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Inspire Brands' run on Dunkin' is a bet on coffee chain's post-COVID growth

Inspire Brands Inc.'s deal to buy Dunkin' Brands Group Inc. for a head-turning $11.3 billion illustrates the appeal of quick-service restaurants amidst a pandemic and could mark the beginning of further consolidation within the restaurant space.

Privately held Inspire Brands said Oct. 30 that it planned to acquire the parent company of the Dunkin' and Baskin-Robbins chains, including the assumption of Dunkin' Brands' debt. The $11.3 billion price represents a 20% premium to Dunkin's Oct. 23 closing share price, according to a UBS report. Inspire's portfolio already includes Arby's, Buffalo Wild Wings, SONIC Drive-In and Jimmy John's.

The deal, which would take Dunkin' private, would strengthen Inspire's portfolio of brands at a time when carry-out and delivery options are crucial to the success of restaurants and chains are edging out many independent eateries. Inspire wants to come out stronger on the other side of the pandemic, according to Jason Ware, partner and chief investment officer at Albion Financial Group.

"I think now is the time if you're a buyer of assets to look to consolidate your franchises and your brands and your ability to reach more customers," Ware said.

The pandemic is wreaking havoc on independent eateries and coffee shops. More than half of specialty coffeehouses, especially ones with three locations or fewer, are going to close because many are not geared toward delivery or have drive-thru lanes, according to R.J. Hottovy, a senior restaurant analyst at Morningstar. In contrast, Dunkin's focus on convenience has helped the chain beat earnings estimates as it looks to grow its footprint.

"We believe that the long-term potential for Dunkin' restaurant expansion is unchanged," Scott Murphy, president of Dunkin' Americas, said during an earnings call on Oct. 29. "We are still a growth brand."

Rumors that Dunkin' could be involved in some kind of merger or acquisition have popped up for years, Hottovy said. The large purchase price will probably help keep others from placing a bid of their own, the analyst said in an interview.

"The market has already started to price in some pretty aggressive post-pandemic growth," Hottovy said. "I think that was one of the motivations behind the Dunkin' deal."

Dunkin' did not respond to a request for comment. Inspire declined to comment.

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Inspire Brands' deal to acquire Dunkin' Brands has the second-highest transaction value of restaurant deals over the last decade, according to S&P Global Market Intelligence. The largest was in 2014 when Restaurant Brands International Inc. bought Tim Hortons Inc. for $13.44 billion. The third-largest deal to close since 2011 was Rye Parent Corp.'s $7.75 billion purchase of Panera Bread. More recently, Yum! Brands Inc. said March 18 that it closed the acquisition of The Habit Restaurants Inc. for about $375 million.

There will likely be more deals before the end of 2020 that target struggling restaurant chains or others in growth mode, though they probably will not be as big as the Dunkin' deal, Hottovy said.

"I'm pretty sure there's some conversations going on with a lot of chains right now," Hottovy said. "There's probably some other good sized deals out there."

Most big restaurant chains are generally reporting improving growth even as the future of their industry remains in flux and some brands are improving faster than others. Dunkin's U.S. same-store sales growth improved from an 18.7% decline in its fiscal second quarter to 0.9% growth in its fiscal third quarter. Meanwhile, The Wendy's Co., a smaller rival that also sells breakfast items, reported Nov. 4 U.S. same-store sales growth of 7% for the quarter ended Sept. 27. Dunkin' Brands' much larger rival Starbucks Corp. reported on Oct. 29 its Americas and U.S. comparable store sales declined 9% for its fourth quarter ended Sept. 27 — an improvement from a 40% drop in the prior quarter.

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Dunkin' Brands' revenue increased from $1.25 billion in 2016 to $1.31 billion for the year ended Sept. 26, 2020, and its net income in that time grew from $175 million to $220 million, according to Market Intelligence. Dunkin's comparable sales have improved and the brand's emerging success in the western U.S. is a positive sign for future potential growth, Sharon Zackfia, a William Blair analyst, said in a note Oct. 29.

"We also continue to like Dunkin's long-term strategic pillars centered on digital, menu innovation, and a multiyear reimaging that we expect to bolster comps and EPS growth in years to come," Zackfia said.

The company is still considerably smaller than Starbucks, which posted $23.52 billion in revenue and $1.38 billion in net income excluding exceptions for the year ended Sept. 27, according to Market Intelligence. McDonald's Corp., which reports earnings Nov. 9, also competes in the breakfast and coffee space. Breakfast was one of the hardest-hit times of the day across the restaurant industry because fewer people are commuting into work during the pandemic.

Companies with strong delivery and takeout operations have benefitted from the shift in eating patterns brought on by the pandemic and dining room closures. Chains like Dunkin, Chipotle Mexican Grill Inc. and Domino's Pizza Inc. are hitting valuations that have not been seen in a long time, which suggests markets appear willing to pay a premium not just for current market shares but also for market shares expected in the years to come, Hottovy said. Shares of Dunkin' were up 40.5% year-to-date Nov. 4. Shares of Chipotle were up 54.4% and shares of Domino's were up 34.0% in the same period.

Dunkin's deal with Inspire Brands will likely increase competition among the large chains, Hottovy said. Starbucks has already been adding smaller stores and drive-thru lanes aimed at improving convenience, and Dunkin' has added more premium products to its menu.

"We're going to see competition intensify among the players that do survive," Hottovy said. "Not only normal competition, but them also searching to encroach on each other's territory."