The details of my Big Bet against Krispy Kreme

[HoldingFolding]

The Nikkei also announced a tie up with Lotte in Japan yesterday. Dunkin Donuts has been very successful here and has about 1500 stores. Interestingly, the Japanese franchaise often does better than its US counterpart. An example being 7-11 which eventually bought out the US parent company; however, that would be a ways down the road.

[DesertCat]

[ QUOTE ]
The Nikkei also announced a tie up with Lotte in Japan yesterday. Dunkin Donuts has been very successful here and has about 1500 stores. Interestingly, the Japanese franchaise often does better than its US counterpart. An example being 7-11 which eventually bought out the US parent company; however, that would be a ways down the road.

[/ QUOTE ]

Realize that Dunkin Donuts is, unlike Krispy Kreme, a tremendously successful franchise in the U.S. It has much higher margins and many more outlets than KKD. It has a real business model that works.

I'm not greatly worried that international expansion would save KKD's bacon, they need much more help than a few extra royalties can provide (and it takes time for new stores to roll). Lastly, a bad business model in the U.S. is probably a bad business model everywhere. Of course, if the Kuwaitis want to directly invest $100M in equity, then it doesn't matter if I am right, they will have more liquidity than my options will have lifespan. But I have to think that's unlikely, esp. once any "savior" sees their financials.

I'm really looking to read the analysis of someone who thinks KKD's existing business actually works (or can be quickly fixed), adequate liquidity, and will shortly create shareholder value in excess of today's price. That would directly contradict my thesis, and make my bets too risky.

[KaneKungFu123]

http://yahoo.reuters.com/stocks/QuoteCom...KD.N&rpc=44

[KaneKungFu123]

"Yes, but OTM options (especially deep OTM) are really really red (really). Example, a stock selling for $40, will have spread of a few pennies, like 40.02/39.98. An OTM option's spread however will be huge. The JAN 08 $2.50 put he bought, for example, has a .50/.35 spread. That means, immediately, his P&L is 30% in the red."

Im confused about Options trading. Is it the same as betting a baseball game at a sportsbook? You are simply making a contract with the Options Company. In other words, you are saying that the Vig is too steep?

[Sniper]

KKF,

First, the spreads on low volume stocks can also get quite large at times too. It is not a reason to not trade them. It is merely a reason to pay more attention to what you are doing.

Second, I believe the spreads were a bit tighter when he opened his positions. At least they were when I looked at them.

While market makers typically take the opposite side of options trades, which they then might hedge off with regular shares, anyone can trade options. The market makers might also be buying at the bid and selling at the ask, pocketing some quick $$$.

While each option trade involves 2 parties, one buying and one selling; the trades are not linked once the transaction is complete. Meaning that you don't need to reverse the trade with the same counterparty. Your position is simply part of a pool on one side of the trade.

[DesertCat]

[ QUOTE ]

Im confused about Options trading. Is it the same as betting a baseball game at a sportsbook? You are simply making a contract with the Options Company. In other words, you are saying that the Vig is too steep?

[/ QUOTE ]

Similar but different. Essentially these options are very illiquid, leading to the large spreads between what's bid and asked. If I had to get out of my positions the next day, I'd be taking big losses. In order to buy I had to pay the ask price, but if I sell I'd have to pay the bid price. Obviously I could post orders in between the bid/ask and wait, but that didn't work too well so far.

So essentially I need a big drop in KKD's price, and even thne when I sell I'll probably lose some of my profits to the spread.

[KaneKungFu123]

I just read on yahoo message board that the investor who bought a 7% stake in KKD is actually worth 12+ Billion, which makes his position actually quite small.

[DesertCat]

KKD filed a NT-10K and released a press release today after market close. The NT-10K means this means they don't have last years annual report done on time. In it they mention that due to internal control issues their accounting firm, PWC, will disclaim an opinion to the effectiveness of those controls. They intend to release the 2004 report by end of April with this PWC disclaimer. They didn't say when the quarterly or annual reports from 2005 will be ready.

They also reported 4th quarter sales of $120M, a drop of $10M from 3rd quarter. Sales per store dropped 9% over 3rd quarter. Remember that Q3 company store sales were down 19% year over year, so this is a further drop. And Q3 of 2004 was $170M in revenues. They lost money in 2005 but would not say how much, both last quarter and for the year. Note that I am using calendar years to be less confusing, but that KKD's fiscal year is a year ahead, i.e. calendar year 2004 is KKD's FY 2005, and KKD is in FY 2007 right now.

The quote from the CEO struck me as less than inspirational. ""As we move into fiscal 2007, Krispy Kreme is continuing to take the steps necessary to turn around the Company," said Daryl Brewster, President and Chief Executive Officer. "While much work remains, we are starting to see signs of stability in our drive to sustained growth and I am encouraged by the Company's potential." Normally CEO's don't trumpet "signs of stability" as the best possible news.

Lastly, and perhaps most importantly they reported on available liquidity. On Oct. 30 they had $27M in cash, and $34M in available borrowing power, for $61M in total liquidity. According to todays press release as of Jan. 29, they had $22M in cash and $18M in available borrowing capacity for $40M in total liquidity. They lost 1/3 of their liquidity in 3 months. Two more quarters of this and they are out of business. It makes me wonder if some of their lenders are pulling out.

Nothing they reported was very surprising to me or counter to my thesis in any way. It strikes me as very bad news. It remains to be seen how the market will react (after market was down a little) to these events. I'm not sure if the NYSE will move to delist them if they file their financials with PWC's disclaimer. It's a huge disclaimer IMHO, if the internal controls can't be trusted, how can any of the financials be? I'm not an accounting expert so I'm not sure.

If the market shrugs the bad quarter and liquidity news off, I'm not sure it will care about what the 10K for 2004 will say since that bad news will be very old. But if liquidity continues to decline, it could cause more lenders to withdraw and force them into a crisis sooner, rather than later.

[coolandtough]

Down another 4% after hours. I'm glad I'm not the one guy who's covering the stock. His $12 price target seems a little silly at this point. Although that's still better than the most recent report on firstcall, which is a valuengine report with a target of $20.

[DesertCat]

I got my available liquidity calculation wrong, or I didn't realize that KKD changed how they report it, and I included JV's when I shouldn't have. They actually have $38M in total liquidity, and that's down from $52M.

It's clear that they've lost some lenders, that actual burn should be less than $14M. It's unclear whether they are getting close to the line where the lenders pull the plug, but they probably need waivers from their lenders due to the problems with their filings. It will be interesting to see what the lender demand for those waivers, do more pull out, do they pull the plug, or do they squeeze through?

One other interesting option for KKD to raise additional funds is that Zoloft-Cooper (sic) their restructuring expert, has a warrant to buy 1M shares that vested a week or so ago (1 month after new CEO). It was priced at $7.75, so if it was exercised that's almost $8M in additional capital. But I think there is no way in hell that happened. The $1M "spread" from a week ago isn't much cash unless you can immediately flip the shares. Plus there are insider trading issues if good news is coming, or if they flipped them before this bad news was released.

Right now KKD is down to $7.77 and my May/Aug puts are solidly back in the money.