The details of my Big Bet against Krispy Kreme

[DesertCat]

I can't give you good advice. I've taken a "let it ride" attitude, thinking my upside is so great from really bad news that I don't want to take any profits now. But a big portion of my options are $5 or $2.50. The higher priced options don't have as much upside, and I've thought of selling some to cover some of my costs. But I haven't done anything yet.

[jjp]

I understand about advice, I guess I was really interested in if there were any scheduled cash flow or earnings releases coming up.

I don't have a big bet against them, just some of my fun money that I play the market with.

[DesertCat]

[ QUOTE ]
Ok, I should be done buying (for now). Total investment about $20,460, total commissions probably $400.

49 KKDQU ($7.50 May) bought at 35 cents, cost $1,715
50 KKDTU ($7.50 Aug) bought at 85 cents, cost $4,250
50 OKKMA ($5 Jan 07) bought at 45 cents, cost $2,250
100 OKKMZ ($2.5 Jan 07) bought at 15-20 cents, cost $1855
50 YRDMA ($5 Jan 08) bought at $1.15/1.20, cost $5,900
100 YRDMZ ($2.50 Jan 08) bought at 45 cents, cost $4,500

[/ QUOTE ]

KKD escaped filing the calendar year 2005 financials on Monday, via a waiver from their lenders. This was disappointing as I expected it to show how far from profitability they were, and for it to offer further insight into their liquidity issues. Other news is the apparent collapse and purchase of their formerly largest franchisor, and settlement of that franchises legal claims against KKD. The upside of that transaction is they reduced legal liabilities, the downside is fewer stores, less revenues.

Again, no silver bullet for my positions (though KKD is down this morning), and it looks like another lengthy wait. So I've decide to sell the ITM options I bought a few months ago at $12.50 and $10 (nice testament to the value of buying on dips), and take those profits to reduce my exposure here. Effectively, if KKD has a liquidity crisis, my remaining LEAPS have mucho upside. Selling the ITM options only gives up a little of that upside. So today I sold...

20 +KKDMB (KKD Jan 10 Put) @ 2.60 = $5,174.85
Cost -$3134.98
10 +KKDMV (KKD Jan 12.5 Put) @ 4.70 = $4,682.36
Cost -$2,767.49

Profit roughly $4,000. That helps offset a loss of $6,000 on my May and August $7.50s. Actually the August $7.50s haven't expired and are still worth $1,250, but I haven't yet decided to sell them. I control 5k shares with them, and if KKD drops below $7.20 in the next three weeks I'll do better holding them. Right now I'm wishing I had taken profits when KKD was at $7.20 last month. My worst case scenario is now a loss of around $17k.

[DesertCat]

Oh, and one of the reasons I decided to deleverage here is that I am now carrying a small amount of margin debt that I'd like to pay down. It's a little harder to justify carrying marginal positions when they cost 9% a year in interest. And I don't believe in using margin, so it's time to prune positions.

[DesertCat]

I sold my August $7.50s for $750 early this week, net loss of $3500.

Of course today all of the Arizona and New Mexico Krispy Kremes closed. The franchisee, Rigel, filed for bankruptcy. This comes on top of the closure of many of the Southern California stores, as well as some stores in NY, FL and PA the last few weeks. It looks like the franchisees are running out of cash to fund this unsustainable business model.

So KKD must be down, right? Well it's actually still around $8.50. KKD has made a series of announcements about international franchisees (Hong Kong, Mideast, Philippines), etc that seems to have kept investors interested in the stock.

But once again, I can't see the revenues from a small amount of international stores making up for the huge losses they are facing in the U.S. It will take far too long to ramp up intl. and right now it looks like KKD's franchisees are going to shrink at least 10% this quarter. That's 10% less franchise fees, marked up ingrediants and supplies, etc, that are necessary to help KKD cover it's debt payments. My hope is the end is finally near.

[Evan]

[ QUOTE ]
My hope is the end is finally near.

[/ QUOTE ]
I hope you realize that no more Krispe Kremes will make me sad.

[hawk59]

DC,

Do you think it's within the realm of possibility that they sell, say 15mm shares, at $7 or $6 or somewhere around there?

[DesertCat]

[ QUOTE ]
DC,

Do you think it's within the realm of possibility that they sell, say 15mm shares, at $7 or $6 or somewhere around there?

[/ QUOTE ]

Not until they have up to date SEC filings and audited financials. They are still a year and half behind. And once they file accurate financials, I think the picture they'll paint will be so poor that I can't see them being able to float a secondary. No investment bank would take it on.

It's possible they could find a single investor or group to do a PIPE (private investment into public equity) where they get a big discount on the price of some common shares, with some restrictions. But once again, I can't see anyone wealthy enough to do this being dumb enough to do it without having access to timely financials.

But let's assume I'm wrong about all of this. Let's further assume that no more stores close, and revenues stabilize at $400m per year. KKD does a secondary, sells 20m shares at $8 per share, and pays off all debt. KKD then is able to generate 5% in after tax profits, so they make $20m per year. With 80m shares, that means they'll be earning 25 cents per share per year. Is that worth $8.50 per share (34 PE)? Not when their only growth can come from international, and that's so tiny it won't be able to move the needle on their gross sales for four or five years.

And that's the best-case upside scenario. As time has gone on they've released less and less financial data, which implies things are getting pretty bad. By my count at least 19 stores have closed in the last 5 weeks, and I think I've missed some.

[OrangeCat]

[ QUOTE ]

Just finished reading Random Walk. It makes a very, very convincing case for the EMT and is a great read.

[/ QUOTE ]

Then you should read the other side of the story, a very good book called “When Genius Failed.” Basically, it’s the story of some very smart people who lost billions trying to put the EMT into practice. The fallacy behind the EMT was not the only reason they failed, but the story of LTCM should certainly give anyone believing EMT has a practical application some pause. There is a great line in the book that goes something like “The market can always remain inefficient longer than you can remain solvent.”

[Puf2006champ]

When Genius Failed should be required reading for every brand new high stakes poker player. You may be smarter and have more money than everybody else, but even Nobel prize winners can manage to go BUSTO thinking they can ignore risk.

Pufchamp