Most people that own KKD know they have problems. Unfortunataly, they are in the process of a turn around, and as Warren Buffett explains, "Turn arounds seldom turn." And he further explains they should be altogether avoided. This is in my mind and has certainly tempered my bullishness.
I looked at KKD this way however: I think Brewster and Cooper are basically honest guys. I was a little suprised that Cooper did not put KKD in bankruptcy. That is his typical M.O. The fact he didn't, and took stock for a success fee, is a huge positive in my simple mind.
Brewster is also relativly unproven in this particular venue, but I understand the situation and I am willing to wait and see what happens here.
If you examine KKD's financials prior to the Scott Livengood disaterous expansion, KKD would earn about 13% on sales. These figures didn't need restatement. So I take them as truthful. Bears will say this margin can NEVER happen, but it already has happened. The question is: Can it happen again? Of couse I believe it can. More importantly, I expect Wall Street to expect it, eventually. I don't expect much more or less than 13% if everthing goes right. Tim Horton's is also around this margin too.
If KKD has a revenue run rate of 500 mil, that is a potential 65 mil in earnings. This won't happen overnight, but this is what I expect. I have not factored in any positives like sales and store growth, better then average margins, smaller store concept, or menu expansion. (Yes, I do know about the Beatrice issues with this). I simply looked at what the company looked like before Livengood and applied today's metrics.
I simply think franchises like this are harder to kill than the bears imagine. Warren Buffett said also that you should buy companies complete idiots can run because one day they will. Livengood is an example of this, and I still laugh when I think of him, but those days are over. Bears don't seem to think this way, and I respect that.
I could wait for every piece of relvent financial news to be released, but by that time it could be too late. I believe KKD will end up being at growth company with 13% after tax margins.
Bears will say you don't really know. In a word yes, but if I wait I could end up paying $22.00 for the certainty.
>But the problem is that KKD can't franchise in the U.S. until it's financials are up to date. And even when that happens it will be difficult to get any franchisee to buy stores from KKD after the last group lost their shirts.
OK, forget about KKD selling all of their stores to franchisees, that was just an idea.
>What would KKD management say to convince them that the economics of the business have changed? The existing economics drove some of these guys into personal bankruptcy. And the new franchisees would have to pump in millions to update and fix the stores.
Management doesn't need to say anything. Just continue and if possible accelerate the international expansion! That appears to go pretty smoothly. Since they are building new stores, there is no need to "fix" them. With the present signed deals, there should be at least 100 more KKD stores within the next 5 years. And there are so many more countries that are just there waiting to be conquered. You can have an additional 200 stores elsewhere in 10 years. Pure profit. The 13% goal may then seem to be too low!
On 12/16/1999 KKD filed it's S1 for the IPO. Look it up on Edgar please. It provides a summary of the prior 5 years financial history. Those previous 5 years, net income fluncuated between -$3.1M and +$4.6M. It's best year percentage wise was CY 1994 (ending in Jan 05), where the 4.6M in net earnings was on $114M in sales, so less than 4.5% net margin. The average net profit margin for those five years was barely more than 1%. A 13% margin for KKD is a fantasy that bears no resemblance to the truth.
After that period, KKD was able to hugely increase margins, operating profits, and growth rates by inducing franchisees to rapidly open new stores. KKD earned excess profits from the franchise fees, the equipment markups, and the mix markups. But the new franchises were, in aggregate, unprofitable. KKD could appear profitable because it offloaded the actual store losses onto it's franchisee partners.
As you know, the franchisees ran out of money, stopped expanding, and in many cases went out of business, or cut back their store counts dramatically.
Brewster and Cooper may be honest guys. But they've been dealt a tough hand. KKD is a bakery. When run well, it has very low margins. Current franchisees are stuck with stores that are too large and too expensive, built to a business model that doesn't work. It has never been a premium franchise, it has never produced premium franchise profits (except than a period of inducement of franchisees that was arguably fraudulant). It's brand is well known, but there is a big difference between having a well known brand, and healthy business.
Hortons and Dunkin Donuts figured out long ago that just being a baker and selling donuts didn't offer high margins. They are coffee retailers that also sell donuts. That's why their franchisees make money, and their business has high margins and strong growth.
Perhaps Brewster can find the hundreds of millions needed to shut down the large inefficient stores and open new smaller stores. Perhaps he'll find a coffee product that will actually draw in regular repeat business. But even then, he's years behind the leaders in that market who are locking up the best locations and repeat customers. So what will make KKD a growth business? It's unlikely to ever be able to franchise successfully in the U.S. again after what happened to the last group.
Warren Buffett would tell you there is no economic history to show KKD has ever been a strong enough franchise to fit into his category of a business a complete idiot could run. He'd instead use another favorite saying, that when a manager with a strong reputation enters a business with a reputation for poor economics, it's the reputation of the manager that will suffer.
That is the way it was..You see, this is why bears get into trouble. Call me naive, because I deserve it, but what I am hearing from you is an exact account of what has already happened. Thank you. But to build a short position on this? I have a question: What value added as a bear are you bringing. I see a thoughful trend extrapolation of conditions that have been in place for six years, but nothing new. I don't even see the possiblity of change a change for the better in your analysis, and this is exactly what I'm counting on..
My research goes a little deeper into the history of stores, the 1976 Beatrice aqusition, the LBO by management, etc..I think things are a little diffrent now, and I feel I have a good understanding of what it could look like. I am sticking by 13% after tax margins. You think they are identical or worse than six years ago. That had better be.
"Warren Buffett would tell you there is no economic history to show KKD has ever been a strong enough franchise to fit into his category of a business a complete idiot could run. He'd instead use another favorite saying, that when a manager with a strong reputation enters a business with a reputation for poor economics, it's the reputation of the manager that will suffer."
Well its been around since 1937, which is longer than most businesses. Mabey there is something to it afterall..
BTW, during the five years referenced in the S1 (and including the 9 months of the next year) KKD had to take two writeoffs to close stores. If you ignore those charges (which is incorrect since closing down bad stores is a cost of doing business), KKD had $863M in revenues, and net profits of $24M-ish. That's a total net profit margin (before charges) of 2.8% for the entire period.
Applied to todays $440M run rate, you'd expect about $12M in annual net profit, or about 20 cents per share. So today you are paying over a 40 PE, not on earnings, but on possible earnings. A 40 PE is still a huge premium to pay for a growth company that is in the middle of years of consistant, profitable growth. But you are paying that for a company with no growth, no earnings, and still hasn't shown any real signs of a turnaround. You also have to ignore that
- Today's KKD is buried in high cost debt it didn't have in the 1990s. Those higher interest costs make it even harder to reach those slim margin levels.
- That Brewster needs more capital to fix the business. If he's able to get financials updated, he'll probably need to increase that 60M share count dramatically to pay for those changes.
- That not only isn't KKD a growth business, it's shrinking.
- That KKD may need to file bankruptcy and if it does, common shares will be worthless.
- That you don't have any recent, relevant financial data detailed enough to make an accurate valuation estimate from.
You are worried that when you get accurate financial data, that the price will respond and you'll lose a bargain. I'd say that you are overestimating how fast the market will respond. You are assuming huge risks now to ensure you don't lose out on an unlikely opportunity tomorrow. If KKD was trading for $1 per share, I'd understand the risk reward ratio much better. At $8-$9 you are overpaying by at least triple for a KKD that could produce the same margins as it did in the late 90s. And we know todays KKD is far from being able to even achieve that, so you are overpaying that much more.
We own the stock huge and like the turnaround story. Yeah there is hair on it but the way to make money is to do the type of rational thinking you put together. It is not going to turn on a dime but if you look at the Dunkin transaction, it traded at 10x EBITDA. KKD should trade at some discount to that until it re-proves itself but based on old EBITDA projection, a cleaned up operation and some growth, it does not take much on the execution side to dramatically move the enterprise value much higher.
They will file by the deadline and everyone can start digging into the financials and the story and make better valuation assumptions. It is hard to kill off a premier brand and make no doubt about it, KKD's are a great product that are still loved by the public. Management has great incentive to "fix" the company and I believe they will. The only real question is, what is the right price for this stock. It will not file so take bankruptcy off the table.
The other driver of the stock is the fact that 33% of the shares are sold short and create alot of upside should the company execute its turnaround. I don't believe in technicals, just solid research and thinking.
Why are you so confident that KKD will file by the deadline? Their track history is not to file and as I have pointed out KKD management has made no statement or promise that they would file by the 31st.
When do you think the quarterly reports will be presented. Much has happened with KKD's JVs and ADs since the January 29th year end.
Thanks for the white light..The short position will help, but I have mixed emotions. Short sellers are normally "right", so it does bother me to see a position this size. I do belive short seller can be wrong though. AMR is a good example..At 6.5 it had 33% of the float short and is now almost 30.
I believe it can only help the longs here.
"If KKD has a revenue run rate of 500 mil, that is a potential 65 mil in earnings. "
This is a big, big assumptiopn. If KKD has been consistent at something, it is lower and lower revenues per quarter. Last quarter revenue was $111M. The previous it was $116. Unless you are assuming $111M is the bottom, it will be a while before (if ever) you see revenues of $500M.
"This won't happen overnight, but this is what I expect. I have not factored in any positives like sales and store growth, better then average margins, smaller store concept, or menu expansion. "
Brewster has been at the helm for almost 8 months. The restructuring is now about 18 months now. What net positives have you seen? How much longer are you going to wait for these positives to develop? How much longer are we going to wait for the smaller store concept, new menus, etc.? At what point do we simply conclude these won't happen?
13 percent after tax margins (20 percent pre-tax)does not seem possible.
The prior numbers are not to be relied upon according to KKD itself.
During KKD's growth phase, it made a substantial profit selling equipment to the new franchisee stores as well as profit from initial franchise fees. Both of these sources of revenue are now non-existant. Also, KKD has made very good margins overcharging for mix and supplies to the franchise stores. This margin still exists but it is way down and the future of the area developer stores is not good based on closings and bankruptcies of these 'ADs'.
See this is where your logic doesn't make sense. You are telling me that KKD has been unprofitable every year since 1937. Is this true? Has all numbers since 1937 should not be relied upon? The have overcharged for mix and equipment for seventy years? They have actually never made any money?
Let me ask you this. Beatrice bought KKD in 1976. Guess what-KKD sold doughnuts, but according to you "KKD has made very good margins overcharging for mix and supplies to the franchise stores. This margin still exists but it is way down and the future of the area developer stores is not good based on closings and bankruptcies of these 'ADs'."
My research on the Beatrice purchase shows 13% margins for KKD. Ultimatly, I don't think their business will be or can be too much diffrent from the way it was in the 30s, 40s, 50s, 60s, 70s, 80s. Why won't the EVER do 13%? You are taking a 70 year period and taking 6 exceptional years and saying this is the way it will always be. I'm taking 63 years and saying this is how i will probably be. 13% margins.
Now, if only any of that means they can make a profit.
This is a dead dog period.
It never had the appeal that would produce the need for a food show. Any feeling that KKD had a plan and valided marketing comcept is fool hardy.
Every move this stock was to fool the investor. It planned to make money for the insiders and when they did they even wanted more. The team that took this stock public must have had pirates blood, Eye patches, and a parrot on their shoulders.
Only issue one need to review is the rate of growth of competitors to see how wasted their investment in KKD stock was.