One of the most vocal short attacks on Green Mountain Coffee Roasters (GMCR) has come from Whitney Tilson of T2 Partners. Until recently, he was content to run around and bash GMCR based on the David Einhorn presentation last fall (which coincidentally just happened to be made at a Tilson Investment Conference). I certainly understand Tilson repeatedly slapping his buddy Einhorn on the back and exalting Einhorn's presentation over and over, particularly since Tilson recently admitted he was already "painfully short" GMCR at the time of the Einhorn presentation. Plus, someone has to publicly carry the Einhorn mantle as Einhorn has been rather quiet lately-apparently due to the recent record setting 11 million dollar insider trading fine imposed on Einhorn by Britain's FSA. However, Tilson suddenly has a new GMCR battle cry. His recent epiphany has led him to declare that GMCR is actually just Krispy Kreme (KKD). Well, I must say "Sorry Whitney, but GMCR is nowhere close to Krispy Kreme." This is simply a "Chicken Little" moment for Tilson. In reality, the sky is not falling and GMCR is not Krispy Kreme.
In a conference call with his investors on April 18, Tilson discussed his short position in GMCR. The discussion begins at about the thirty four minute mark in the audio presentation if you care to listen. It began with a caller asking whether, in light of the decline in GMCR stock price, Tilson was considering taking off his short position and perhaps even going long? Tilson's answer was an emphatic "no", including his announcement of his recent epiphany that "GMCR is Krispy Kreme." He also reviewed his four justifications in support of his short thesis regarding GMCR. Tilson's "same as Krispy Kreme" claim, as well as his purported short thesis justifications, simply do not withstand scrutiny.
With regard to Krispy Kreme, Tilson actually does nothing more than say we remember how the Krispy Kreme rocket ship crashed, and GMCR is Krispy Kreme, therefore GMCR will crash. This superficial statement is ridiculous-he might as well assert GMCR is Enron, Lehman Brothers, and tulip bulbs all rolled into one. When you go back and look at what really happened at Krispy Kreme, it is evident GMCR is nothing like Krispy Kreme.
The best article explaining Krispy Kreme's demise is "Kremed" by Kate O'Sullivan. Before addressing the factual highlights of her article, it is critical to note this key summary sentence: "The story of Krispy Kreme's troubles is, at bottom, a case study of how not to grow a franchise." She then addresses the underlying problems in great detail, and I am just going to hit the highlights here. KKD was a new public company and under intense pressure to make its numbers each quarter. Eventually, it began to help itself, but hurt it franchisees, by selling the mandatory doughnut equipment and ingredients at extreme markups. Thirty one percent of its sales in 2003 were equipment and ingredients, and Q2 revenues from 2003 to 2004 increased by fifteen percent when same store sales were up only one-tenth of a percent. Franchisees also complained that the parent company was doubling shipments to stores near the end of quarters to help meet estimates. Krispy Kreme also was considering doing an off the books lease, and began repurchasing some franchises at inflated prices and improperly recording the financial details of the transactions. From 2000 to 2004, the company had three different CFOs. In July 2004, the SEC started an informal inquiry, which quickly escalated to a "formal" inquiry within three months. The United States attorney's office in New York also started an investigation. Eventually, Krispy restated it financials for 2001 through three-quarters of 2005-almost five years. The stock price crashed from a high near fifty dollars to under five dollars, and by early 2009 actually fell to almost one dollar per share.
The Krispy Kreme story has no rational relationship to or bearing upon GMCR. With GMCR, we are not dealing with a company which just came public for the first time. More importantly, there are no GMCR franchisees--it is a razor/razorblade business model, not a franchisor/franchisee business model. GMCR, unlike Krispy Kreme, has no ability to channel stuff by foisting excess brewers and K-Cups on Bed Bath and Beyond, Costco, or Wal-Mart. The SEC "informal" inquiry at GMCR started in September 2010, seventeen months ago. Unlike the Krispy Kreme investigation which ramped up from "informal" to "formal" in the first three months, the GMCR matter never evolved to a "formal" inquiry, and no criminal investigation was considered as to GMCR. Moreover, GMCR hired an outside forensic accounting and legal team to audit it books, and after the restatement, no further problems were found. GMCR has not had turnover in the CFO position, and has not changed outside accountants. Tilson's epiphany that "GMCR is Krispy Kreme" is just unfounded fear mongering in order to bolster his short position.
Likewise, the four justifications Tilson proffered in support of his "strong conviction" short position do not withstand scrutiny. He first spent a lot of time harping on the fact GMCR has enjoyed "monopoly market share" and "monopoly pricing", identical to a pharmaceutical company. With two (of over 30 U.S. Keurig patents) expiring in September of this year, Tilson asserts the patent expiration will have a dramatic impact upon GMCR, just as it does upon a pharmaceutical company. Unfortunately Whitney, coffee is not a prescription drug, and no company has a monopoly on the coffee market. Anyone can buy a Mr. Coffee drip coffee maker. (Coincidently, I note that Jarden Corp. (JAH), the maker of Mr. Coffee brewers, entered into a license agreement with Keurig and produces a Mr. Coffee brand brewer which utilizes K-Cups-along with Breville and Cuisinart which also have license agreements to produce K-cup compatible brewers). Furthermore, even if you narrow your focus to just the single serve coffee market, there are numerous single serve competitors-Tassimo, Mars Flavia, Nestle Dolce Gusto, and CBTL. It is not that Keurig and GMCR have a monopoly in the coffee market, they just have the absolute most successful, most popular, best selling brewer/capsule combination in North America. This does not in any way constitute a monopoly, it just demonstrates that GMCR is the clear leader of the single-serve pack. Tilson might as well have an epiphany that Apple has a monopoly on the tablet and cell phone markets, which would be just as inaccurate as his GMCR epiphany.
Tilson next asserts GMCR is a great short because the company struggles with growth. I would agree that, in some respects, GMCR was not fully prepared to deal with the phenomenal success of the Keurig single serve system. Part of the problem goes back to the fact GMCR was at one time simply one of many K-cup licensees of Keurig. Then, GMCR purchased a substantial interest in Keurig, and later purchased the remaining shares of Keurig. Because the other K-cup licensees cried "foul", expressing concern that new owner GMCR would get a better deal on K-cup financial transactions than independent third party K-cup licensees, GMCR and Keurig continued to operate financially as two separate companies-with Keurig still having K-cup licenses in place with everyone, including GMCR even though GMCR fully owned Keurig. This mode of operation eventually led to some of the accounting criticisms down the road. Furthermore, GMCR disclosed it received an informal inquiry letter from the SEC in September 2010, and GMCR did have to eventually restate its financials-although the restated impact was a total cumulative adjustment to earnings of five to six cents spread over a three year and nine month time frame. In any event, I fail to see how being inadequately prepared for rapid growth, and an earnings restatement of about one and one-half cents per year, necessarily translates into a "strong conviction" short position.
Tilson's third point is that insider selling has occurred. The attack lately has been on two sales by Chairman Stiller, totaling one million shares sold. I addressed these sales in detail in a prior article: Green Mountain Coffee Roasters: Shoot First And Ask No Questions. As noted in that article, Stiller only sold 6.9 percent of his holdings, and he still owns 13.4 million shares of GMCR. He is over 70 years old, he has run this company for over 30 years, and has guided it to a market capitalization of over seven billion dollars. He is entitled to reap some of the rewards of his labors.
Finally, Tilson notes GMCR stated it will be spending 700 million on capital expenditures, and Tilson says he can't make the math work. I am not sure what Tilson is claiming here. Management has broken down the capital expenditure categories in the quarterly conference calls and investor presentations. GMCR sales continue to grow, production facilities are being built and/or expanded, and GMCR is the largest private employer in the State of Vermont. In the last reported quarter (Q1-2012), total revenue exceeded one billion dollars for the first time in GMCR history, and 4.2 million Keurig brand brewers were sold-which is more than one-half of the 6.5 million brewers sold in all of FY 2011. These facts support the need for capital expenditures and expansion. If Tilson is instead stating he does not know where the 700 million dollars are coming from, then management has stated in the conference calls that capex will be funded from cash from operations and the existing credit facility. Again, I cannot see these vague, unsupported claims by Tilson constituting any sort of firm foundation supporting a "strong conviction" short position.
The bottom line is that Tilson's recent epiphany that "GMCR is Krispy Kreme" is simply incorrect, just like Chicken Little's pronouncement that "the sky is falling". At the end of that story, Chicken Little and her friends are rushing to tell the lion the disastrous news, when they encounter the sly fox. Since they don't know where the lion is, the fox tells them he knows and will show them the way, but then leads them into his den. Chicken Little and her friends are never seen again. I suspect the GMCR shorts may encounter a similar fate when they continue to follow Tilson and Einhorn further into the short den at this point in time.
Disclaimer: I have no connection with GMCR except a Keurig brewer on my kitchen counter which keeps chugging along. I am not a convicted felon like GMCR basher Sam Antar, nor have I have been subject to an 11 million dollar fine like David Einhorn.