It has been widely reported that Inspire Brands, controlled by private equity firm, Roark Capital, is negotiating to buy Dunkin’ Brands (DNKN) for about $11 billion, including approximately $3 billion of debt. This amounts to about 22x EBITDA in calendar 2019, and the same multiple of consensus 2021 estimates.
Franchising companies are attracting investors, including private equity owners, largely because of their supposedly free cash flow from the royalty stream. We have written many times that the cash flow is not entirely “free” because some of that income stream should be reinvested in the system to maintain its relevance and franchisee profitability.
For the moment, let’s put that concern aside for the moment, since interest rates are close to zero, the music is playing and investors are dancing. More relevant in the short term is that the $3 billion of debt is about 6x trailing and projected EBITDA, so the debt-load is already at the top of the range currently viewed as comfortable by the marketplace. There is therefore no more leverage that can be squeezed out of this situation.
However, executives at Roark and Inspire Brands are far from ignorant or reckless, so let’s think about the potential appeal. It is no secret that Dunkin’ is surviving better than most, not as well as some, due to the preponderance of drive-thru locations, while limited during the pandemic by less breakfast traffic. Indeed, same store sales in Q2 were down 18.7% at US stores. It is also well known that this fifty-year old worldwide brand (forgetting about its much smaller sister brand, Baskin Robbins) is most heavily concentrated in the northeast, with expansion opportunities out west and abroad. On the other hand, the Dunkin’ brand can no doubt benefit from continued reinvention, as they have consistently lagged Starbucks in terms of growth, sales comps and store level profitability. With those broad-brush thoughts out of the way, it occurs to us that:
It is not hard to imagine that $500 million of past (’19) and future (’21) EBITDA (forget about ’20) could become $600 million-$650 million after G&A and advertising efficiencies, with another $25-35 million thrown in from Dunkin products spread through Inspire’s other brands. That brings the debt, as a multiple of EBITDA, down quite a bit, allows for new borrowing that can be reinvested in the business or paid out to equity holders.
The only other suitor that comes to mind is Yum Brands, large enough to absorb Dunkin’ without “betting the company,” with enough scale to get administrative synergies, and enough existing units to get a material benefit from the addition of Dunkin’ products. Wendy’s already has a breakfast program and adequate debt, and doesn’t have enough units to get a material benefit from adding Dunkin’ products. Domino’s or Papa John’s or Wingstop couldn’t put Dunkin’ products to enough use. Jack in the Box is nowhere near large enough. Restaurant Brands already has Tim Horton’s. Chipotle, with their company operated locations, enjoys being debt free and wouldn’t tolerate 25-30% dilution of their equity. McDonald’s doesn’t need it, and is not in an acquisition mode.
Conclusion: The acquisition of Dunkin’ by Inspire makes more sense at a record high valuation than is apparent on the surface. Unless Yum Brands competes for it or Inspire Brands gets discouraged somehow, Inspire will be in the coffee business, to be spread to their currently owned franchise systems. Current Dunkin’ shareholders will say “thank you very much.”