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Despite rumors, Donatos Pizzeria isn't for sale, says official

McDonald's struggles have stock analysts speculating it will sell Donatos. Company executives dispute the story.

February 3, 2003

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When McDonald's Corp. purchased Donatos Pizzeria in the spring of 1999, then-CEO Jack Greenberg claimed his company now owned the "gold standard" in the pizza business.

Some speculated the burger giant would use the 146-store, Columbus, Ohio-based chain as a co-brand option to combat Tricon's (now Yum! Brands) burgeoning multi-concept model. McDonald's franchisees saw the purchase as a potential opportunity for adding a non-competing brand to their own restaurant portfolios.

Since then, the glow of the Donatos gold standard has lost its luster, and speculation about its future below the "Golden Arches" is drastically different.

During a Jan. 16 conference call, McDonald's newly appointed CEO Jim Cantalupo told stock analysts and the press that for the first time since the company went public 37 years ago, it lost money -- $343 million.

Unable to improve same-store sales or generate repeat visits with price discounts, Cantalupo said the company was working feverishly on new ideas it hopes will reverse the troubling tide of losses.

Several analysts listening to the call thought McDonald's should try an old but proven idea: Focus on the core brand and strongly consider dumping any brand that shrinks Ronald's return on investment.

That idea, analysts believe, may equate not only to the sale of Donatos, but 690-store home-meal-replacement chain Boston Market as well. McDonald's acquired Boston Market in 1999. Neither "partner brand," as McDonald's calls them, turned in positive numbers, and neither system grew in 2002.

Though Donatos began the year with 197 stores, it finished with 181. In 2002 it closed 36 stores, including 30 in a three-week period that saw its 23 Atlanta market stores vanish.

"The facts are they've been closing them, and that's not a good sign," said John Glass, an analyst who covers restaurant stocks for CIBC World Markets in Boston. "It doesn't make money, it's actually negative to earnings. But that's not just Donatos; it's all the partner brands."

Chicago-based Morningstar analyst Carl Sibelski, who covers McDonald's, said that Donatos' growth since its '99 purchase hasn't been impressive enough to convince him McDonald's wants to expand the concept.

"If they can't grow it profitably to at least 1,000 stores, it's probably not going to be something they're interested in keeping," said Sibelski. "And I think (McDonald's) has proven that they're probably not going to be able grow that one."

Representatives of both Donatos and McDonald's deny the company is destined for the auction block. Donatos senior vice president Tom Krouse said he's fielded several calls about the rumored sale, but that the rumor has no merit.

"I couldn't tell you anything beyond all we know, and that's business as usual -- which is very good right now," Krouse said. "So I don't have any information that would support that rumor."

Jennifer Newton, director of communications for partner brands at Oakbrook, Ill.-based McDonald's, said the company doesn't respond to rumors. "If we tried to talk about and refute every rumor we hear, that would be all that we were doing rather than running the business and serving customers."

New and improved, but is it enough?

While Krouse acknowledged the pizza chain's numbers shrank this year, he said store losses were small compared to the chain's remaining unit numbers. He said that the closings -- particularly units lost in Atlanta -- were tough tests in the ongoing process of positioning the chain for rapid growth, something he believes McDonald's still plans to do with Donatos.

McDonald's expansion plans, he added, include two stages: incubation and acceleration.

"The incubation stage is where we learn what our strengths and weaknesses are ... and try to get the unit economics where they should be," Krouse said. "That's where we also develop the model that will allow us to accelerate."

Visible proof of Donatos' evolving operation is its new "Pizzeria" concept. The stores -- many of which are red-brick freestanding structures -- seat 90 to 110 customers and offer a full menu of pizzas, sandwiches, salads and desserts.

The Pizzerias feature the company's new "dine at your own pace" service model, which Krouse claims "puts the customer in control." Phones at each table allow diners to call the kitchen to order food or drinks. Each Pizzeria also includes a separate area for carryout and a drive-up window.

"What we're trying to do is take down all the barriers to the ways people consume pizza," Krouse said.

In the past year, Pizzerias have opened in Philadelphia, Orlando, Fla., and Cleveland, as well as Munich, Germany, marking the company's first step into the international market. Krouse wouldn't give specifics, but he said results at those stores, especially at the Munich unit, are impressive.

But not impressive enough to convince some analysts Donatos shouldn't be sold.

Donatos isn't contributing to McDonald's bottom line, Sibelski said, and it's an unnecessary distraction from the burger brand.

"The partner brands as a whole only make up about 2.5 percent of McDonald's systemwide sales, so it's almost a rounding error when I do an evaluation of McDonald's," Sibelski said. "And given all the other stuff they have to confront right now, they may be able to use the cash (from a sale) tomorrow."

Like Sibelski, Glass believes the rapid growth of Chipotle Mexican Grill, McDonald's quick-casual Mexican chain, is proof that it, not Donatos, is the corporation's favored son. Unit numbers grew 31 percent from 177 to 232 in 2002, from a base of about 50 units when McDonald's bought a minority interest in the Denver-based chain in 1998 (it now owns 90 percent).

"They've signaled quite clearly that Chipotle is their winner and they're growing that pretty hard," he said. "It's also unclear whether Donatos is differentiated enough to really make a difference."

Sibelski said McDonald's initial interest in the U.S. pizza market -- a restaurant segment that dominates dinnertime fast-food sales, a feat burgers never have accomplished -- has waned in the face of stiff competition.

And despite Donatos' plans to open 200 restaurants in Germany by 2005, Glass isn't convinced McDonald's is in the pizza business for the long haul.

"The plans that were made under a former administration may be different from the plans under a different administration. Things change." Glass said.

Sibelski suspects Donatos' march into Germany may be mere posturing.

"When you try to sell something, you don't want it to look like it's not working out," he said. "So you probably just want to keep going on with your plans until you find somebody that really wants it."

Steady as she goes

Though likely tired of calls about sale rumors, Krouse handles them affably.

"No, yours is the first call about this -- today anyway," he said with a laugh. According to Krouse, whether Donatos is owned by McDonald's or bought by another firm, the chain will remain a strong and innovative pizza market player now and in the future. And until different instructions come from Oakbrook, the company will stay the course.

"All we're doing is staying focused on getting people the very best pizza experience," said Krouse. "When they reward us with sales and results, that's all that matters. And that's all that matters to McDonald's as well."

McDonald's Newton remains bullish on Donatos as well, and said the company isn't deterred from its goals by the speculation.

"All aspects of our business are under scrutiny, but Donatos is out there doing a lot of great things to prove out their concept," she said.