The Breakdown

Explaining Southern California's economy

Dunkin' Donuts: The return to California, by the numbers

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There haven't been any actual Dunkin' Donuts stores in California since the 1990s, but that's all about to change. This isn't you father's Dunkin' Donuts. This is a whole new, amped-up, recently IPO'd and private-equity enabled Dunkin' Donuts. Not a cheerful place to stop in for a delicious coffee and and sticky ring of fried dough, but Starbucks worst nightmare.

Dunkin' Donuts, which has become something of a hipster alternative to 'Bucks, has almost no presence west of the Mississippi. However, following its $400 million initial public offering last year, it's putting itself under pressure to grow. Understandably, given that it's stock price has bumped along in a narrow trading range since its successful debut (it came out at $19 and has lived reliably above that ever since). But it's trading at 100 times earnings (not unusual for a newly IPO'd company), which means that investors are expecting this sucker to go someplace.

To do that, ticker symbol DNKN needs to open new markets (or re-open old ones) and go head-to-head with the competition. In this case, that's Starbucks and McDonald's. That's right: We have a coffee war a-brewin' in the West. 

One wonders how nice Dunkin' Donuts will play. It's owned by a trio of private-equity firms, all major players: Bain Capital (the house that Mitt Romney built), the Carlyle Group, and Thomas H. Lee Partners. Having taken the company public, these firms are bound to be considering their exit strategies. The investment has been a fairly good one so far. But it looks as if the investors want it to get better.

The big advantage Dunkin' Donuts has over Starbucks is price: a basic cup of coffee is cheaper, as are the coffee beverages (of which there are far fewer than 'Bucks, making staff training much easier). But this means that Dunkin' Donuts has lower profit margins than Starbucks. It also has a less virtuous mix of foods to go with the inexpensive coffee. Donuts are donuts. They are not a healthy dietetic option. Nor are cake pops, necessarily, but Starbucks also sells nutritious sandwiches and so on.

Dunkin' Donuts has, in short, a trashier color scheme than 'Bucks and is weak on health. Oh, and its drinks are kind of..large. You can see where this is going demographically.

To ameliorate this situation, DNKN is going to have to think about juking its image and expanding its food offerings, without compromising the useful perception that it's not as pretentious as 'Bucks (it's certainly not a "third space" where you hang out for six hours with your laptop). It's moved in this direction already, ribbing Starbucks in some ads.

But Dunkin' Donuts also has to remember that McDonald's, with its McCafe concept, has already taken up residence in this neighborhood — and Mickey D's has WAY more food choices, most of which fall outside the realm of breakfast. (You haven't really lived until you washed down an Angus Deluxe with a really big iced latte.) McDonald's also doesn't need to be an anti-Starbucks. It's McDonald's! 

Additionally, Dunkin' Donuts is going to have to grow its business in the U.S., primarily. It's international revenues are a drop in the bucket when compared with Satrbucks.

On the plus side, DNKN has already outperformed SBUX and MCD this year, by a decent margin. So it's poised for growth, in a recovering economy. 

And THAT'S where Dunkin' Donuts may find its formula for success. The Great Recession has trained consumers to be much more price conscious than they were before the downturn. If Dunkin' Donuts can offer coffee beverages that compete with Starbucks on quality and undercut Starbucks on price, DNKN may make up its discount on volume — and win customers from 'Bucks who can't stomach the premium price of an SBUX latte.

Jim Cramer completely disagrees — last year, he saw 'Bucks are the faster-growing, relatively cheaper stock. But he also saw the private-equity guys headed for the exits, something that hasn't yet happened in force. So we'll see if Dunkin' Donuts can disrupt Starbucks in the West. I think the chances are good that it can move its share price north in 2012.

Follow Matthew DeBord and the DeBord Report on Twitter.

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