It has been widely reported that Inspire Brands, controlled by private equity firm, Roark,  is negotiating to buy Dunkin’ Brands (DNKN) for about $8B, which, including approximately $3B of debt, values DNKN at about $11B. This amounts to about 22x EBITDA in calendar ’19, 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 $3B 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 not too much more leverage that can be currently 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 it’s 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 a little company called 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:

  • The $500M of historical and projected EBITDA for DNKN is after spending $507M in ’19 on advertising and $237M on G&A. Inspire Brands owns about 11,000 stores among its subsidiaries, including Sonic, Jimmy John’s, Buffalo Wild Wings and Arby’s. No doubt there are certain “synergies’ that could be achieved as advertising and SG&A are consolidated with the DNKN system that includes almost 10,000 stores within 21,000 distribution points. It wouldn’t surprise us if the numbers crunchers at Inspire have figured out that somewhere between $100 and $200M could be saved, out of the total of over $700M in ads and G&A.
  • Dunkin’ can sell coffee to 10000 new locations. If coffee is only 1% of $10B in sales, and the profit margin is 25%, that would be $25M of additional profit.
  • There is no other major brand in public hands that could as easily (and inexpensively) be rolled into Inspire’s existing ten thousand locations than Dunkin’s COFFEE and other offerings, whether or not a new daypart is desired. Dunkin’s coffee alone has a great deal of consumer acceptance and could be a meaningful addition at Inspire’s other brands. So: Dunkin 21,000 points of distribution could become more like 31,000, with minimal incremental investment by various franchisees. If 10,000 existing Inspire locations do something over $10B systemwide, a 5% addition to sales (throughout the day from Dunkin’ products) would add $500M to sales. A 5% royalty rate would amount to $25M of additional royalties, plus about $10M of additional advertising contributions. We could be high or low with these broad brush suggested numbers, but this seems like a material opportunity to us.
  • Dunkin’ franchised units an be cross sold to other Inspire brands. The same strip center housing a Jimmy John’s can house a Dunkin’ or and even a Baskin Robbins next store. Hard to quantify but another plus.

It is not hard to imagine (on a spread sheet, at least) that $500M of past (’19) and future (’21) EBITDA (forget about ’20) could become $650-$700M after G&A and advertising efficiencies, with another $50M thrown in from additional profit margin, royalties and ad contribution by way of 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 for DNKN 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, and current Dunkin’ shareholders will say “thank you very much.”

Roger Lipton