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Commentary

Greenlight Capital’s Detailed Presentation on GMCR

On Monday, Greenlight Capital (of David Einhorn fame) threw up a presentation  on a stock that was, before that day, an investor darling: Green Mountain Coffee Roasters (GMCR). This is a US listed company. Post the presentation the stock absolutely tanked, down 10% first and then, down 15% yesterday.

Greenlight’s 110 presentation talks in detail  about the company’s business model, which had evolved into a razor/razor blade model where they would sell a single cup brewing machine at cost, and charge heavily for “K-Cups” – a patented coffee filter + grounds + cup combination that goes into their brewers. They’ve already sold 13 million brewers and over 9 billion K-cups, growing CAGR 57% since 2010.

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Except now, there’s a problem, says Greenlight. The market valued GMCR at $92, even when it’s projected 2011 EPS was just $1.61, because of the immense long term value perceived. The expectation was the sales would continue to be strong and deals like their recent ones with Starbucks would augment revenues, to bring the longer term EPS to $9 per share. What Greenlight finds is that they have probably overestimated the metrics used to calculate such long term value:

  • The patent on the K-Cups expires next year – and their “razor blade” model will hurt when anyone can manufacture a K-Cup for the huge installed base (7.5 to 10 million) of brewers.
  • The figures are overstated in terms of Daily cups per brewer, and in addressing eventual competition
  • This brings down long term EPS projections to $3.5, at which point the current prices is way high.
  • Plus, there is a lot of capex for what should be a profit making machine, they have some acquisitions that leave unanswered questions, and SEC inquiries into revenue generation practices.
  • Greenlight conducted field research, talking to ex-employees, and alleges that there was likely some inventory they would ship to themselves to keep sales numbers high, or sell to a wholesaler (who in turn was 51% of their “receivables”). The latter is similar to the past DLF strategy of selling to a promoter owned corp but not getting paid until, well, the shit hit the fan and they merged that promoter owned company back into DLF.
  • In the March quarter, they showed phenomenal results and the shares went up 19% – after which, (surprise, surprise) they sold 7.1 million shares in an equity offering. The CEO and directors also sold part of their shares in that offering.
  • There’s not much free cash flow being generated – strange for what should be a clean FMCG company; in all, that this company is going nowhere.

And, kaboom:

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In my view the shareholder shenanigans are par for the course anywhere in the world; most companies have that kind of crap going on in some way or the other. But most of these are low priced stocks because people know.

The going-off-patent is the big concern, but I wonder how Gillette will handle it when the Mach-3 patents expire. It’s likely for them too that people made generic blades, and honestly, I would buy cheaper blades any day.

We don’t know if Greenlight has a bearish position on stock (but why else would they give away such detailed analysis for free?).

Oh, and you’ll like the whole thing:

This is the kind of analysis – skeptical and detailed – that we need in India. I’m really sick of only seeing glowing recommendations or negative reports disguised as buy calls with target prices less than 2% away. We simply don’t like to name and shame our companies; perhaps it’s the fear of lack of access to company management. People like me don’t care about access to management, so we should write more. Greenlight’s quality is something to aspire for.

  • Soham Das says:

    Where did you get hold of this presentation?
    I was following Jacob’s website, and a resourceful guy as he is, even he couldnt upload the actual presentation

  • RS says:

    On the Gillette / Mach-3 question – the patent isn’t the only thing protecting Gillette, it is also the perceived quality of the blades. Customers might continue to pay a premium for time tested quality Gillette has delivered, because the cost of experimentation is high, ie. bad product = bleeding face.
    If GMCR had managed to build a brand around quality Coffee (ala Starbucks) and not the technology, they could have mitigated some of the losses from patent expiry.
    As for Gillette, they have Fusion lined up, which they will no doubt transition customers to
    as part of their long term strategy: http://www.cartoonstock.com/newscartoons/cartoonists/rro/lowres/rron268l.jpg

  • DJ says:

    Hmm, I wonder if there are short sellers like Einhorn and Chanos in India. I mean there’s obviously got to be, but, I can’t think of any that are visible. People like Shankar Sharma are often brought out as bears but that’s a different thing. It would be nice to see detailed company analysis on the bearish side as well. Like the one Einhorn made his name by – by taking on Allied and then writing a book about it.

  • abc says:

    i have been wondering…how come no indian blogger has been disccusing about value investing congress…nice post