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Wall Street equity strategist, Chuck Neul, recently blogged his opinion on the pending IPO of Dunkin' Donuts [DNKN] and the involvement of private equity firms taking Dunkin' Donuts public. In Mr. Neul’s opinion, private equity firms, such as, Bain Capital Partners, destroy the long term viability of their acquisitions by siphoning cash prior to taking their portfolio companies public.
It doesn't take a genius to consider what this sort of cash siphoning by the private equity firm can do to the long term viability of the acquisition, once it has been prepared for an IPO.
Franchisees are at significant risk when a franchise is sold; especially, when the franchisor is acquired by a private equity firm. As demonstrated immediately after the 2006 acquisition of Dunkin’ Donuts, the private equity owners fully exploited the franchised assets by engaging in a tactic known as refranchising to increase additional sources of revenue.
For example, DD, upon going private, engaged in a practice by which they receive extra fees by exercising clauses in franchisees' agreements to essentially take units from current owners and resell them, for more money, to other parties. Known as "refranchising," this allowed the franchiser, DD, to selectively break up smaller, multiple-unit franchisees who were profitable, but whose stores would be more valuable to slightly larger franchisee groups.
Litigation is a profitable business for Dunkin’ Donuts because it allows Dunkin’ to expend the franchisee’s marketing funds to pay for the franchisor’s legal expenses. The Dunkin’ Donuts franchise agreement states the franchisee is responsible for legal expenses incurred by the franchisor. When the legal fees are recouped, instead of the funds being returned to the franchisee’s marketing funds, the management of the Dunkin’ franchisor self manages the accounting of the funds and credits them as refranchising gains and other revenues to the corporate parent.
Further, as some of these franchisees who were being, in effect, driven out of business, litigated these moves, resulting fees from the resale of the units became income to the franchiser, or private equity group. Through a process that is rather murky to those of us not in the business, the private equity groups were able to fund such a program from the franchisees' own marketing expenditures, but keep the gains for the corporate unit.
The murky accounting practices leads the Wall Street equity strategist to believe “the imminent spinning of DD, the franchiser, back into public hands, seems, well, rather like a pig in a poke.”
Chuck Neul has no interest in purchasing DNKN shares for his equity portfolio. He questions if the average institutional and retail investors will be able to comprehend the financial engineering that the Dunkin’ franchisor endured during its ownership under the consortium of private equity funds.
My own equity portfolio selection process would not see DD as a candidate for some time, if ever. But I wonder how much the average investor, even on the institutional side, really comprehend about what may have been done to and with DD, the franchiser, during its tenure as a private equity-owned acquisition.