Krispy Kreme: The Anatomy of a Buyback
On September 17, 2014, Krispy Kreme announced that its board of directors had authorized an increase in its stock buyback from $80 million to $105 million. Good news, bad news or no news? That is the question that is begging for an answer. To provide some background to the stock buyback, it is worth noting that Krispy Kreme shares were trading at $17/share at the time of the announcement, but that was 30% lower than the price in November 2013. While analysts explained the stock price drop by noting that Krispy Kreme’s revenue growth and earnings numbers had come in under expectations, it is also worth taking a big-picture look at the trials and tribulations that this company has gone through over its life time. Started in 1933, in Winston-Salem, North Carolina, Krispy Kreme went public in 2000 and saw explosive growth between 2000 and 2004, as consumers fell in love with its glazed donuts and new stores opened up all over the country. A combination of over-expansion, accounting scandals and a high debt burden created financial problems. The company closed non-profitable stores, shrunk its ambitions and proceeded to dig itself out of its debt-laden hole. It paid down the bulk of its debt in 2012 and 2013 and emerged in 2014 as a lightly levered company with a debt ratio of about 10% and modest growth opportunities in the United States (and global ambitions).
As I note in my post on buybacks, it is impossible to assess the full effect of buybacks, without understanding what the intrinsic value per share for a company is. I use the company's most recent annual and quarterly reports to gather this information and value the company at $10.75/share, about $6.25/share less than the current stock price. I then make an assumption that the company will carry through on its buyback promise and buy back 60 million shares at a price per share of $18 (a premium over the current stock price and an even larger premium over the estimated value per share). I also assume that the buyback will be funded with $40 million in cash (they have about $55.7 million in cash) and $68 million in debt (reversing the deleveraging that you saw in the last two years). There are three effects to work through and I do so in this buybacks spreadsheet.
1. The leverage effect: Using debt to fund the buyback lowers the cost of capital marginally from 5.78% to 5.72%, resulting in a value increase of $23.6 million in enterprise value (about 2%). The effect of the buyback on value is slight and is coming almost entirely from the additional tax benefits of debt, but it is at odds with their recent attempts to pay off debt and reduce default risk.
2. The value transfer effect: Since the buyback is at $18, higher than the estimated value of $10.75, the buyback will transfer value from those shareholders who do not tender to those who do tender. The price per share for the remaining stockholders will drop to $16.56.
3. The value gap effect: The remaining shareholders will then face another danger, assuming that my intrinsic value estimate is right. They will see the stock price drop even further when (and if) the gap closes.
Bottom line: If you are stockholder in Krispy Kreme, tender your shares in the buyback and leave the company. If you remain as a stockholder in the company, you are not only subsidizing the tendering shareholders but you risk a significant loss of principal, if the market corrects itself.