The last week of July was arguably the busiest week for IPO offerings since
November 2007. It seems investors let their stomachs do the walking, as Dunkin
Brands (NASDAQ: DNKN ), Teavana Holdings (NYSE: TEA ) and Chef's Warehouse
(NASDAQ: CHEF ) all went public, averaging a whopping 42.3% first-day return.
It's mind-boggling when you consider the markets are flat for the year. Who in
their right minds is buying this stuff? Not me, that's for sure. Especially
puzzling is Dunkin Brands, which hasn't been a growth story for several years,
yet investors were willing to plunk down $19 per share for a business with
excessive debt and marginal possibilities for growth. If you were lucky enough
to have gotten shares at $19, I hope you've sold because in 12 to 24 months,
Dunkin's stock will be trading well below the offering price. Here's why:
Valuation A lot's been bandied about in the media regarding Dunkin's IPO
valuation. At the IPO price of $19, the market gave it an enterprise value of
$3.7 billion. A week later, thanks to its 46.6% first-day pop, that number is
more like $4.6 billion. That's 16 times EBITDA. McDonald's (NYSE: MCD ) and
Starbucks (NASDAQ: SBUX ) have multiples of 10.9 and 13.6, respectively. Dunkin
is in the ballpark until you consider that its debt level when compared to
EBITDA is four times McDonald's and 20 times Starbucks. It's not even close
to being in the same league. But forget traditional valuation metrics for a
moment. I'd like to look at the current value from a different perspective a
historical one. J. Lyons & Company bought Baskin-Robbins for $45.5 million in
1973. Allied Breweries subsequently acquired Lyons in 1978, then in 1990, the
merged firm bought Dunkin Donuts for $323 million. Factoring in inflation, the
two companies sold for $706 million in 2006 dollars. I use the year 2006 because
that is when Bain Capital, The Carlyle Group and Thomas H. Lee Partners paid
$2.4 billion to acquire the iconic brands. Is it possible that its enterprise
value could grow from $706 million in 1990 to $4.6 billion today, given its
earnings history? To do so, its enterprise value would have to increase 8.9%
annually for 22 consecutive years. Keep in mind the S&P 500 returned 6.2%
annually in the same period. I'm skeptical, and you should be, too.
Second-quarter results Let's assume for one second that Dunkin's enterprise
value did grow 9% annually during the past two decades. If that is indeed so,
its second-quarter earnings report is nothing short of horrendous. You don't
grow a business at that rate for that long without delivering exceptional
results every quarter. Sure, revenues increased 4.4% to $157 million, but net
profits dropped 3.5% to $24.7 million. That's hardly bedazzling. Worse is the
fact its same-store sales at U.S. Dunkin outlets, the supposed growth driver,
increased 3.8%, less than half what Starbucks did in the same three-month
period. And don't get me started about Baskin-Robbins. Have you been in one of
their outlets lately? Save yourself the misery and head to the local gelato
store. That business is on life support. The Three Amigos It all makes sense
when you consider who the sponsors of the IPO are. Private equity's sole
purpose is to make money for its investors. You've heard the story before.
They buy a company for $2.4 billion, use as little of their own money as
possible (in this case, $800 million) pay themselves lavish dividends of $590
million prior to the IPO and then, in the immortal words of Randolph Duke,
"Sell, Sell, Sell." Have they improved the business? Not on your life. You
can be sure that the debt, while it was owned by Allied-Lyons, was negligible,
and now it's $1.5 billion. In the five years they've owned Dunkin Brands,
same-store sales have increased 1.1% annually. In the five years prior to their
takeover, the average was 5.9%. While they'll argue they bought the company at
the worst possible time, I'd argue it wasn't a problem of timing but rather
the price paid, fueled by easily obtained debt securitization . The bottom line?
You don't have to be a rocket scientist to know Dunkin Brands' stock is a
ticking time bomb. Own with extreme caution.
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