Friday, March 04, 2005

Speculation vs. Investing

Today, on a rumor that Warren Buffett might be investing in Krispy Kreme Doughnuts (KKD), the struggling doughnut maker's share price skyrocketed 23% to $7.50 per share, making it the largest percentage gainer on the NYSE. With value in its well-known brand name and customer base, Krispy Kreme could quickly recover much of what it lost over the past year (52-week trading range of $5 to $40), if a deep-pocketed investor like Buffett steps in and stabilizes the company. On the other hand, overburdened by loans to its franchisees, the company could also just as easily fade away into history as another one-time high-flyer that bit the dust.

From my humble position as a retail investor, a purchase of Krispy Kreme's shares at this point would be pure speculation, since I have no idea how true the rumor is. For Buffett, however, assuming he is able to get attractive terms in a convertible preferred deal and find synergies with his Dairy Queen holdings, Krispy Kreme could be a very lucrative investment. Playing at the corporate level, Buffett has access to so much more information than I do. In this type of deal looking for a "white knight," he is also in a good position to dictate terms very favorable to himself and Berkshire Hathaway. If Buffett invests in Krispy Kreme, he will probably end up hitting a "home run," just as he has in other white knight plays (e.g., investment in Salomon Brothers in 1991 following a Treasury auction trading scandal that led to the dismissal of CEO John Gutfreund, head trader John Meriwether and others, and almost put the investment bank out of business).

One, albeit very limited, way to participate in upside from a possible investment in Krispy Kreme by Buffett is simply to own Berkshire Hathaway shares. (Disclosure: I have been long Berkshire Hathaway shares for many years.) Since Krispy Kreme is a very small company compared to Berkshire Hathaway, any success Buffett has with the Krispy Kreme deal will have only a tiny impact on Berkshire Hathaway's share price, however.

So, as a retail investor, it is really very hard to profit from a possible Krispy Kreme recovery without walking into a highly speculative situation. Personally, I would rather be sidelined than speculate. Only if the deal one day begins to look more like an attractive investment than like throwing the dice will I seriously consider stepping in.

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