TAKEOVER TIME IN RESTAURANT LAND – ZOE’S KITCHEN FOR SURE, AND PERHAPS DUNKIN’ DONUTS?
About a year ago, two high priced acquisitions were made, namely Panera Bread and Popeye’s Chicken. We said at the time that these two deals were not harbingers of a broader trend. Panera was a strategic acquisition by a deep pocketed European buyer (JAB) . Popeye’s (PKLI) was a another franchise vehicle for the highly leveraged financial engineers at Restaurant Brands (QSR). Inexpensive capital (i.e.very low interest rates) and highly valued paper (QSR equity was trading at over 20x trailing EBITDA, with access to billions of debt) allow for some abnormal risk taking. Some have called it “misallocation of capital”.
It’s a year later, and two more highly priced deals are now on the radar screen. Zoe’s Kitchen has been bid for by Cava Grill, joined by Ron Shaich of Panera fame. ZOES is trading above the $12.75 suggested price, in the expectation that a higher bid could emerge. You can find our most recent description of Zoe’s, from our website article here:
We are not going to comment further on this situation, at the current time, other than to alert our readers that it is an interesting case study.
Dunkin’ Brands Group, a much larger company, has been recently touted as an acquisition target, perhaps by Coca Cola (KO), and DNKN is trading at an all time high. The latest writeup, from our website, on DNKN is provided here:
Our attitude here is that, Coca Cola, or anyone else, would be paying an unnecessarily high price for a Company that is not the industry leader. The Dunkin’ brand has been lagging the dominant Starbucks by a large measure, clearly losing market share, and there is no reason to believe that will change in the foreseeable future. While Dunkin’ works to refresh it’s approach, Starbucks is more aggressive than ever as it works to overcome the “law of large numbers” and cope with industry headwinds such as the increasing cost of labor.
DNKN trades today at about 18x trailing twelve months EBITDA, twenty seven times estimated earnings for 12/31/18, and it is difficult to project more than high single digit earnings growth in ’19 and beyond. If DNKN remains public, stock buybacks might take EPS growth into low low double digits, but DNKN has already leveraged its balance sheet to about 5x trailing EBITDA, so stock buybacks won’t do too much more than cover executive options. Few investors are enthused about paying 25x forward earnings, and 18x TTM EBITDA, for a company building earnings something like 10%. This is especially true in the case of DNKN, where a cash can be made that much of the free cash flow should be re-invested in the system. New and improved products, marketing, mobile order and pay, and other obviously lagging elements of the system are overdue to be addressed. The franchisees have been fighting the daily battle while the Company has bought back over a billion dollars worth of stock, and new highs in the stock have enriched the franchisor’s executives.
Asset light franchisors, with their supposedly free cash flow (because franchise systems have to be supported) are very desirable properties. Furthermore, Coca Cola, or another deep pocketed strategic acquirer could make the case, as Warren Buffet has often made, that one can afford to pay a fair price for a high quality asset run by proven dedicated executives, and the long term success will overcome the initial premium price. In this case, however, we don’t believe that DNKN has either a dominant industry position, nor is the management team outstanding.
Lastly, if KO or someone else is determined to get into the franchised coffee shop business, we suggest that this USA economic expansion and stock market boom is closer to its end than its beginning. A more opportune time to purchase almost anything may not be far away. We wouldn’t want to own DNKN at this valuation because the Company’s performance doesn’t support the stock price. We suggest, further, that potential purchaser’s of DNKN would be better advised to play another day.
Roger Lipton