DNKN - NEEDS A CATALYST BUT PLENTY OF DOWNSIDE

DNKN announced the pricing of its secondary today at $25.62.

This announcement is very convenient as whispers point to same-store sales trends continuing to accelerate in the fourth quarter.  We have been hearing that K-Cups are partly responsible for the improvement in trends.  A skeptical analyst would say the timing is perfect for the insiders to sell.

Insiders are selling into strong top-line trends following Dunkin’ Brands reporting what seemed to be a strong quarter but in truth was boosted by one-time gains.  While same-store sales are important, they are less important for DNKN, which is a predominantly franchised business, than growth in points of distribution (PODs).  On this metric the company has not updated the investment community on the backlog trends in 2011.  We only know what happened in 2010.  Again, a skeptical analyst would question why there is not more disclosure on this important metric.

Going back to the IPO, the timing of the sale of DNKN by insiders could not have been done at a better time.  The IPO was initially priced at the peak of the coffee bubble see chart below.  At that time the bubble was accented by the staggering valuation of GMCR which has since seen its multiple drop by 66%.   

Do you think the collapse of the coffee bubble prompted "the insiders" to ask the underwriters to waive the 180 day lockup restriction.  Do you think the collapse in GMCR valuation had anything to do with it?  I do!  The Green Mountain story turned out to be based on less-solid foundations than initially thought and we believe that Dunkin Brands will play out the same way over time. 

If you are buying the secondary you are paying 15x NTM EBITDA for DNKN.  This represents a 46% and 30% premium to GMCR and SBUX, respectively. 

Given that SBUX is a far superior company with a proven track record and global growth coming from multiple channels of distribution, I believe that SBUX should trade at a premium to DNKN not the other way around.  If DNKN were to trade at a 10% discount to SBUX it would suggest there is 49.6% downside in DNKN today to $12.91.  Even trading at the same EV/EBITDA (NTM) multiple as SBUX would imply an almost 40% decline to roughly $16.

The DNKN premium is due to what the Street believes is "white space" growth west of the Mississippi.  To accomplish this goal, management must build a backlog of stores that will allow them to open 500 stores per year beginning in 2013, up from a projected range of 220-240 in 2011.  Importantly, the company has not updated the investment community about the backlog.

Prior to the secondary, only 21% of the company was in the hands of the public.  After tonight, roughly 37.5% of the company will be freely traded.  

Following the secondary there are a few reasons to be concerned. 

  1. There will be less pressure on the massive numbers of underwriters to prop up this stock - the fees have been collected
  2. The increased liquidity will make it easier to short the stock
  3. Financial performance will become a focus and to date it's been marginal at best. 

The K-Cup story is stealing the limelight at the moment when it comes to Dunkin’ but once the focus turns to other topics, specifically of the growth strategy, execution will be what matters most and for that fact we remain bearish.

DNKN - NEEDS A CATALYST BUT PLENTY OF DOWNSIDE - QSR VALUATION

Howard Penney

Managing Director

Rory Green

Analyst