Dunkin's IPO: Strong Brand Name Awash in Debt

Jul.27.11 | About: Dunkin' Brands (DNKN)

This analysis of Dunkin Brands (NASDAQ:DNKN) was provided to TradingIPOs subscribers in advance of its IPO. On July 26, the company priced its IPO at $19/share, over the top end of its range.

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Dunkin Brands plans on offering 25.6 million shares at a range of $16-$18. JP Morgan, Barclays, Morgan Stanley, BofA Merrill Lynch and Goldman Sachs are leading the deal, Baird, Blair, Raymond James and six others are co-managing. Post-IPO DNKN will have 129.7 million shares outstanding for a market cap of $2.205 billion on a pricing of $17. IPO proceeds will be used to help retire 9.58% senior debt notes.

3 private equity funds (Bain/Carlyle/Lee) will own a combined 75% of DNKN post-IPO. Those three took control of DNKN in a 2006 leveraged buyout. The buyout loaded up DNKN's balance sheet with a massive amount of debt. Even utilizing IPO proceeds on IPO to repay debt, DNKN will have a shade under $1.5 billion of debt on the balance sheet post-IPO. Way too much for this sort of business, most of it there to pad the pockets of the private equity manjority owners.

In addition, the controlling private equity entities paid themselves a $500 million dividend pre-IPO.
From the prospectus: 'We are one of the world’s leading franchisors of quick service restaurants (“QSRs”) serving hot and cold coffee and baked goods, as well as hard serve ice cream.'
DNKN does not operate restaurants, they only franchise brands. They have two brands, Dunkin' Donuts and Baskin Robbin's. Dunkin Donuts is a market leader in New England and New York while Baskins Robbins has been a bit of a disaster performance-wise in the US the past few years.

There are 16,000+ franchised stores in 57 countries: 9,805 Dunkin' Donuts bringing in an average of $42,500 in annual franchise fees, 6,482 Basking Robbins bringing in an average of $20,700 in franchise fees annually.
Dunkin' Donuts has the #2 position in US coffee servings and breakfast sandwiches. Baskin Robbins is the #1 chain for hard serve ice cream.
Dunkin' Donuts accounts for 76% of revenues, Baskin Robbins 24%.
Revenues from Dunkin' Donuts are nearly all US based; Baskin Robbins, however, generates 1/3 of their revenues internationally.

Same Store Sales - Dunkin' Donuts was on a roll before the 2008 recession hit, with 45 straight quarters of same store sales growth. 2 negative years in 2008/2009 rebounding with just a 2.3% same store increase in 2010. Coming off two negative years of same store sales, the 2.3% increase in 2010 is not that impressive. Great brand name, however it appears the recession may have permanently changed some of their customers' spending habits. On a per store basis, DNKN is pretty much where they were in 2007 revenue wise. Baskin Robbins, on the other hand, has been losing traction rapidly with three straight years of same store sales declines. 2008 saw a 2.2% decrease, followed by 6% in 2009 and an alarming 5.2% dip in 2010. A fading brand.
In the 2nd quarter of 2011, Dunkin' Donuts same store sales increased 4%, while Baskin Robbins decreased again 3.5%.

Dunkin' Donuts holds a whopping 52% 'quick service restaurant' ((NYSE:QSR)) in New England. That is a stunning number. In addition they hold a 57% coffee QSR market share in New England.
Coffee represents 60% of Dunkin' Donuts sales, overtaking donuts sometime in the '90s.
Dunkin' Donuts has over 1/2 their stores in New England and only 109 stores total in the western US. Focus going forward is to increase store count in eastern cities outside of New England.
39 new Dunkin' Donuts stores in the 2nd quarter of 2011.
Competitors include 7 Eleven, Burger King, Cold Stone Creamery, Dairy Queen, McDonald’s (NYSE:MCD), Quick Trip, Starbucks (NASDAQ:SBUX), Subway, Tim Hortons (THI), WaWa and Wendy’s (NYSE:WEN).

Financials
$1.5 billion in debt is a huge issue here.
2010 - $577 million, a 7% increase over 2009. Solid 34% operating margins. Good margins here due to the pure franchise model. Debt servicing (taking into account debt paid on IPO) ate up 37% of revenues, simply way too much for a franchise business model that should have this extensive debt. Net margins of 15.5%, EPS of $0.70.
2011 - Revenues look to grow 10% in 2011, driven by Dunkin' Donuts same store sales growth and new franchised locations. Total revenues of $635 million. Operating margins and net margins are in the same ballpark. Let's go with 16% net margins. At that run rate EPS would be $0.78. On a pricing of $17, DNKN would trade 22 X's 2011 earnings.
Quick look at THI and SBUX:
SBUX - $29.8 billion cap with a great balance sheet, $1.4 billion in net cash. Trades 27 X's 2011 estimates with an 8% growth rate.
THI - $7.96 billion market cap with a solid balance sheet of a shade over $100 million in net debt. Trades 20 X's 2011 estimates with an 8% growth rate.
DNKN - $2.2 billion cap at $18. Lousy private equity bloated balance sheet of $1.4 billion in net debt. Would trade 22 X's 2011 estimates with a 10% growth rate.

Conclusion - Great brand name here in Dunkin' Donuts. However, there's a whopping $1.5 billion in debt, laid on to pad the pockets of private equity. Baskin Robbins appears to be a fading brand name, losing customers per location at a frightening clip.
We've seen strong brand name deals awash in debt work if priced correctly. Range here seems about right when one factors in the negatives. Nothing to get too excited about. Solid sector, great brand name and looks priced about right in range. Neutral to slight recommend due to the Dunkin' Donuts brand name in the northeast.