The art of the CEO takeover

By U.S. News & World Report

Dan D'Aniello was all ears in 2005 when Jon Luther, CEO of Dunkin' Brands, called and said he was looking for somebody to buy his company. The parent company of Dunkin' Donuts had long been part of the British conglomerate Allied Domecq, which had just been purchased by French spirits company Pernod Ricard. The new beverage titan planned to focus strictly on its core business, and coffee and doughnuts didn't fit.

D'Aniello, a co-founder of Washington, D.C.'s Carlyle Group, had known Luther for years. Both had been rising stars at Marriott International (MAR, news, msgs) in the 1980s. Luther had earned plaudits for turning around the Popeyes fried-chicken chain in the late '90s. D'Aniello jumped into action. (D'Aniello on the advantages of private equity.)

He called principals at two other private-equity firms, Thomas H. Lee Partners and Bain Capital, who agreed to invest equally with Carlyle and share the risk.

The consortium tried to make a fast deal with Pernod but was told it would have to participate in a formal auction. Several other bidders emerged, and the Carlyle team raised its offer at least once. Finally, last December, the Carlyle consortium won its prize, for $2.4 billion.

'The brand was becoming tired'

Carlyle execs say the Dunkin' deal highlights how private money can empower management, open new doors and help overcome the neglect some businesses suffer from distracted corporate parents -- all reasons an increasing number of CEOs have been seeking private buyouts.

"Dunkin' had had spotty experiences," D'Aniello says. "The brand was becoming tired. Because Allied Domecq was not investing, there was an opportunity to grow the business."

Unlike some buyout targets, Dunkin' was not a troubled company with assets that could be readily carved up and sold. It didn't come cheap, either -- the purchase price reflected an expectation of considerable future growth.

What lured the buyers was a strong management team, a predictable flow of revenue from franchise fees and bright growth prospects beyond Dunkin's home turf in the eastern United States, where most of its 7,100 worldwide stores are clustered.

"If one thing sums up the opportunity," D'Aniello explains, "it's that 80% of our revenue comes from the geography between Boston and D.C."

Outsource the doughnut making

Once the deal was finalized, in March, Luther and his new partners began pouring a fresh strategy for Dunkin'.

A new 11-person board was formed, with three slots going to each of the private-equity owners. Luther and Chief Operating Officer Will Kussell, who each invested some of their own money in the deal, took the other two seats. Luther began to raise standards for franchisees, hunting for business people capable of handling a network of three to five stores, not just one or two.

The team raised growth targets, too. Instead of adding 500 to 600 stores a year -- Allied Domecq's goal -- Dunkin' now aims for 800 to 1,000. And Luther has decided to put the Togo's sandwich-shop chain on the block and focus squarely on coffee and doughnuts, along with ice cream sold by the company's other brand, Baskin-Robbins.

Luther is also challenging some cherished traditions. To boost efficiency, the company may outsource doughnut making at some stores. And it's exploring ways to draw more diners for lunch, without souring them on breakfast.

Eye on China

Both sides seem pleased so far. The owners say that Dunkin's revenue for fiscal year 2006, which ended in August, beat their targets. And Luther feels he's getting more support than he used to. When Dunkin' was owned by Allied Domecq, he says, "I used to fly to England to beg for attention. Now I make a phone call and get three calls back within an hour." And Luther still feels as if he's in charge of the Canton, Mass., company: "They haven't camped out here. Most of the time I initiate the conversation."

The new owners should be particularly helpful priming overseas growth. Mercuries & Associates, a Taiwanese company that invests with Carlyle, asked Carlyle about Dunkin' Donuts franchising opportunities. The lead was passed to Luther's team, and within three months a deal was in place for Mercuries to open 100 Dunkin' outlets in Taiwan, starting in January -- the brand's debut there.

The new owners could be especially helpful in China and other developing countries Dunkin' hasn't yet dipped into. Carlyle, for instance, has an Asia-Pacific real-estate team that could help find good storefront space. "They bring a dimensional perspective we don't have," says Luther.

Such connections aren't free. Dunkin' pays its owners an undisclosed "management fee," which Luther describes as "moderate," for their time, advice and overhead. The sudden change has also left some franchisees feeling shut out, with management raising the bar too high, too fast.

"They paid a premium price for the brands, and now management is under a lot of pressure to crank up performance," says Mark Dubinsky, president of DD Independent Franchise Owners, which represents about 200 owners with 1,500 stores.

One complaint: promotions on coffee and baked goods, which draw traffic to stores but cut into profit margins. Franchisees also tried to purchase a small equity stake in Dunkin' Brands and get a board seat during the sale last year -- and were rebuffed. Dunkin' says franchisees are adequately represented on an advisory council that will give input to the board twice a year, starting in 2007.

They could get another chance to become shareholders once the private owners feel it's time to cash out. The most likely "exit strategy" for the private owners is a public stock offering. They could also sell to a "strategic owner" like Yum! Brands (YUM, news, msgs) or McDonald's (MCD, news, msgs). But to reap the market-beating returns private equity promises its investors, Dunkin' must first show that it can grow aggressively, get leaner and remain stable.

It could be a few years before that order is ready.

This article was reported and written by Rick Newman for U.S. News & World Report.