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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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    • 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)?

    • 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".

    • Precisely - you now have the game.

      The franchisees KNOW they are stuffed. Their objective - get out of the game as much skin as they can before they fold it over.

      Cooper will not close stores nor will the franchisees (unless the stores are very cheap to close) because they close easily in the bankruptcy.

      This strategy is real. Its just very high stakes and if you are a franchisee you would need to think how you maximise your exit from this disaster.

      Zip

    • 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?

    • <<<... and if you are a franchisee you would need to think how you maximise your exit from this disaster.>>>

      I would think that most franchisees are already slow paying or even withholding the franchise fees. I would be making 1,001 excuse why not to pay on time and in full the loans for equipment that are due to KKD. The reason is that I have no clue what's going to happen to the mother ship or I have a suit pending against KKD...

      In the end, it boils down to, does KKD want a little money from the franchisee's royalties and loan payments or do they want to foreclose on the store and take their liabilities and have to make some big writedowns.

    • If franchisees have greatly slowed or even stopped ALL payments to kkd (including payments for mix), then the remaining $75 million (of the $225 million loan) will go fast as it effectively keeps the franchisees afloat.

      This is another incentive for pooper scooper not to release info, i.e. we don't know what's going on with kkd receivables (franchisee payables) and cash balances.

      kkd would be hesitant to foreclose on the franchisees (for violating franchise agreements) or even cutoff mix "sales" as the resulting publicity (from sudden store closures or a spat between the franchisee and kkd) would make more clear the flaws of the business model.

    • Slow paying - of course... you would rather pay yourself than KKD.

    • di_vur_se_fi wrote:

      "If franchisees have greatly slowed or even stopped ALL payments to kkd (including payments for mix), then the remaining $75 million (of the $225 million loan) will go fast as it effectively keeps the franchisees afloat.

      This is another incentive for pooper scooper not to release info, i.e. we don't know what's going on with kkd receivables (franchisee payables) and cash balances."

      Precisely. It is not hard to file the accounts of a donut chain. Even if the data is stolen there are accounting procedures for filing fress start accounts.

      Cooper is sophisticated enough to know those procedures. So what is going on here is an ELECTION by Cooper not to file accounts.

      He does not want to file accounts because this is a game of chess with the franchisees.

    • "I don't agree that the franchisees are toast. I think KKD is toast the franchisees have the leverage. KKD needs them more than they need KKD."

      Maybe... It is the franchisees interest to avoid paying KDD anything. If the franchisees can outlast KKD then KKD goes bust and the franchisees have an arrangement - presumably on much better terms than the existing arangement.

      But I still think this is unlikely. I suspect that the franchisees are stuffed either way. The franchisees have built too many stores and committed too much for equipment. The franchisees also have to close stores. In other words - for most of them bankruptcy or handing over to KKD is the right outcome.

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