David's Tea Is Uninvestable

I love tea, in fact, it pains me to write this article. David’s Tea (NASDAQ:DTEA) is one of my favorite shops. With that said, investors cannot allow emotions to get in the way of reality. Several red flags were reaffirmed during Q1 2017 earnings. David’s Tea has all the characteristics of a company headed to zero.
“David” is Gone
The “David” in David’s Tea made a b-line out of the company in 2016. Given his lack of business experience, some may consider this good news. His partner and co-founder may actually be worse, though. To quote David:

I started it at 27 and I’m 33 now so you know the company grew faster than I was able to gain years of experience and it got to the point where I had never run a major company (like David’s Tea) that was doing a lot of sales and had multiple stores and I don’t know if I saw it as clearly as I should have at the time but Hersch, my partner, certainly did.

So the obvious next step is to look into “Hersch”. He has experience running a large company with multiple stores… We’ll get to that…
Yet Another C-Suite Departure
In the Q1 report released today, the company announced that CFO Luis Borgen is departing to “pursue other interests”. Considering the company is performing terribly operationally; I’d expect this to be forced on behalf of the board. Regardless his legacy will be remembered as an incompetent who destroyed 80% of IPO investor’s value. I have no faith in the board finding a decent CFO.
Some longs will call this a positive. First, it is never good news when a company is struggling to see a C-Suite member go. Second, when David’s Tea lost “David”, they did a search for talent. They tapped Sylvain Toutant; a name I remembered from somewhere! No where good though. They tapped the former disgraced head of Societe des Alcools (Quebec’s provincial liquor outfit) to head the unit. He was off the map since he resigned from a scandal-ridden tenure in 2007. Why David’s Tea tapped a person with no executive experience in 8 years is baffling. I’d almost wonder if the founders had a relationship with him, but that is purely speculation.
Sylvan left in October 2016 (with a tenure of a little over a year) and was replaced by Joel Silver. Silver has essentially no record, which is frankly better than that of the previous CEO. He ran his own venture capital firm which I can find no information on. The only noteworthy thing I could find was he held “several positions of increasing responsibility at Indigo Books & Music”. My favorite of his credentials, which is proudly shown on David’s Tea announcement of his appointment is his co-founding of Salesdriver.com. I checked the site, it doesn’t exist anymore…
Founder Has a History of Wiping out Longs
What kept me from investing in David’s Tea during
Source: Y Charts
Earnings Are Still Terrible
On top of the aforementioned CFO departure, the company posted very weak results. The CEO made mention of the US storebase remaining weak saying
“ There has been significant effort trying to penetrate the U.S. market while there has been some success it has been limited, we will not abandon the U.S. market but we do intend to emulate the Canadian success in the U.S. with the necessary adjustment to perfect our business model. We want to address all markets proportionally to unlock all potential value while the growth of our U.S. store base will be limited in the short term we must improve the performance of our existing store base particularly where we have density such as the New England and the Midwest. The American consumer is different and we must adapt our marketing approach accordingly.”
A problem I had with the company back in 2015 was they continued to pump out unprofitable store with huge expansion plans in the U.S. And the CEO sounds like they still have long-term growth plans for the U.S. market. This same type of aggressive US push has essentially bankrupted Le Chateau. The new CEO Doug Silver didn’t create the situation, but he apparently wants to perpetuate it…
SG&A represents half of sales now which is frankly hilarious in how pathetic it is. It must cost a lot to pay that rockstar management team who’s wiped out 80% of shareholder value. Starbucks (NASDAQ:SBUX) runs about 5% SG&A to sales for some context. Adjusted fully diluted income per share went negative to -C$.04 per share vs. C$.06. The 5.7% comp increase is completely fueled by slashing margins. I’d have taken the Q1 2016 margins any day over this quarter.
Is There Anything Redeemable?
It is likely that the right management team could turn the company around. This would likely require a scale-back or shutting down of US operations, and a re-positioning of the brand to the high end. What longs can find encouraging is the company’s $56 million cash balance. This is on a company with a market cap of $150 million and very little cash burn. The company reminds me of 2013 BlackBerry (BBRY); failed growth plans, negative earnings but a pile of cash. If I had any faith David’s Tea could find a strong CFO and CEO to run the company, it’d be an interesting play. But considering my favorite David’s Tea CEO has been the one who’s biggest accomplishment is a defunct website (the current one), I have little faith in this happening.
Let me say this, David’s Tea will not be around 10 years from now if it keeps its US store base. The company does not have a grasp on the US market, it has no moat, nowhere near the brand loyalty or recognition it does in Canada. Not only does the CEO want to keep the US store base, he’s disappointed he can’t keep up with the massive expansion plans… The best outcome for longs at this point would be a private equity firm taking the company out. Since the probability of this happening is pretty low, a board shakeup is the next best thing.
Conclusion
The CFO departure months after a CEO departure is very concerning to me. Comps are not improving and the CEO even promotes future US expansions. David’s Tea has the weakest management team I’ve seen in a mid cap company. A popular short seller Mark Cohodes says “don’t bet the horse, bet the jockey”. I couldn’t think of a better jockey to bet against. I am not shorting given the company’s cash balance, but I may consider doing so if comps continue to worsen.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in DTEA over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Long: SBUX

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