them). As they do the franchisees will one-by-one give up the ghost. KKD can't honour the debt but it can ASSUME OWNERSHIP OF THE FRANCHISEE - which is more or less what will happen with KremeCo.

      When it assumes ownership of the franchisees it winds up controlling all 400 stores. Only then does it file bankruptcy. Then KKD can shrink from 400 unprofitable stores to 100-200 profitable ones.

      Silverpoint will own it.

      There is NO POINT filing bankruptcy until the franchisees fold it.

      And there is no point filing the accounts until you have assumed the franchisees - because if you do that the gig is up.

      Its the only hypothesis I can think of that fits all the facts.

      Zipper

      • 3 Replies to zipperdydoodah
      • You are point on in my book.Before the Publis offering there was a "core" of active stores that were profitable.there is no doubt in my mind that once the Frans' are driven out ,a new KKD will arise.Not that any current equity holders will have any interest left...hank

      • Why pay even a nominal sum for franchises? If KKD wants to take stores from franchisees, they can do take away their franchise rights at any time without paying a cent. All franchisees are likely in violation of their franchise agreements, specifically agreements to open franchises on a specific schedule. Since there hasn't been a new store in years, my guess is they are all in violation. And revoking franchise rights means KKD can start over new store concepts in key markets, an possibly new franchise partners, etc, instead of being stuck with stores that are too large and expensive to ever make money.

        So why doesn't KKD revoke franchise rights? My guess is there are three key reasons.

        1) They'll lose the remaining franchise and mix fees they can suck out of the franchisees before they finally go belly up.
        2) Franchisees have legal claims and fraud allegations (ala GCFF) against KKD they will pursue in court, so KKD wants to play nice for as long as possible.
        3) KKD has no more borrowing capacity, and the $19M in remaining cash is dwindling with the recent cash outflow to buy GCFF and the loss of $3M+ in AR to Rigel. How are they ever going to build a new store or con a new franchise partner?

        I think the hubris of posters on this board is to think that Cooper or Silverpoint or the invisible new CEO have some "grand plan" to save KKD or instead, profit from it's demise.

        Instead, I think all parties are pedaling as fast as they can until the wheels fall off the bike. Cooper is making great money, they have no incentive to quit, bankruptcy just means more fees. The invisible CEO is a CEO of a public company for the first time in his life, he'll milk that for as long as possible and then blame the results on others (unless he can make a lateral move to another public company CEO spot). Silverpoint made a horrible loan that they are stuck with, I mean, is the guy who sponsored it even there anymore?

        Silverpoint doesn't want bankruptcy. Then they have to fight it out with all the other creditors, all of whom are going to use alleged fraud as a reason to move their claims in front of Silverpoint. So they'll milk KKD for as much interest as they can get before BK, all the while praying for some sort of magical turnaround that could enable them to exit with their loan fully repaid.

        The only way KKD buys more stores, even for nominal amounts, is if someone holds a gun to their head. That's essentially what GCFF did, and KKD was lucky GCFF ran out of cash and settled their claims cheap.

      • Many people (like me) have also believed the same hypothesis, but don't bother sometimes responding to people who just disagree about everything...so yes, you nailed it on the head in your post - the remaining question is merely about the time frames...

        Oh and also, I think Cooper needs to ensure that KKD corporate has control of a majority of the stores first prior to BK in order to control the Krispy Kreme brand, as I've mentioned. I don't know where that critical mass is, but it's obvious from franchisee comments that KKD corporate is trying to push the biggest ones into BK first. Conversly I think there are franchisees that are playing a similar game.

        Again I ask..."WHO (which lender consortium) HAS THE DEEPEST POCKETS?!?!"

        If I recall correctly, I think I posted this question LONG before your hypothesis post...

    • Nice post.

      Others here have hypothesized that bk (voluntary by cooper) has not happened to date because it can't, i.e. a certain amount of time has to pass before the previous lenders (the Wachovia syndicate) are protected.

      Regarding failing franchisees, my read of the loan covenants is that kkd is restricted to $15 million in capex and $6 million in acquisitions. How will they finance the asset purchases of the potentially bankrupt franchisees? Are you assuming that Silver Point will allow such transactions (because it fits your hypothesis of their end game motivation)?

    • Having missed the original discussion in its entirety, I have just read all 74 posts in retrospect of subsequent developments. Makes a lot of sense, yet things haven't worked out as suggested, particularly with respect to cash flow and timing -- the rolling up of franchisees is continuing but at a slower pace.

      Would be much interested in updated discussion from Zipper, Di_vur_se_fi et al.

      Cooper's strategy aside, how to rationalize the current share price, continued institutional longs, lack of trading volume, etc. Assumptions of stupidity and hedging aren't all that satisfying to me, yet??

      • 2 Replies to diogenes1234
      • <<Assumptions of stupidity and hedging aren't all that satisfying to me, yet??>>

        How about the stupidity of your continued declarations that Erskine Bowles will be indicted for corrupting KKD?? Pretty stupid, isn't it, digenetic?

        And your allegations that people that had waited in line at KKD openings were paid by KKD to do so?? Take a look at Lawboy's posted viseo....How many were paid for waiting in line at the HK opening? I'm sure you, the genus that you are, can pick 'em out on a video, right?

        Say, how's your and your daughter's favorite donut company, Wicnchells, doin'?? How much development do THEY have going on?

    • I once wrote a post (my first on this board) pointing out what Stephen Cooper's strategy is.

      The post is linked back and it suggested that Stephen Cooper was wanting to organise the franchisees to file bankruptcy first.

      At the time it was a controversial post - several people (prominent on this board) thought I did not have much grasp of the issue.

      But Di - bless him (or her!) did and (s)he instantly recognised it as an idea worth following.

      I am gratified that 4 months later my post is recognised by the major players on this board to be essentially accurate...

      I still maintain the sequential bankruptcy strategy is the one that will be followed. Buying shares immediately prior to bankruptcy (for nominal considerations - say 50 grand each) is the basic ideal... they need to give the prior owners something or the current owners might act to spite them. But small amounts will do...

      Zipper

      • 1 Reply to zipperdydoodah
      • That's actually what happened with Freedom Rings.

        kkd bought Freedom Rings 30% ownership stake for "nominal" consideration, then took them into bk.

        How would kkd replicate this with other franchisees?

        Much more difficult because the other franchisees have major non-kkd creditors (Freedom Rings doesn't - look at the creditor filing, they even stiffed a high school for about $1300 (I wonder if the hapless soul sitting in the drive thru at the closing of a suburban Philly store had paid for his doughnuts - lol)) who must be negotiated with and compensated during any reorganization.

        Also greatly complicating matters is the SCAP abuse lawsuit as kkd has found out with ST, Lonestar and gcff.

        I don't see any way that pooper scooper can pull this off in a timely manner and, given the horrendous cashflow, time is not on his side.

    • First, I don't get the sense that you've really researched this business in any depth and think you are overestimating its potential profitability. The economics of KKD outlets are mediocre at best, as demonstrated by the fact that KKD averaged only about $2.5 million per year profit for the 5 years prior to the IPO. That's not much to show for 60 years in business and about 130 outlets. The "profitability" that people see in the post IPO years resulted from (a) honeymoon sales periods from new corporate stores, (b) sales of marked up doughnut making equipment to new franchise stores, (c) royalties and doughnut mix markups from franchise stores that had huge sales during their honeymoon period and (d) almost certainly all kinds of creative accounting, including capitalizing expenses.

      KKD has traditionally been primarily a wholesale business. There's no evidence that they can make retail-only economics work.

      With regard to what's going on now, I suspect that as you suggest Cooper & Silver Point may be waiting for a few franchisees to fold and let that trigger KKD's bankruptcy. In addition to getting hit with loan guarantees, KKD will also have to write off accounts receivable and lose the royalties and doughnut mix markups from the failed franchisees. The royalties are virtually 100% gross margin and KKD's financials have a lot of leverage to them. KKD cash flow will become inadequate to service their debt as franchisees fold and sales continue to decline in corporate and franchise outlets opened in the last 2-3 years.

      Once KKD produces restated financials that show how much past profit was inflated and a few more franchisees fold (which I don't think should take much longer), the inevitability of a KKD bankruptcy will become more obvious and the stock will plummet. That reduces the risk of Cooper having to deal with more shareholder lawsuits relating to a premature bankruptcy filing.

      In addition, I recall that one of the conditions of the banks that were formerly KKD's lenders selling their loans was that the business was adequately capitalized to continue as a going concern for some period. Cooper and Silver Point may have a gentleman's agreement with Wachovia and BB&T to operate for a few months so that the banks are less likely to be charged with fraudulent conveyance and drug back into this swamp.

      I think Cooper and Silver Point have known where this is headed for some time and are letting it play out. Who will be surprised to see yet another delay in setting the terms of Cooper's "success fee"? Cooper knows the stock is worthless, but wants to let the market come to that conclusion rather than making it obvious with the conditions he has to meet to earn his "success fee".

      • 1 Reply to mungerian
      • You may be right. The most profitable store after they close them all down might only make $100K per year. If they have 50 stores in the most profitable outcome - then they make $5 million a a year - and that is not enough to make Silverpoint happy.

        Silverpoint is in my view suggesting that they can get to say 100 stores making $200K per year or $20 million. If they have that then the business might be worth $200 million and they will have acquired it for something like $120. (The line of credit will not be drawn.)

        But to get to 100 stores - the only outcome that makes any sense from Silverpoint's perspective - they need to have their pick of ALL the stores - not just the company owned stores - so they must assume the franchisees.

        They will. See you Mr Franchisee - $50 thousand for your business or you file bankruptcy. If you file bankruptcy we can't honour the guarantees we gave because Silverpoint (our lenders) consider that an event of default.

        So for you Mr Franchisee - its $50 thousand or nothing.

        When we have thus assumed the remaining franchises we file bankruptcy.

        Then Silverpoint owns the WHOLE business.

        Of course it only makes sense from Silverpoint's perspective if there are 100 good stores in the whole world.

        Zip

    • Interesting hypothesis but here is devil's advocate for you.
      Most probably the individual franchises are corporations in their own right.
      KKD the parent would only be a creditor of that corporation. If the franchise goes bust, KKD cannot take it over, it can only get in line.
      KKD cannot take over Kremco Cananda because it went bankrupt as only a partner in Kremco. The creditors still have to get the remainder of the saleable assets.

      • 1 Reply to marieldon2001
      • <<KKD the parent would only be a creditor of that corporation. If the franchise goes bust, KKD cannot take it over, it can only get in line.
        KKD cannot take over Kremco Cananda because it went bankrupt as only a partner in Kremco. The creditors still have to get the remainder of the saleable assets. >>

        not true - it's called DIP financing! pay all the creditors, become the only creditor, claim the assets of company. i.e. effectively get the company for the DIP amount.

        Now, in KremeKo's case they did not do that, they only put up a measly $1.5mm, so it looks like they don't intend on buying KremeKo unless they put up more.

        And by the way, if they want to acqire the company they can just pay creditors to go away, that's what ch.11 is for.

        So maybe they'll have to go into a ch.11, but defenitely not "get in line".

    • Well di_vurt, since everything you talk about is speculation, let's call it speculation.

      A chimp with a dartboard could make better choices than you anyway.

    • Is there some way to draw an actual KKD franchisee (not an emplyee, but the owner) into this discussion?

      On second thought, a high-placed employee of a franchisee might be privy to the owner's thinking.

      Anyone with connections -- or enough chutzpah -- out there?

    • How come this scenario, where Kooper grimly waits to outlast the franchisees, did not work with KremeKo? Why should it work with the others?

    • I didn't realize you had a dartboard.

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