Flame Out To Buy Out?

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The fast food industry is a hard industry to break into. Far too often new concepts catch on fast, but management isn't up to the challenge of profitably growing the business. After the almost inevitable flame out is when the company gets to prove if it is a survivor or just a fad. Krispy Kreme (NYSE: KKD) has had its time in the flame and now it has a chance to prove it’s more than just a market confection. Only there are rumors that it might get bought out first.

Into the Fire
Krispy Kreme isn't really a new restaurant chain. The company, known for its sickeningly sweet glazed doughnuts, was founded around the time of the Great Depression. It remained a regional sensation for decades until the late 1990s when management went on an expansion spree. The shift from regional sensation to cultural icon was pretty swift.

However, moving from being a hard to find specialty to an easily found commodity made the sugary treats much less culturally desirable. People no longer saw the company as special and sales fell, hard. Throw in an accounting scandal and ousted CEOs and it’s not surprising that the stock has been trading in the single digits for several years.

Righting the Ship
It hasn't been an easy road for Krispy Kreme or its shareholders, which have endured years of red ink while the company has tried to downsize to a more manageable size through store closures. Now, with quarterly sales on what appears to be a notable uptrend, the company is again looking to expand. It has plenty of room for that based on its small size, but it is a severe underdog.

Clearly Dunkin' Brands Group (NASDAQ: DNKN) and its name sake restaurant own the doughnut space. Then there's Tim Horton's (THI), a solid number two as it expands from Canada into the United States. This duo has clear leads in the doughnut space. While Krispy Kreme could become a solid number three, it also means that the company has two entrenched industry leaders to fight along the way. And now that Krispy Kreme isn't new and cool, since the brand has been around the block once already, it might be difficult to break through.

Branching Out
Of course the big thing about Dunkin isn't its doughnuts, it’s the coffee. The company has also been branching out into other products, trying to take on the challenge from fast food companies looking to expand into the breakfast segment, like McDonald's (MCD). Tim Horton's has followed an almost identical course. That Krispy Kreme is going down the same expanded menu avenue doesn't help it stand out.

In fact, with companies from McDonald's to Burger King (BKW) trying to reach into the breakfast segment, Krispy Kreme is going to have an uphill climb on its hands. That doesn't even include coffee king Starbucks (NASDAQ: SBUX). While that company has had a hard time reaching beyond its coffee roots, there is little question that it has the higher end, trendy pitch down pat.

That said, Starbucks is possibly a cautionary tale. The company is known for coffee, even though it has tried for years to sell other things, including food and, at one point, music. Coffee, however, is the only thing that has ever stuck. Luckily for Starbucks that has been enough for it keep its business growing for years, though it, too, went through a brief rough spot. That said, the coffee giant has been buying up other concepts recently, including tea stores and a French bakery concept, in an effort to increase its growth potential. Krispy Kreme might have more troubles than it thinks trying to imitate its main competitors.

A Buyout?
Krispy Kreme's shares, however, have been on an upswing lately because it could be a buyout. Turning profitable again surely helped the share price, too. But the 75% advance the shares have experienced over the last three months is too large to be explained by a return to the black. The only problem with the buyout rumor is who would the buyer be?

<img src="http://media.ycharts.com/charts/11588eee08aad0e81161a75ac1819e67.png" />

KKD data by YCharts

One name thrown around is Wendy's (NASDAQ: WEN), the struggling burger joint. This seems an odd fit for two reasons. First, the company once owned Tim Horton's and got rid of it. Why buy another breakfast chain? Second, the experience of buying Arby's should have taught Wendy's management the lesson that combining two struggling brands doesn't make a good company. Moreover, since Wendy's is having a difficult time right now, why would Krispy Kreme want to be bought by the company?

After Wendy's there really aren't too many other options. Yum! Brands (YUM) is focusing its efforts on China and other emerging markets, so it probably wouldn't want to bother with Krispy Kreme. That said, Yum! is a collection of brands, so the doughnut company might fit well inside that company. Most other restaurant chains simply wouldn't be a logical fit or aren't financially strong enough for the pairing to make sense. A buyout by a private equity firm seems far more likely.

A Fitting End?
This wouldn't be the first time a restaurant coming back from near disaster spent time in the hands of a private equity shop. In fact, Burger King has played that game a couple of times in its effort to compete with industry giant McDonald's. What type of buyout offer the company would receive, however, with its shares up so much in such a short period of time, is a big question mark. A 75% gain would seem to discount much of the prospective offer, which would leave the deal either dead in the water or at only a modest premium to recent prices.

Investors are probably better off avoiding the speculation around Krispy Kreme. If the rumor mill proves untrue and the shares drop accordingly, however, it might be worth considering for aggressive investors willing to bet the company's recent efforts will garner it additional market share.


<img height="85" src="/media/images/user_14110/signiture_large.jpg" width="245" />

ReubenGBrewer has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus