Dunkin' Donuts IPO: Another Boston Chicken?

Something with Dunkin' smells a lot like what Boston Chicken was cooking up in the 1990s.

Boston Chicken, now Boston Market, was a Wall Street darling in the mid-1990s as the chain grew rapidly, opening stores throughout the United States and sending the company's stock flying higher and higher. But the company was merely creating a steady stream of revenue from one-time development fees and increasing royalties through franchise sales.

Once growth slowed, somebody thought to look at the success of the existing franchises, taking a look under the company's proverbial hood. Seems Boston Chicken had dismal same-store sales year-over-year, and many locations were losing money, fast. When the new-store growth slowed, investors and the company had little to show for their stock.

Boston Chicken filed for bankruptcy in 1998. The chain was renamed Boston market, and eventually taken over by private equity firm Sun Capital Partners.

Similarly, Wall Street and financial journalists have fallen for Dunkin' Group (NASDAQ: DNKN) via the company's stock IPO. Wednesday was a giant love-fest, as investors sent Dunkin's IPO up more than 40 percent on the trading day and sometimes-jaded financial journalists turned as sweet and mushy as a cherry-filled glazed donut.

I'm afraid the excitment over Dunkin', which also owns Baskin-Robbins ice cream stores, might not last so long. The ingredients here have striking resemblance to Boston Chicken's 1990s story.

Consider:

-- Same-store sales at Dunkin' are relatively flat, and that's been the case for the past several years. Dunkin' reported negative same-store sales in 2008 and 2009 and only a modest 2.3 percent increase in 2010 on the backbone on enhanced market in advance of the IPO.

-- The company has a debt problem. Dunkin' is essentially a franchiser, yet the company brought $1.5 billion in debt to its IPO.

-- Baskin-Robbins is on the decline, and has been for years.

-- Dunkin' has an aggressive growth plan for new stores, which must be the only reason investors are valuing Dunkin' at IPO at almost 80 times earnings as competitor Starbucks trades at roughly 28 times trailing earnings. But as investors like Dunkin's plan to grow to double current size in the U.S. alone -- adding 500 stores per year -- while expanding abroad as well, that may be the Biggest Boston Chicken catch.

Since same-store sales are flat, and have been, and Dunkin's set-up doesn't allow for much food-offerings expansion beyond what's already being done, the company will drive its growth from one-time franchise fees and roll out fees much like Boston Chicken did.

For a while, that works OK -- but only until it doesn't, causing the cream to rise to the top of Dunkin's coffee.

Other problems loom as well. Starbucks is listed as Dunkin's primary competitor and New York is one of Dunkin's strongest markets. Yet visits to Dunkin' stores and Starbucks stores within proximity to one another as a business morning cranks up reveals two very different tales.

At several Dunkin' stores visited, the crowd was one to three. At several Starbucks stores visited in the same time period, the crowd was 15-25.

Big difference.

Also, since Dunkin' stores are franchised, the company has less control over how stores are run. One common complaint against Dunkin' is that many stores have cleanliness issues. Since some are open 24 hours a day, keeping the store clean with limited personnel to contain costs is a challenge.

Sub-par customer service is another common complaint about Dunkin'. Because the chain has added breakfast and lunch sandwiches and more complicated coffee and specialty drinks to its menu to creep up same-store sales, the staff often has a difficult task of managing it all. At one New York store visited, one gentleman waiting in line said he "knew better" than stopping there for "something besides donuts."

The biggest asset for Dunkin' is its established brand name. The company has almost 7,000 U.S. stores and thousands of other global locations. Current management has done a good job of changing the brand and sales mix so that coffee is now the company's leading seller, not donuts.

Still, there's only so much money to be made from selling coffee and donuts, especially when customer service is sub-par on average and many stores face cleanliness issues. Bring in the debt issue, and consider that Dunkin' plans to derive its growth from one-time store openings, and you have the recipe for another serving of Boston Chicken.

For investors, it may taste good on the first bite. How long that good flavor lasts, remains the biggest question.