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The Krying Shame of Krispy Kreme



Krispy Kreme (KKD) is exactly the type of story that made me want to write about stocks. It's a company that never should have been brought public, certainly not at the time they did. If you're familiar with the background of the chain, and the specifics of their business, there's been nothing surprising about the implosion to date but, unless your timing was exquisite there weren't many ways to profit from it.

In its heyday, when the stock rode to $50 on the backs of shorts who got in disastrously early, Krispy Kreme was all the cocktail party rage. "They are the next Starbucks (SBX)!" people would chortle, "People really like doughnuts!"

I hope so because that's all the buy and hold crowd is going to end up with on KKD; one big, fat doughnut of nothingness.

It's time to make the Doughnuts

Imagine that it's 1999 and you were running Krispy Kreme. You've got a great brand name and an addictive product. You're running what could be a terrific little company, you own some of your own stores and you've got franchisees simply begging you to take their money.

You're happy to take that money, signing 'em up, sending them mix and waiting for your cut to come back to you. You're making nice coin and you've got all the doughnuts you can eat. Life is good.

Then the I-banks arrive. You may have called them or they might have set up the meeting, either way, the message is the same: "You have a nice little company here but it should be huge. You should be the king of doughnut bling. It is your destiny and all you need to do is go public..."

Now, you and the I-banker ("Mr. Faust") may or may not know the truth about your business. You may or may not understand that you have little to no control over your franchises. You might understand that doughnuts, while tasty, aren't an explosive growth category.

Or you may really believe that you can grow at the 50-odd-% per year that's going to be necessary to keep you a Wall St. darling. Either way, you bite on the idea of an IPO. Shortly after you do, both the best and the worst thing that can possibly happen to your company comes to pass: Your stock gets hot.

A hot stock means big pressure. You now have everyone counting on you (except the shorts, who you loathe). If you didn't have tight controls before, and you didn't, you can't fix them now. Shoring up your franchises will take time and require slowing the process down while you do things like figure out exactly how many kiosks you have going into how many malls all over the country.

You may have done that kind of thing when you were private but you can't do it now that you're public. Your company has a P/E of 50 and the stock quintupled in its first 30 months. If you slow down now your light and fluffy doughnut empire is going to get smushed into the density of an 8 P/E steel company. The shorts, who you hate, will win at the expense of your fans, who you love.

You really don't want that to happen. You may or may not be a criminal, per se, but you aren't exactly going to hound your CFO about "the details" on cash flows. That stuff will work itself out and, hey, nothing says "ignore the details" quite as well as beating the snot out of your sand-bagged estimates.

This is the End...

Of course Krispy Kreme imploded. It's always been a matter of time and there are plenty of folks who have been saying so all along. It ended the way every cult stock from Taser (TASR) to Iomega (IOM) ended: the fad cooled, growth projections were laughable to begin with and management spent far too long trying to obscure that fact. KKD is running down a time honored and well-grooved path and there will be plenty of other cults to take its place.

So what do I think the smart play in the stock is now? The same as it has ever been: avoid any contact, long or short. The board can throw all the bums involved in our above hypothetical out the door and it won't change the slow-growth reality of selling doughnuts. You don't want it long because it remains a horror show.

You could try to ride it to zero on the short side but it's late in the game for that now. New management will be looking to "unlock unrecognized value" any way they can and there's a LOT of private equity groups running around looking for just about anything to buy.

Whenever they name a new CEO his first message is going to be from a Mr. Faust, calling to share some great ideas his firm has regarding taking you private. If the stock gets crushed any more from here Mr. Faust is going to be sitting in the new CEO's lobby like Bud Fox waiting for Mr. Gecco.

From the cradle to the grave, IPO to LBO, that's hitting for the I-Banking Cycle and likely the eventual path for Krispy Kreme. It's a sad, somewhat disgusting story arc from the perspective of investors but it's hard to make money on it as it happens. As I said, it's the kind of story that made me want to write about stocks... I never said anything about it making me want to trade it.

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No positions in stocks mentioned.

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