Domino’s delivered for Bain
Romney’s Bain made big profit from the pizza chain, but left it saddled with debt
Amid a flash of cameras, Mitt Romney signed the check to buy Domino’s Pizza with a flourish. It was a huge deal for Romney’s Bain Capital back in 1998, worth $1.1 billion.
Thomas Monaghan, the pizza magnate and orphan raised by nuns in the Detroit area, was cashing out all but a small stake. He wanted the proceeds to start a Catholic university. So he handed over control of the company he built from a small pizza shop in Ypsilanti, Mich., in 1960, to Romney and the partners of Bain Capital.
Domino’s was not in need of rescue, nor was it a classic turnaround case for Bain. But it was still a bonanza for the Boston leveraged buyout firm, which makes money by buying and selling businesses. Bain reaped a 500 percent return on its investment in the nation’s largest pizza delivery chain over 12 years.
Domino’s grew its revenues and earnings under Bain, but its debt also surged to $1.5 billion, leaving the chain with a higher debt ratio than most of its rivals, and interest payments that eat up half its profit each year.
On the campaign trail, Romney, who left Bain in 1999, counts Domino’s among his corporate success stories, saying it has grown and paid off for investors. But the company also was left with greater risk than before, and must count on its franchisees to deliver a steady stream of cash to cover the debt.
“They’re much more highly leveraged than any of their competitors,’’ said Edith Hotchkiss, a professor of finance at Boston College’s Carroll School of Management who has studied the effects of private equity on businesses. “Companies were able to borrow at that level only just before the financial crisis.’’
High levels of debt don’t always lead to problems, but they can when the economy slows or the company stumbles. In the classic private equity model, Bain set out to improve Domino’s, with the expectation that it would generate plenty of money to make payments on its debt.
To buy Domino’s, Bain put up a third of the money in cash and borrowed the rest. It took money out in several chunks including: a 2003 refinancing of the company’s debt, a 2004 initial public stock offering, and an $897 million “monster dividend’’ paid to Bain and other investors in 2007. In each instance, the company borrowed money or refinanced old debt to make the payouts.
Romney’s political rivals have attacked him for a number of deals during his tenure at Bain Capital where the companies went bankrupt, sometimes after Bain cashed out. And while Bain says it makes companies run better, Hotchkiss says part of that is sheer pressure: Companies with high levels of debt have to generate profits and be careful with costs, or risk bankruptcy.
“The argument for higher leverage in the first place is that it really forces you to run these firms for maximum efficiency,’’ she said. “You can’t make mistakes.’’
The Domino’s debt is due in April. Executives can extend that deadline for two one-year periods, during which they plan to refinance the borrowings. The current interest rate is 5.9 percent, and it will rise a quarter-point with each extension. Domino’s was going to refinance the debt last summer but scrapped the effort when the financial markets turned chaotic.
Lynn Liddle, a company spokeswoman, acknowledged there’s a risk of interest rates rising. But she said the debt is not holding the company back. Domino’s stock soared 113 percent last year.
“In another case, that might restrain a company, but definitely not in the case of Domino’s Pizza,’’ she said.
Domino’s and Bain executives insist the debt is not a problem because the company has strong cash flow from its franchisees, and because theirs is not a capital intensive business requiring large outlays on equipment and other big expenses. The franchisees pay for most capital investments, like store upgrades.
“This is a terrific success story by any standard, and it’s clear the capital structure was never a constraint on the growth of Domino’s,’’ said Bain Capital managing director Mark Nunnelly, who served on the Domino’s board for 12 years. “Domino’s delivered significant value to both private and public shareholders during our ownership,’’ he said, citing growth in profits and sales, market share, and customer satisfaction.
Revenues grew 9 percent during the last five years Bain was an investor in the company, through 2010, while operating income grew 6.3 percent. In 2010 (the last full year reported by Domino’s) nearly half that income, or $97 million, went to pay interest on the debt.
Romney recently cited Domino’s as a place where he had created 7,900 jobs, in a breakdown of the 110,000 jobs he says he helped create at companies he worked with at Bain, along with Staples Inc. and The Sports Authority. But he has since dropped Domino’s from the list, focusing instead on start-ups.
In reality, the job picture is mixed. At the corporate level, Domino’s, based in Ann Arbor, Mich., has actually cut 3,300 jobs, or 24 percent of the 13,500 people it had on the payroll in 2004, the year it went public. That’s partly a result of selling off about 175 company-owned stores to franchisees.
At the same time, the number of people working for the independent franchise owners - not employed by Domino’s corporate - has grown by about 38,000, to 170,000, around the world, according to public filings. Domino’s won’t discuss job numbers, but much of the growth has come from abroad.
Domino’s operates about 9,500 restaurants, all but 400 of them run by franchisees. The company makes its money selling cheese and dough and other ingredients to the stores, and on the royalties the store owners send them from their sales.
Some current and former restaurant owners say they have struggled since the recession hit, as customers spent less and ordered out less. They say central decisions, voted on by the franchisees and supported by management, have made life harder, like when they slashed the prices of pizzas roughly in half back in 2009, to $5.99. That boosted business for a while, one franchisee explained, with a blitz of national TV advertising that the franchisees pay for. But it also means they have to sell more pizzas to make money, at the same time prices for the ingredients have been soaring.
“They drove me into the ground,’’ said one former franchisee whose business failed last year. “If I could have sold my pizzas for the price my market could bear, I might have made it.’’ The franchisee spoke on condition that his name not be used, for fear of retaliation by the company.
Other franchisees said it’s true they need to sell more pizzas now, but they attribute that to competing in a tough economy, not to pressure from the front office.
Jeffrey Litman, who with his wife owns 20 Domino’s stores in the Denver area and has been in the business for 37 years, said there was concern back when Monaghan sold the company that the franchisees might suffer. But, he said, “In general they recognize they can’t do anything to weaken the franchise. We drive the sales.’’
Bain says it helped Domino’s raise standards, and that it brought better marketing and new discipline to the company that helped store owners sell more pizza. There were updated uniforms, new computer systems, redesigned stores, and new product rollouts.
At the same time, the company took on some of the trappings of corporate America, with top executives enjoying personal use of the company’s private jet and directors earning fees of $180,000 a year.
Meanwhile, the quality of the pizza itself had become a big problem. In 2009, near the end of Bain’s involvement, the company had to overhaul its core product, after Domino’s pizza ranked last among its competitors in taste.
“You can’t be a pizza delivery company that’s just strong with delivery,’’ the company’s marketing chief, Russell Weiner, said during an investor conference earlier this month.
Domino’s pizza has since received high taste marks. Company executives are counting on growth overseas in places such as Malaysia and India. They also said they have become accustomed to being a company with high leverage.
“We’re comfortable with debt,’’ said Michael Lawton, Domino’s chief financial officer, at the investment conference. He described the 2007 “monster dividend’’ in which investors, led by Bain, received a $897 million payout from the company. The management team is used to living within the constraints of financial leverage, he said. “We can handle this.’’