The Lockdown Series

Domino’s Pizza Poland ($DPP.L). A “Christmas Season” relisting that has gone unnoticed. The Lack Of Scale Has Been Addressed. 200% upside.

Domino’s pizza franchises globally have been flying in a lockdown environment. Shares in the UK, Australia and US franchises have all traded near 5 year highs, directors have been buying shares and typically pizza franchises have benefited from the move to online orders and take away aggregators like Just Eat and

Domino’s Pizza Poland (DPP) has been the poor cousin and has suffered in recent years as a subscale franchise despite a strong top down macro dynamic in Poland. As a smaller player (#5 in the market) going through expansion and early stage store rollouts there has been little sign of profits and a number of capital raises. We believe the DPP merger with Dominium Pizza (DOM), a Polish peer, announced in August 2020 is a game changer giving DPP scale and a hardened local management team (ex Dominium).

Given the DPP shares were suspended from trading on the deal announcement, the merger subject to competition authority review (there were no issues) and, now, this week after many months have been re-admitted to trading after the transaction completion and the share activity shows they have gone unnoticed with limited analytical comment.

If you read the company release from Friday, you can see that post completion the merged Dominium and Dominos business will be rebranded and be approximately 130 stores with growth options. This will give it a top 3 position alongside local player Da Grasso (186 locations) and Pizza Hut (153 locations) in the Polish market. There has been plenty of top down analysis over the years of Domino restaurants per capita and urban populations and how 400+ locations are feasible in Poland if you benchmark to more mature Domino markets.

The new DPP management team (former Dominium CEO) can now focus on revenue and cost synergies of the combined entity, address the loss making Dominos Pizza business while considering the Telepizza stores which have publically been flagged for sale.

The Collective believe DPP will see significant catch up with UK, Australia and US peers via addressing profitability, an equity re-rating and ultimately being consolidated into a larger group. The shares currently trade at 7.5 pence and a market cap of circa £40mn (post completion of the transaction and new share issuance in January, current share count will change). This points to 1.3x 2019 turnover versus its larger Domino cousins on 3 to 4x.

If the new management can execute, get the enlarged business back to higher profitability and growth and consolidate some more stores along the way – the upside will be significant. The Collective believe that DPP should trade at 2x turnover. Beyond this, it is quite normal to see country franchises get acquired by the larger entities. We suspect DPP will be no different in due course. On a 2 to 3 year view this equates to 200% upside or more. This is an under analysed opportunity. Buy.

Chart 1: 2 year performance – Domino’s Poland (blue) minus 43%, Domino’s UK (purple) + 42%, Domino’s US (green) + 62%, Domino’s Australia (yellow) + 117%

Background – A Favourable Top Down dynamic

The take away pizza business model has proven to be very resilient in a “lockdown era” with most of the quoted Domino’s pizza franchises share prices trading near their highs. The ability for Domino franchises to churn out like for like sales growth in excess of GDP growth, coupled with a structural move towards online and app based engagement for food delivery has been validated through the crisis. For many years Domino’s in the UK was described as an “app company” not a “pizza company”. Through the crisis, in the UK and Australia Domino franchises, we have seen insider company director buying and, in addition, this confidence is reflected in robust share price multiples.

Poland: Nice Top Down, Poor Market Structure – Until Now.

There is one Domino franchise that has failed to participate in this trend – Domino’s Pizza Poland (DPP), a micro cap listed on the London AIM exchange. Quite the opposite, the shares have traded at their lows and were valued at a fraction of their larger peers at 0.7x EV/2019 revenue prior to re-listing. This is despite the franchise in Poland showing resilient trading (+3% on like for like in April and May 2020) during a period when the Polish economy was expected to contract 8% (versus a European average of 12%).

The merger with the local player and the rebrand will double the number of Domino’s branded locations in Poland and have meaningful implications for scale and profitability. It is important we explore the reason for Domino’s Poland being the poor cousin and what is now going to change post the Dominium transaction.

Corporate History And The Poland Pizza Market

Firstly, some background. In June 2010 DP Poland (DPP) secured the Master Franchise for Domino’s Pizza Poland ahead of a July 2010 flotation on London’s AIM exchange. The company placed 13mn shares at 50 pence. The first store was opened in February 2011. Company owned stores are loss making in their first year and as you keep opening new stores these losses mount – the estate needs to mature and it is very capital intensive. As a result, the company has had to go through a number of capital raises and there has been a series of raises in July 2015, October 2016, June 2017 and March 2019.

This has not been straight forward nor has it been the first attempt at creating a Domino’s franchise in Poland. Post the collapse of Communism there was high demand for American brands in Eastern Europe and at the time a company, International Fast Food (IFF), had great success with the Burger King franchise. The number of visitors to McDonalds and Burger King in Eastern Bloc countries far exceeded the US. As a result, the CEO of IFF set up Capital Acquisitions Inc and acquired the Domino’s franchise for Poland. However, he warned in 1993  

Those who come into Eastern Europe with the intent to make money straight away will soon find a one-way ticket home”.

CEO, IFF, 1993.

How right he was. Amrest acquired International Fast Food in 2001 for the strength of Burger King but nothing ever came of Domino’s Poland in the 1990’s.

As a result, Domino’s Poland has never been a venture without risk and shareholders have been both patient and supported capital raises in eager anticipation of an inflection point. Could the Dominium transaction this summer provide that inflection point? We believe so – and now it has the benefit of a hardened local management team from Dominium who have built a 20% EBITDA margin business locally since the 1990’s.

Why Has It Been So Challenging?

What should not be forgotten, and what was disclosed at the time of Domino’s  Poland (DPP) listing, is the terms of the Poland Master Franchise Agreement with Dominoes US effectively imposed a store roll out plan and obligation on the newly listed DPP. This was a 15 year agreement from 2010, with a 10 year extension in 2025, requiring royalty payments back to the US franchisor and a legal commitment to open stores at a certain annual rate requiring store refurbishment and operating leases for stores. Behind the stores, there are now 2 central commissaries in Poland (central warehouses for dough and ingredients preparation) that have absorbed more capital expenditure but have the ability to support up to 150 stores. In addition, the Master Franchise Agreement will almost certainly be extended given this favourable dynamic. Why would the US Domino’s, the franchise owner, not capitalise on this?

Financials – Cash Burn And Capital Raises

As a result, despite revenue growing in December 2019 to  £14mn versus £12.7mn and £10.4mn in the prior years, the business has remained loss making with a negative operating cash flow in 2019 of £2.2mn. The company has been a serial equity issuer with placements in 2015, 2017 and 2019 to compensate for operating losses and capital expenditure. This has been supported by shareholders with Pageant  (an Ireland based family office) using the 2019 equity raise to drive a meaningful increase in its shareholding with a purchase of 30mn shares at 6pence per share and is now the largest shareholder in Domino’s Poland after the PE owner of Dominium – the latter owning 45% of the enlarged share capital post transaction.

Is Market Consolidation The Ultimate Solution?

The main issue has been that the market structure is poor, fragmented and that Domino’s Poland was sub scale. You do not want to be in a position where the largest operators in the market are more aggressive local entities and where the higher quality brands (Pizza Hut, Dominos and Telepizza) are subscale versus local competition.

There was no doubt that Domino’s Pizza Poland needed a solution. It has now been 10 years since its listing and the company has never generated a profit. This solution had to come from the market structure itself – which is what has happened. The appearance of Faynon Limited (the Butler brothers, the owners of the Starbucks franchise in Ireland) on the shareholder register in July 2020 alongside long standing shareholders Pageant, Fidelity and former CEO / Board Member of Domino Pizza UK Plc, Chris Moore, is an endorsement of the potential within the, now, enlarged group.

Some Market History

To give some background, Poland is a fragmented fast food and delivery market with McDonalds, Subway, Costa all are present in the QSR segment. Amrest, a quoted company, has the franchise for KFC, Burger King and Starbucks and 80 Pizza Huts. Telepizza, a previously quoted Spanish company and now part of KKR private equity, is also present with its own Telepizza brand. This is before giving consideration to local players.

The information available in the public domain prior to the Domino Pizza and Dominium merger is as follows:

  • DA Grasso is a lower quality local franchise and has 170+ stores
  • Amrest (ref Q1 2020 investor presentation, publicly quoted) operates through Europe, Middle East, Russia and China. Within Poland it has 283 KFC, 155 Pizza Hut, 45 Burger King and 73 Starbucks.  Only a small number of Pizza Huts deliver (most are restaurants)
  • Telepizza (ref 2018 investor presentation, acquired by KKR in 2019 and delisted) operates mainly in Spain and Portugal. Within Poland, it has 35 own Stores in Poland and 78 franchisees in Poland i.e 113 restaurants.
  • Dominium is a local player with 70 stores that are own stores (all COCO)
  • Domino’s Pizza Poland has 69 restaurants (46 own stores, 23 franchisees)

The conclusion is that post the Dominium / Dominos merger and rebrand (press in summer 2020) that the Dominos brand  at 139 stores and growing will match Da Grasso (170 locations) and Pizza Hut (155 locations). This looks to be a good deal from a market presence perspective.

It’s Not All About Stores – What About Online Aggregators?

One should not forget the role of aggregators and food delivery companies. This was a headwind for the Domino’s Pizza historically but now given improved partnerships with “” (German food delivery app) and Glovo (a large Spanish food delivery app) that are both present in Poland, the dynamic is improving and the company has commented that ½ of its new customers come via so the company would appear on the right side of this structural trend now.

How Profitable Could The New Entity Be?

The company provided some basic enlarged group figures with its 18th December 2020 release for the enlarged group.

  • Revenue = DPP £14mn + DOM £17mn = £31mn (2019)
  • EBITDA = DPP (0.4)mn + DOM £3.5mn = £3.1mn + £2.7mn synergies = £5.8mn EBITDA

The cost synergies look well deserved – you are looking at store network overlap, head quarter synergies and addressing loss making stores. The latter is a really important point when you bring store networks together that people always underestimate.

This is before you get into revenue synergies and potential benefits of rebrand and pricing alignment which could be expected. The stores will get branded as Domino or “Dominium by Domino” for a 3 year transition period and then go all Domino. These rebrands can create a lot of trading uplift.

Pricing analysis also looks interesting – some desktop analysis shows that DOM pricing is low versus DPP. As of this December 2020, a large Hawaii pizza at DOM is 34 slotzy versus DPP at 45 slotzy. Given DOM and DPP will have a combined brand the lack of revenue synergies in the 18th December release looks very conservative.

More Deals To Come? Telepizza And Domino’s  (post Dominium) Should Combine

It should be noted that market consolidation almost happened in 2019. Amrest (Pizza Hut) made a successful bid for Telepizza Poland at 8mn Euro in July 2018. At the time it was expected that a lot of the Telepizza stores would be closed and/or converted to Pizza Hut. However, the anti-trust authority blocked the deal.

Interestingly, Telepizza is now a forced seller of the Polish (and Czech) businesses and notes such in its 2019 published accounts.  As a reminder 35 are own Stores in Poland and 78 franchisees in Poland i.e 113 restaurants. There was a global agreement between Telepizza and Pizza Hut (Yum Brands) to sell its assets in Poland and Czech Republic as part of a global alliance. The two entities agreed, outside of Spain and Portugal, they did not want the co-existence of Telepizza and Pizza Hut brands within a single market.

From the 2019 Telepizza accounts (published March 2020)

“In 2019, the Group [Telepizza] held talks with several groups interested in acquiring the Poland and Czech Republic businesses, and on the date of authorising these consolidated annual accounts [March 2020]  for issue the terms and conditions for their potential sale are being negotiated.

In view of the foregoing, the Telepizza Group’s businesses in Poland and the Czech Republic were classified on 31 December 2018 as held for sale in the consolidated statement of financial position and as profit/(loss) from discontinued operations in the consolidated income statement, as required by the applicable standards. The sales transactions are expected to be effective in 2020.”

Obviously, this has not happened but it should be expected. Although Telepizza is not publicly quoted it is backed by KKR and there are bondholder reports. Such reports can be found online and state that their Polish entity loses money in terms of accounting profit. This will keep a lid on valuation.

One would have to consider if the entire Telepizza entity can be acquired by one of the large 3 players now. It is very possible it is broken up, or there are “remedy locations” to get competition clearance. The last reference price was €8mn for the entire Telepizza Poland group. So taking on Telepizza, or a portion of, is not a big ask my any means for the enlarged DPP + DOM with EBITDA of €6 to €7mn in 2021.

The Blue Skies For DPP?

The large franchise groups are active and don’t hold back on acquisitions. A simple assessment of one of the more acquisitive groups, Domino Pizza Enterprises (Australia), shows a business that has been involved in M&A transactions for Domino franchises in 2004, 2005, 2006, 2008, 2009, 2013, 2016, 2017 and 2018 globally. Acquiring a country franchise is a normal year for these entities. Domino’s UK Plc is not too different with M&A most years.

If the DPP management can deliver 2 to 3 years of operational performance, store rollouts, synergies and acquire/rebrand a portion of Telepizza you could be looking at a business that is doing £40mn of revenue (or more) and 20% EBITDA margin = £8mn of EBITDA and probably on the low side. Something like £10mn of EBITDA is very doable when you start considering further in-country expansion. What would someone pay for a higher growth, profitable and market leading country franchise? We think 15x EBITDA is not an issue versus 5 year averages of 15 or 20x for the larger groups which are on a lower growth rate in more mature markets.

If 15x £10mn EBITDA points to £150mn Enterprise Value – what is the equity worth? As of Dec 2019, DOM had 25mn zloty (£5mn) of borrowings and DPP had £130k. This points to an equity value of £145mn versus an enlarged share count of circa 560mn = 26 pence.

Suddenly, 200% upside versus the current 8 pence looks very realistic. Buy.

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The Collective are a panel of stock enthusiasts writing about high conviction investment opportunities with high return potential.

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