Following months of lockdowns, restrictions and closures, restaurants are struggling to remain as profitable as before the COVID-19 outbreak. Inspire Brands, majority-owned by affiliates of private equity firm Roark Capital Group, believes that this context is irrelevant, as it plans to acquire Dunkin’ Brands Group. Since bursting onto the scene in 2018, Inspire Brands Inc. has acquired five companies: Arby’s, Buffalo Wild Wings, Sonic Drive-In, Rusty Taco and Jimmy John’s. The acquisition of Dunkin’ Brands Group, parent company of Dunkin’ and Baskin-Robbins, gives the Inspire Brands portfolio its first chain focused on coffee and breakfast. Inspire Brands said the all-cash deal to privatize Dunkin’ Brands 9 years after it first became listed would be valued at $106.50 per share. That represents a nearly 30% premium per share to Dunkin’ Brands’ 30-day volume-weighted average price of $81.93, causing the company’s shares to surge more than 16% at the opening price on October 26.

Under the terms of the merger agreement announced on October 30, 2020, the deal valued at $11.3 billion, including debt, represents the second largest and most expensive transaction in the restaurant industry which is equal to approximately 23x Dunkin’s EBITDA. This is a high multiple, especially compared to the average multiple for U.S. restaurant deals over $10 million, which was 10.9x EBITDA in 2018, according to Bain & Company.

Figure 1. Previous transactions in the restaurant industry

Thus, why Dunkin’ is worth $11.3 billion and is this valuation justified? Will Dunkin’ show a resilience to the pandemic that no other restaurant can offer?

A resilience coming from an ability to adapt

Before the pandemic, fast food chains invested heavily in breakfast to meet growing consumer demand. But today, coffee and breakfast sales are plummeting as morning commuters work primarily from home. As a result, Dunkin’ U.S. comparable sales fell by 18.7% in the second quarter of 2020 and the company announced a plan to close 800 “low-volume, underperforming locations” this year. McDonalds, whose sales fell 30% in the second quarter, will close 200 outposts in 2020. Even though McDonald’s sales improved in the third quarter, breakfast market still “struggles”, said McDonald’s CEO Steve Easterbrook. Starbucks, whom net sales dropped 38% in the second quarter, will close 400 locations through 2021 and invest in pandemic-proof sales solutions such as mobile pick-ups and drive-through orders, reports CNBC. Globally, Dunkin’, McDonalds and Starbucks will close a combined 1,400 locations across the U.S., as the pandemic is sinking the breakfast market.

Although coffee and fast-food chains have been under pressure, Dunkin’ and Baskin-Robbins’ sales have improved from their lockdown lows in recent weeks. “Dunkin’ is thriving in a COVID world,” said Scott Murphy, president of Dunkin’ Americas, as Dunkin’ and Baskin-Robbins announced a surprise increase of 1.6% in U.S. comparable sales in the third quarter. Dunkin’s performance improved sequentially in each month of the third quarter. To help turn sales around, the company took some initiatives such as new driving tools, curbside pickup and improved digital applications. By 2018, Dunkin’ was already investing in digital-ordering tools with its $100 million plan to “accelerate its beverage-led strategy”. Today, about 70% of Dunkin’ restaurants are equipped with drive-through windows. 

In recent years, Dunkin’ also focused on rebranding its flagship chain to underscore its focus on coffee. In 2018, it dropped the words “Donuts” from its name and now generates more than half of its sales from drinks. It has since invested in new espresso equipment to benefit from higher margin on espresso-based coffees over cheaper options. As a result, during the global pandemic, fast-food chains, especially those with drive-throughs like Dunkin’ has stood tall and held up better than sit-down chains. This deal comes on top of the recent wave of restaurant takeovers that preceded the pandemic and reflects Roark Capital’s view that Dunkin’ will survive, and even thrive for the foreseeable future.

An inspired decision to acquire

We understood that Dunkin’ is a resilient company: it succeeded in repositioning itself as a brand and makes it through the pandemic, despite some locations closing for now. For a Private Equity firm focusing on restauration like Roark Capital, it hence makes sense to focus on such targets. But besides being sounder than others, the premium paid might not be worth it. So, what is the reasoning behind Inspire Brands’ acquisition strategy?

From its website, we get more insight on their investment philosophy: “In an industry facing increasing disruption, our leaders saw an opportunity to build a restaurant company unlike any other – one that brings together differentiated yet complementary brands and aims to make them stronger than they would be on their own.” To go further, Inspire Brands owns 5 franchises: Arby’s, Buffalo Wild Wings, Sonic, Rusty Taco and Jimmy John’s. This amounts to a portfolio of 14.6 billion in Sales, more than 11,000 restaurants with 1,400 franchisees and a presence in 14 countries, allowing Inspire to be among the largest restaurant companies in the US. That said, Inspire Brands is only about 2.5 years old, but has already a clear strategy of acquiring and franchising more and more over time.

It makes sense, therefore, to acquire Dunkin’ to consolidate a portfolio focused on restauration, designed to be diversifying geographically and qualitatively, while pushing each company’s strategy to adapt to uncertainty, to increase brand value and to remain complementary to cope with cannibalization risks.

From burgers to tacos through chicken wings and sandwiches, what was Inspire Brands’ portfolio lacking? A breakfast restaurant, focused more on selling sweet food and drinks, allowing it to attract not only people for lunch and dinner, but also for their morning coffee. Not to say that Dunkin’ is settled in 40 countries and accounts for 12,500 Dunkin’ and 7,000 Baskin Robbins locations worldwide, allowing Inspire Brands to reach more countries than ever before with this unique transaction. This leads to an increase in the value of synergy.

Figure 2. Source: Worldwide restaurants reported by Dunkin’ Brands

At this point, it should be noted that, to secure this value of synergy, Inspire Brands will have to succeed in increasing Dunkin’ revenue over time, optimizing processes, reducing expenses and keeping an ambitious strategy in line with the legal, political and economic constraints. From an absolute point of view and prior to talking more about the multiple paid, it can be argued that Inspire Brands will enjoy a beneficial impact from synergy effect, declining itself from generating higher cash flows and reaching a new pool of customers worldwide.

Multiplying the premium paid or the profit made?

Inspire Brands’ primary backer Roark Capital is known for being actively involved in the operation of its portfolio companies. Indeed, Roark Capital is somewhat unique from other private equity firm in that it manages portfolio companies at arm’s length, investing in their digital abilities and holding its investments for a long time (over a decade). Formerly, Roark Capital has focused on publicly traded acquisitions primarily viewed as turnarounds. Dunkin’ does not fit the pattern, being an undeniably desirable target for Roark Capital. With Dunkin’, Inspire Brands would almost triple its number of restaurants worldwide to 31,600, ahead of Restaurant Brands International Inc., owner of Burger King.

Figure 3. Source: Worldwide restaurant numbers reported by companies

However, Inspire Brands acquisition price of Dunkin’ reflects a high valuation. From a valuation standpoint, using Discounted Cash Flow (DCF) method, with a forecast horizon of 10 years as it best reflects Roark Capital investment, Dunkin’ enterprise value equals to $12,356 million with an implied share price of $117.74.

(1) WACC of 7.5%
(2) Terminal EBITDA Multiple of 21.8x (average EV/EBITDA from Dunkin’ comps historical output)

Figure 4. Self-valuation of Dunkin’s intrinsic indirect approach. Source: Dunkin’s Annual Report on 10-K Form

Our valuation therefore shows that Dunkin’s fair value is at a 25.9x its FY2019 EBITDA. Considering the closing price of $88.79 at announcement date, the closing price of $99.71 at merger agreement date and the current market price of $107.39, our opinion is that Inspire Brands acquisition of Dunkin’ Brands at $11.3 billion with debt is slightly below its intrinsic value. The premium on share price from announcement date represents 20.95%, which is equivalent to the one paid by Inspire Brands. In most optimistic scenarios, for instance in case a vaccine is relatively quickly found and accepted worldwide, mitigating the effects of COVID-19, Dunkin’ could know a decrease of its WACC and/or an increase of its expected cash flows, bringing Dunkin’s enterprise value higher and making this deal even better for Inspire Brands. Indeed, as markets do not pressure expectations and forecasts, Dunkin’ will regain valuable flexibility. Nevertheless, in most pessimistic scenarios, Dunkin’ could struggle to cover its debt level with cash flows from operations, which could represent concerns, although the current interest coverage ratio shows that it has the ability to service debt.

It is worth remembering that the acquisition price is mainly driven by the potential for value creation resulting from the transaction’s synergies. Thus, Dunkin’s acquisition is seen as a synergistic move for Inspire Brands. While the potential for cost synergies from the deal is not obvious, Dunkin’s brands add complementary guest experiences and a successful international franchise business model to Inspire brands’ current portfolio. Indeed, Dunkin Brands’ sources of profit are royalties and store licensing fees through its 100% franchise business model. One of the opportunities for Dunkin’ to move forward as a private company is that it may be more willing to invest in growth through store renovation and expansion. Inspire Brands’ aim is to build a full-spectrum collection of restaurants. Apart from the long-term growth potential of Dunkin’ and its large-scale international platform, this deal also strengthens Inspire Brands through robust consumer packaged goods licensing infrastructure and more than 15 million loyalty members. Moreover, they would increase their knowledge of the different markets where Dunkin’ is already located and open new restaurants of other brands in these locations. This might indeed be worth the premium paid. As a result, Inspire Brands would benefit from an additional $1.4 billion in annual sales through highly franchised, asset-light models that may be in a position of growth or in state of flux. It should be noted that because of the high valuation of Dunkin’ and the synergies opportunities for Inspire Brands, we are not expecting a competing bid for Dunkin’ acquisition even if the deal is structured as a tender offer.

Figure 5. Source: Internal Companies’ websites

The COVID-19 outbreak forced restaurants to reinvent their way of operating, facing the risk of closing temporarily. Dunkin’ is among the companies that best adapted to fit the requirements of such a situation, as it took upstream initiatives such as new driving tools, curbside pickup and improved digital applications.

Thanks to this, Dunkin’ is thriving in this era relatively to some of its peers. It avoids being in a distressed situation and even enjoys a high absolute valuation. In this context, Inspire Brands decided to acquire Dunkin’ and believed it was worth 23 times EBITDA. This could allow the former to enjoy an increasing value of synergy, since Dunkin’ does not operate on the same type of meals.

In the light of these facts and after running our own valuation, we believe that Inspire Brands took a great decision to take Dunkin’ private again. We expect this acquisition deal to be finalized by the end of the year.


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