Chit Chat Stocks - Dutch Bros (BROS) | Not So Deep Dive

Episode Date: October 5, 2021

Dutch Bros is a drive-thru coffee chain currently operating across 11 west coast states. With only 37 locations in 2018, the company has grown to 182 locations at the end of 2020. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of Dutch Bros. Enjoy the show! Our Tuesday Not So Deep Dives are sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "CCM" and get $10 off: https://7investing.com/subscribe/aff/4/ Interested in more of Brad’s work? Find his Substack: https://stockmarketnerd.substack.com/ Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Contact us: [e-mail] Timestamps Company Background | (3:15) Industry | (9:02) Management & Ownership | (12:07) Valuation | (15:56) Earnings | (18:04) Balance Sheet | (22:04) Our Analysis | (25:05) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode. We have Brad Freeman on the show coming in every other week with this one. And we are going to be talking about Dutch Bros,

one of the, well, I think it was because of the ticker for some certain investors out there, kind of liked that ticker name, but it's been one of the hottest IPOs. So we wanted to check it out. We read through the S1 and we're going to talk about it today. Brad, have you ever heard of Dutch Bros? Because I know you're on the east, you know, towards the east coast. They're not really out there. Yeah. Yeah. I've never heard of the brand up until its IPO, believe it or not. So this is brand new to me. No, I've never been, but Ryan has been, he can say there is kind of a cult following. We'll save it for anecdotal evidence. We'll save it for anecdotal evidence for sure. But it is very interesting and it's going to be a nice little fun one here. But let's

talk about potential multi-baggers first. Our flagship sponsor, the aim of potential multi-baggers is to find stocks that can go up 10X over the next 10 years or compound at 26% per year. So a high bar there. And they've actually outdone that since the beginning. And it's not just for a year or something. It's been quite a few years. We're probably coming up on year five or something like that. There's tons of different things you get with it. Chris, the head of potential the multibaggers has another team of analysts with him. I'm not sure how many there are, but there are a few that are helping them out with the service. There are also several portfolios different for different styles and stuff like that. Each month, Chris shows you what he would

add to, to build a portfolio over time. So there's helping, you know, teaching you how to, you know, do some portfolio management, all that stuff. All portfolios can be tracked in real time, which is also great. There's tons of transparency here. Any of the two week free trial, right? And also, he has a really interesting background as to when he started Potential Multi-Baggers, kind of his transition away from teaching. If you ever want to listen to that, you have to dig through all of our episodes and you can find it. But it's pretty interesting. Yeah, yeah, definitely. And he is, you know, he does love talking with people.

So if you're part of the service, you'll be able to talk with him personally and ask all those questions too. Accountability is important to him. And with the live portfolios, you can see how every pick is doing in real time. So if you want to become a multi, you can go to Seeking Alpha and look for From Growth to Value, Google it, or go to at From Value on Twitter. Ryan, I'm going to let you introduce Dutch Bros and talk about, give a quick hit on 7investing because that'll be coming out right when you're listening to this. Yeah, so we are recording this on Thursday before this drops. And so tomorrow, the 7investing recs will come out. That's the first of the month, I believe.

So we're kind of eager to see those. It's always good lead gen. So remember, you can use our code CCM. That's enough of the sponsorships. Let's get to the show. So we are talking Dutch Bros today, and I am a customer, so I'll kind of go through what they do. So the first line there is one. There's a few words that are all caps, so just ignore those.

But it says, Dutch Bros is a high-growth operator and franchisor of drive-thru shops that focus on serving high-quality, all caps, handcrafted beverages, unparalleled speed, all caps, and superior service, all caps. Look, they're passionate. i don't think that you can tell they are very passionate yes uh it's pretty much a chain of drive-through coffee stands but they also generate a lot of sales from their blue rebel brand which is basically just a flavored energy drink um it's a lot i guess like a red bull soda i think that's maybe why they call it rebel uh because it's basically tied to that um kind of the names are similar and it tastes like a similar drink but if the reason i bring that up is because that drives that is the leading uh product in the afternoon so that drives a lot of traffic

throughout the day past the morning um and then more operationally dutch bros has 471 stores across 11 states it's pretty much all west coast sorry brad you haven't got to experience this maybe in a few years we're a rapid expansion they said it's coming so they're gonna hit michigan eventually? Right now they have, it's Washington, Oregon, which is where they started, California, Idaho, Nevada, Arizona, Colorado. And then over the last year, I think it was over the last year, they moved into New Mexico, Utah, Texas, and Oklahoma. And about 56% of their stores right now are franchised and the remaining 44% are company operated, but the company operated store count has gone from 37 at the beginning of 2018 to 182 at the end of 2020. So they're really focused

on uh having most of the stores be company operated uh kind of long term and they target 25 000 square foot lots for the whole uh for the whole premise premises except the actual shop is less than a thousand feet so it's mostly just drive-through lanes there's like a little patio as well um but if if you've ever driven past one they basically just have like three three four or five different drive-through lanes that converge into one. And usually it's kind of congested. There's a lot of traffic because people are trying to get through. Sometimes the shops will have two lanes. It's a lot like a traditional coffee stand, just with more traffic essentially. And then they also, they have escape lanes. They made sure to point that out. So if you

ever need to get out, you ever want to abandon ship halfway through your order, you can just hop out um 90 of their product sales are from drinks they have funny names for all their drinks so some of the examples i found were ice tigers blood lemonade golden eagle freeze which i think is just like caramel frappuccino um and then electric berry rebel so it's stuff like that it sounds weird but their cult-like following that they've cultivated uh loves it and it's it's like a barrier to like learning the nomenclature is like a barrier to entry and as a consumer yeah like once you're in you feel like a part of an exclusive group it's weird i know the rational consumer that brett is doesn't really understand congratulations on the yeah i'm being in that

exclusive group a little bit history about the company so the company was originally founded by you guessed it two brothers with dutch descendants i think um they better be yeah or else they're their line to us. Yeah. And so their names are Travis and Dane Boersma. I might be butchering that last name, but Dane has since passed, but Travis is still the executive chairman, which Brad will talk more about. And it was actually started in 1992. So this is all mentioned and Travis writes like an opening letter in the S1. It's worth a read. And they were both third generation dairy farmers that I believe grew up in Grants Pass, Oregon. I know that's at least where the company started, but basically they started out by purchasing an espresso machine

selling out of their barn. And they also had a stereo to go along with it, which they ended up doing pretty well. So they eventually bought a push cart. They moved to downtown Grants Pass, Oregon, where they kept that same model. And basically the stereo and an espresso machine started to do pretty well. They made about $100 a day from that. They started to train some people. They had five of those. And then eventually they moved to a drive-thru with a patio. So this is kind of, it's like the lemonade stand gone corporate, if you will. It's kind of like the ideal, I guess, small business growth story. And so later someone asked, I think it was one of their recurring customers. They said they wanted to try to do

the same thing in a nearby town. And he said he would pay to use the Dutch Bros name. That was basically the inception of their franchising model. And then 30 years have passed. So they've obviously grown but in 2008 they stopped allowing new franchisees to open stores i believe this slowed growth um and instead they said only people that are part of the dutch bro system were allowed to open new stores so i think the goal of this was to help maintain the culture and keep the experience the same they they've said they say this in their asset one but they said every time you come to a dutch bros want to feel like a celebration um and so the culture is a big part of the experience for the customers. I think they wanted to preserve that. And so that's

why they've tried to keep it all within the Dutch Bros system. So existing franchisees can open new stores and then employees can obviously open new stores as well. But they have to go through this leadership pathway program, which I'll talk a little bit more about later. I think that gives a little background and context to the business. Great overview. I'll hit industry competition. Pretty simple, but honestly, it's a little tough to identify because they're really selling something different than Starbucks. You can identify Starbucks as a competitor, but I almost say it's like a half competitor because they're not targeting just the monotonous morning drinks, stuff like that. As Ryan described, it's trying to be more of a special experience, for lack of

a better word. But the restaurant industry as a whole is about $600 to $800 billion estimated in the US. It could be as high as a trillion. I know the numbers just range around there. I don't know how helpful that is, but that's just kind of, you know, if they ever expanded to food or something like that, there's no market saturation that they're going to hit anytime soon. Dutch Bros though is going after drinks and coffee. Coffee is estimated to be about 5 billion sales in the US. That could have been a number, Starbucks could be higher than that. So that could have been just like at home or only in store, but just know that coffee's not like the dollar sales aren't going to be that high. I think I may have gotten a smaller number there

that could have just been a subset of the coffee market and then drinks overall though are going to be definitely higher like ryan mentioned they're not just selling coffee and i think 82 percent of their drinks are sold cold so a lot of them you know a lot of the customers are just going for these mixed drinks and the blue rebel um you know people kind of know about that that's the the classic one that is their their huge um will be a comparison ryan so something that is popular kind of like uh taco bell has that one right uh what's it called it's kind of like that like you know that's their number one drink that's that's dutch bros it the blue rebel is just the energy base and then it's like derivative drinks off that so you can like add flavors and stuff

like that that's basically just the the the core of it is the energy drink blue rebel all right and then for reference again uh if you're wondering about their store count potential uh starbucks has 15 000 stores in the united states alone i don't think dutch bros has the potential to get that high, but just know that for coffee and these little shops, I mean, there's plenty of room to go into multiple towns and stuff like that. And then from a competitor standpoint, I'd probably identify the, you know, individual coffee stands. And while there's also bikini baristas too, which, you know, people laugh about, but they're, they're very popular and there's a ton of them. Those, uh, are definitely their main competitors. Just those little stands

that are similar to Dutch Bros, but just people have on their own or those small chains in local areas. Starbucks is probably less of a competitor, although you're really competing. I think for someone's quote, like specialty drink that a lot of people have, they may have once a day or once every few days, it could be an energy drink, soda, something like that. You're really competing for that time. Brad, do you want to hit management and ownership? Ryan, you have one thing. Oh, that's something just before. I think, I think your coffee number might be a little bit off. Yeah. I could have written down wrong. Starbucks has 27 billion in annual revenue. Now all that comes from coffee and they obviously have a lot of international, but yeah.

But I think it's higher than 5 billion. I think, yeah, I must've gotten a subset of either at home or, or restaurant only, but yeah, that's, that's probably a little low, Brad carry on management and ownership. Sure. So Travis Boersma, we got a pretty good overview of him. If you're, if you're interested in getting an idea of his personality, just go to his LinkedIn profile and look at his picture. A picture here is worth more than 1000 words,

but he does have the cleanest LinkedIn experience page. I think I've ever seen. It's just co-founder and president of Dutch Bros. And that has been his professional career. So good for him figuring out something he's passionate about and making it work. But moving on to the current executive team, the CEO is Joth Ritchie. So he's been with the company just since January 2019. He also currently serves on the Racial Justice Council for Oregon's governor and on the board of directors for the Oregon Business Council. Borsma, that family is also very much so based in Oregon. So very strong ties to that state. He's also been the president of Stumptown Coffee Roasters, where he delivered a lot of profitable growth. He got up to $64

million in revenue before he left. So it wasn't tiny. Pretty good success there. Former CEO of Jones Soda. I used to drink a lot of Jones Soda. So that put a smile on my face. Yeah. It's a good drink. I absolutely love it. It's a good drink. Similar. It actually makes sense. Yeah, it makes perfect sense. And just 32 ratings on Glassdoor. So very, very little grain of salt here, but 90% rating for those very limited reviews. But the CFO is Charles Gemley. Pretty impressive resume here. He's been with the company since January of 2020. He's with Starbucks for 12 years from 2006 to 2018, climbed from vice president of China to the senior vice president of finance, global digital and

store development. So three very important things. He was also the CFO, former CFO of Young China from 2003, 2006. So the resume here is really, it's pristine. The COO is Brian Maxwell. He's actually been with the company since 1992, where he began as a Broista manager. And I can't say Broista with a straight face. I have that in anecdotal evidence, so I'll have to ask about that. Okay. So the quote for his experience was Broista, manager and mind blower. So he definitely took a lot of pride in his job making people delicious drinks, but he climbed the ladder for three decades and he's now the COO. So really interesting and compelling contrast between a CEO and a CFO with really relevant, impressive experience. And then an operator who's been here

for 30 years and knows the culture, I'm sure, as well as the Boersmas. But from an ownership structure, the word to describe it is bananas. There are four different classes of stock. So one of their core investors, TSG Community Partners, owns 100% of the Class C stock, 33% of the Class A stock, and 22% of the combined voting power overall. That's after the offering. The Boersma family owns all of the class B stock and 44.1% of the class A stock for 74% of the combined voting power. Richie and Gemily own just 3.3% of class A and virtually zero voting power. And Brian Maxwell, the guy who I just talked about being with the company for three decades,

climbing the ladder, he is not listed as a shareholder on the S1, which I was a little bummed out about. I mean, climbing the ladder for three decades, give him a nice fat equity package to say thank you for being with us for 30 years and climbing all the way up the ladder. But I digress that that's the crazy ownership structure. Yeah, no, that's a good overview. I got to say a guy named Joth Ritchie fits in perfectly with the, you know, the kind of culture that seem they seem they have there that his name seems on point to me. But I'll hit valuation market cap is about $7.3 billion. You should remember that this is

a recent IPO. There was a lot of hype around it and the stocks traded almost like a meme stock where it's been up or down like 10% of the day. So make sure to recheck these numbers. I'm going on a market cap of $7.3 billion. Ticker is BROS. So just bros. Perfect ticker. I love it. I can't believe that no one had taken that one before. Trailing 12-month price to sales of 18. Trailing 12-month price to gross profit of 52.5. I think this is an important point here. Ryan will get into more on the earnings, I bet, but the gross margins are not, as you expect with a restaurant, it's not software. They're going to be a bit lower. Trailing 12-month price to operating cashflow is 82. It's not bad. However, I don't think that, and this could just be an assumption

on my part, but I don't think that conversion is sustainable. I forget, I didn't write down specifically why, but whenever I looked at the statement, I saw some things that I was like, all right, is that going to continue every year? I don't know, but it might. And then they have a lot of sbc as well i'd i'd say that uh they had i believe around 60 million in operating cash flow in 2019 and then 55 million in operating cash flow in 2020 um so i think and i think it's around 20 cash flow margins but uh what are your last point and then i'll talk more yeah and i just i see that versus 29 contribution margin i think is that sustainable i don't know brad you have Awesome. Could that, could those cashflow margins be related to, well, I guess it's

operating cashflow. So nevermind. I was thinking about CapEx from all this expansion that they're doing, but that would not impact operating cashflow at all. So nevermind. I think a lot of it is SBC. So how would you like to treat that? I think that might be wrong. All right. Well, the last thing we have is, and I saw this in the S1, they have 17 million shares that may be granted another 2021 equity incentive plan. Shares outstanding are, what, $165 million. So it's not like crazy, but I would expect dilution going forward. That's something you should probably price in here.

Ryan, do you want to hit earnings? Yeah, so I'll go through it. Sorry, I'm trying to figure out. I think you might be wrong on the SBC number. But they had $404 million in trailing 12-month revenue. And then from 2019 to 2020, revenue grew at about 37% year over year. they released this after I think the second quarter financially. So I'll have some of the 2020 numbers to give sort of a more annual look at it. But in 2020, they had same shop sales growth

of 2%. The reason I put that down is this is a year when traffic largely dropped because of COVID. And they mentioned that. They mentioned the difficulty that COVID brought. For reference, even though Starbucks is in the same model, I think their comp store sales dropped by 15%. They've had 14 consecutive years of same shop sales. So I think that gives you same shop sales growth. I think it gives you an idea of how much the customers like it. And then 2019 to 2020, they grew store count by 19%. The company stated that its 2020 contribution margin was 29%. So that's basically just the profitability on a per shop basis. So that's excluding corporate expenses. And then last 12 month adjusted EBITDA margin was 20%.

percent. I guess take that with what you will. And then in 2019, Dutch Bros had operating cash flow margins of 24 percent. Keep in mind, gap free cash flow accounting is actually pretty useful for a business like this. So if you if you traditionally just look at free cash flow as operating cash. You said gap free cash flow. Sorry, man. Traditional accounting for free cash flow. So operating cash flow minus purchases of property and equipment because that's them expanding to new stores. So that's kind of their CapEx or their growth CapEx, if you will. And so free cashflow margin for 2019 was only 7%. So over time, as new store expansion starts to become smaller, which I think it will have to, if your store base gets large enough,

they should see a little bit better cashflow conversion. There will probably, I imagine there's some maintenance CapEx on like keeping the stores up to date, keeping the coffee roasters. There's got to be kind of depreciating those or finding new ones. So there's probably some I don't think free cash flow margin will ever be equivalent to operating cash flow margin. But it's it's not I mean, free cash flow margin right now, I think we'll get much closer to that 20 percent number over time. It should. And that's that's probably a debate you have to have as an investor. And then you have the question on cash flow, Ryan. So in 2020, they had $53 million in operating cash flow, and they had $35 million in SBC.

But in 2019, it was a lot less. So they had $56 million in operating cash flow, very similar, but only $6.7 million in SBC. I don't know what number to trust going forward, but there's going to be some. It might be as high as it was in 2020. That might have been a one-time thing. Who knows? Balance sheet, though. Let's wrap up the first half.

Brad, what do you have for that? Sure. Before that, a quick question for Ryan, because he's been to the store. Or is there in-house dining there or is it just only drive-thru? There's like a patio that you can kind of sit at and order. Okay. Ian said he used to go there all the time. I guess we could ask him.

I was just going to, actually, I didn't realize I have a few more numbers just to cite. 91% of their shops that have been open for more than 15 months generate shop-level contribution margin above 20%. thought that figure was kind of interesting and then within the last within the first two months of launching a mobile app Dutch Bros had 1.6 million member activations um and they launched this during COVID so that's kind of to give you an idea of and that is I'll talk about that but it's much higher on a per store basis than a company like Starbucks who also has a cult like following but um they now have 2.3 million active members um but I'll let Brad kind of hit the balance sheet. Yeah. Just, I asked about the, the in-store option just because kind of trying to

gauge how big of an impact COVID-19 had on their operations. Maybe it even could have been seen as honestly, I honestly think it was a benefit. Yeah. Yeah. Cause, cause I mean, you're not going into Starbucks to get coffee, but that's maybe a little more palatable for people who are nervous. They give, they give a chart of COVID's impact and COVID certainly did not help the business. Yeah. It was like two months of down, but then it was back up. Right. Yeah. And I mean, there was just less commuting, which I imagine this is the, that can, that's true. That can make an impact. Yeah. Good point. Definitely competing factors, but, but moving on to a balance sheet and liquidity. So

we talked about this at length before the show, but the companies, all of the sources you're going to find, we'll say that the company raised nearly $500 million in cash, but a lot of this cash, as Brett told me, was used to kind of clean up some credit facilities that they had outstanding and also to buy back some of the stock from these four classes of shares that they had just to kind of clean up the balance sheet a little bit. So it looks like, and we're not 100% positive, but it looks like according to their pro forma cash position that it's only around $50 million despite the $500 million raise. After the IPO, now that's not the end of the world considering they are profitable, but it is definitely something to keep in mind. They do

also have still 24 million in outstanding credit revolvers. They've got another 191.7 million in long-term debt outstanding that's going to mature over the next five years. That's got a 5% interest rate on it. But again, net income positive. So liquidity isn't ideal, but it's manageable. Yeah. I think if you're interested in Dutch Bros, you definitely, I mean, the balance sheet for the first 10Q will be very interesting because I want to see how everything shook out because they're giving you the numbers. You can kind of add it up. And there's also the one thing we don't know if there was that option for the underwriter option to purchase more shares. So they could have raised more than what they originally had on the S1. So the cash balance might be slightly

higher. Again, Brad had a tough task this week with the balance sheet and ownership. It was a it confusing but hopefully we cleared it up a bit and simplified it i think a a proxy and a 10q a proxy statement and a 10q would be very helpful it will be helpful and that's why um that's why ipos that's a big reason why people like us we like to wait sometimes brad yeah also if we could institute a rule going forward only two classes of shares for ipo that would be greatly appreciated yeah i'm gonna run for congress and that's gonna be my whole uh that's gonna be my whole whatever platform no adjusted EBITDA uh and no um only two classes of share structure max all right yeah yeah let's hit the ad break and we'll get back and have more analysis on Dutch Bros

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all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply okay welcome back we have anecdotal evidence now um ryan can probably talk more to the experience um unfortunately i haven't been to one but brad what are your thoughts on this i know you haven't been to one but what are your thoughts on the concept? This is the question I have for you. Do you think it could work in Michigan? Okay. So I actually, I guess I do have a little anecdotal evidence. I love coffee. I've never been to Dutch Bros, but I drink a couple of cups of coffee every single day. And at my campus in undergrad, there was this, like it was on a corner of two really busy streets. And it was

just this little tiny hundred foot shack, square foot shack that just sold coffee. And that was it. It was called Bear Claw. And it sounds like Dutch Bros, their entire property was dedicated to people in line waiting to service them. They were always busy, great coffee. Hopefully this gives them some new business. I love them. They're really nice. But that kind of reminds me a little bit without the cool culture and the culty aspect of it, that reminds me of business model, a little bit of Dutch Bros and it worked really, really well. So very anecdotal evidence there. All right, Ryan? Yeah. So I'm not necessarily a recurring customer now just because I don't really go out and buy that much coffee. But in college, there is one kind of near my college town and I've been

there several times. To kind of give an experience, to illustrate what it's like, you basically drive up, you pull into one of those five lanes. It's usually quite congested and it's usually on a busy corner. So it's a little stressful in that regard. But then you have what they call a runner come up to your car and this has become sort of a funny thing on tiktok of people they're they're almost like invasive of personal space they like lean into the car and like ask you how you're doing it's it's a little weird but you take your order there you go through and then on the at the shop they're basically just blasting music um and that's the whole like make it a celebration thing they're trying to get it energetic it does yeah they do a good job they it does feel very fun

when you go uh people tend to love it and feels like chick-fil-a a bit yeah and i mean they give away like a lot of free stuff they have their loyalty rewards program which i think is like one free drink every 10 drinks and that's been shifted over to the app they give away a like that whatever the puppuccinos for your dog there's stickers we've got some on our fridge over here people love the stickers they they did compare their uh dutch bros brand like the the well i bet we have it on the on our fridge here um in the s1 they compared it to um nurturing the nike swoosh that's ambitious wow but i i think they got a long way to go there but again that that is you know that that's a good goal to have they they compared it that i

was like guys you may you know maybe something smaller i don't know that's what they're trying of build though some some similar to that sort of brand um i have never been the only thing i thought was kind of funny is the s1 was their culture they don't they don't miss on what they're gonna like be like why like ryan said the s1 was yelling at me a bit i was like reading it i was like stop you know i don't know that that doesn't really matter but the one thing i want to talk about though is this kind of like one of the bro eastern names is funny and you know it's a good name it sticks with the brand but on a serious note as an investor do you think that and right you talked about it the fun loving stuff the coming into your car and trying to talk

talk you up you know get all energized do you think in certain areas of the country that might not fly as well well we'll see because they just expanded into oklahoma and they've seen seem to be doing well in texas since they've kind of opened multiple stores there uh i just kind of thing about the northeast i don't know like they come in the car and someone's like who's this guy like i i think if there's anywhere that it wouldn't work the only reason i think it might not work in the northeast is uh traffic congestion especially in a city like new york or something like that new york city can't yeah but i just don't see how it work in a city like that um but more rural yeah i figure if it can work in the south it's gonna work in the north

i know i think the south is way easier of a transition i'm gonna disagree with you that That's a lot more family-friendly atmosphere. Yeah, I guess we'll see. I mean, it's not like they go scorched earth and just add a whole bunch of stores at once. They do test stores, essentially. And they do test stores in regions, right? They're kind of going on certain regions.

Yeah, and they kind of try to make it dense geographically, so like multiple stores around the same area. I guess we'll see. Yeah, I could be totally wrong. It's just something that popped up in my mind. I know Starbucks has had trouble in certain areas. So not everything can go to even just in different parts of the United States, but future growth opportunities. This one's probably going to be simple,

but Brad, what do you got for us? Yeah, extremely simple. So I'll, I'll try and get a tiny bit creative. They did not really mention international expansion. The word international and global didn't show up in the S1. So it really seems like they, they, they rightfully so see this opportunity as fruitful and, and in the early innings, and they're going to approach it in the United States, but, China, they are more and more loving their coffee. That is a strong growth market for Starbucks at

this point in time. The transition away from tea into coffee is a very real one there. So maybe a few years down the road, that could be a promising second market to dabble in. Now, there's a lot of macroeconomic and political issues to sort out before they can pull that off, but a couple of companies, Nike and Starbucks, just to name a couple, have been able to pull it off. So that might be a really well-placed expansion project after they feel like they've established their presence in the United States. Yeah. It sounds like it's, you know, it's obviously really hard to do, to go to the different culture. And you probably, as like an investor, you're like, nah, they're never going to be able to do that. But you would have said the same thing

about starbucks 15 years ago and they're a lot more successful than people thought so i there's a dutch president looks like they're going to do it now but i i wouldn't discount that because for some reason the you know american brands have traveled internationally a lot better than people may have assumed yeah and i know that uh i know that i took sort of the basically the only growth opportunity because it's a very replicable model um so i i chose new store expansion so sorry to you guys, but I think it could work anywhere in the US except maybe New York. My experience on the East Coast with Dunkin' Donuts and Starbucks there doesn't seem very different from the West Coast. It seems like a pretty similar culture. Management said they think

they can get to 4,000 locations in the US. Right now, I think it was 471. uh the the caveat with this is okay so here's a quote from the last one they said we currently have a strong new shop pipeline with approximately 250 new sites identified which is well in excess of our planned new company operated stores to be opened in 2022 and 2023 the issue is that they cannot expand store count uh really really fast and maybe that isn't necessarily an issue maybe they are choosing not to. And because they have the, because they're trying to keep everything within the Dutch bro system, the employees that want to start one or the broistas that want to start their own have to go through basically the education or the Dutch bro schooling of how to own

and operate one, which I think they call like the leadership pathway program. And so it takes time to do that. And so they don't, and they're not just letting franchisees come in and just add new ones so um the even with even with a even if they had a whole bunch of cash there's limited store expansion they have to go at it gradually and obviously as you get more broistas in the pathway program you can start to grow faster but it will take time for that store expansion um 4 000 locations in the u.s i would assume will take 10 years 10 years probably probably yeah and that is a bit confusing because i wish they could tell us what their projections of store count will in 2022 and 2023 because they say 250 new sites identified but how many are you planning to open

each year that would be a very useful thing for investors um in your huge s1 uh but i i have some just simple as locking in core customers with the app this will really help save store sales growth you know they launched that very recently i think it was in 2020 right around or 2019. yeah it was during covet during kovitz um they already had 22.3 million reward members in the first five months after launch which is he excuse me huge for their limited region i mean that's just a great number it shows how much people love this company yeah for reference uh i believe so starbucks has 15 you said what 15 000 stores in the us i think they had 19 million members at the end of 2020 which is i want to say that's good that's good that is good and this is i want to

want to say double the pace, you got 2.3 million members. So a 10th of the member base on a much smaller fraction of the store base. Yeah. Hopefully they can leverage that asset to, I don't know, get into other stuff, but highlights and lowlights. Brad, what did you like? What'd you dislike about this company? Yeah. Love the makeup of the team. That contrast between having the president, the co-founder around with the company 30 years later, and having that COO climbed all the way up the ladder and stuck around despite not getting any equity. And the CEO, and then comparing that with the CEO and the CFO, which is really relevant experience, new, bringing new energy and life and blood to the company, hopefully, it was just a very well

balanced team. But the low light, this was the most complicated balance sheet and ownership structure that I've read in a very, very long time. So that could be absolutely fine and just the way it is. But I mean, the simpler, the better with those kinds of things. And that was the furthest thing from simple. Yeah, they could have been doing it for a reason. And obviously they did it for a reason. You're not going to choose four for no reason. But my question always is, why? And if you're not explaining that clearly to me, I get a bit worried. It could be nothing, but it also could be something. Yeah. All right, Ryan. Highlight for me, the cult-like following, especially where I'm from, the loyalty app

metrics. They showed a lot of resilience during the pandemic and employees seem happy. The culture totally checks out. So all the sort of qualitative things that I look for, the qualitative characteristics uh they all seem to check the box uh low lights for me yes the reorganization transaction was overly complicated um and it actually threw off the market cap for like every major financial site for so like i think a lot of them still had it wrong uh yeah like i mean robin gets a lot of stuff wrong but like robin had had it wrong people are like whoa dutch bros a 1 billion dollar market cap like oh yeah like wow i'm gonna buy that now like i mean it was like a 6x difference Now, I will say that I asked the IR team via an email and they were very direct.

They told me exactly how many shares outstanding they had and they explained it in a very easy to understand manner. So nice to see that they're approachable on that part. They aren't overly liquid. They don't have, they are using this basically as a, they're using the whole IPO process, it seems like, to kind of just clean up their balance sheet. Maybe that isn't a huge problem, but I wish it would have been more clearly stated. Yeah, definitely. Because I think, all right, you're diluting shareholders and you're going to have these equity incentive plans that you just started out. I would hope that you'd raised enough money where we're going to be comfortable and we're not going to be worried about further

dilution. Because you think when you're raising $500 million, you're not. But like we explained before, the pro forma stuff might be a bit less than people are expecting. Highlights for me, I mean, I think everything checks out with the business operations. Unit economics are great for a restaurant, you know, I mean, contribution margin at 29% is great. Reinvestment runaway is huge. And the brand is fantastic. I mean, those are the three checks you want. Boom, done. Lowlights though, besides the one you guys mentioned, which I agree on, when I read the S1 and I loved everything I read, and then I get to the related party stuff, and I see that the founder's nephew is the chief culture officer and that two other relatives are

a part of the executive team, that concerns me. I bet it's not a big issue, but when you combine that with having sole voting power under this one person, I have to trust that person with my money. And it's only this one person. It's not a democracy. And when I see that, I think, okay, maybe this person was qualified for the job, but I'll admit it's a yellow flag for me, for sure. Did you happen to see how much he's getting paid? no but i i mean either way yeah i mean there are definitely it's it's a very family-oriented business uh that like they're trying to you can tell they're trying to yeah for sure i mean it might not matter yeah um yeah that's pretty much all we have for highlights of the lights

yeah bull case brad what do you think go right here going forward yeah i kind of i see chipotle as kind of the the bull case um in the in the adjacency of drinks and coffee so chipotle started i think in colorado and denver um and they had a very strong west coast presence and had absolutely no trouble expanding eastern throughout the united states um if that kind of brand stickiness and loyalty is similar um for dutch pros then it really looks like they have a long runway for future expansion across a pretty pretty darn large market yeah ryan i mean the bull case yeah i like the chipotle analogy the bull case is that the model works everywhere um within that 10 years they get to the 4 000 stores um and they've sort of become saturated let's say in the us that would

be a great problem to have um and they also made a lot of uh recent infrastructure investments they talked about which was just really appropriate that's because they had a lot of material weaknesses yeah and the uh hopefully that maybe that adds a few points or a few percentage points to a company operating margins but uh wouldn't you think that's going to hurt it though because of employees employee account the infrastructure investments i'm talking about like uh the tech stack like getting it all okay well i was thinking of a point of sale system i was thinking of accounting thing because one thing popped up to me and they asked one as they said a risk was that they didn't have they had few people on staff that currently had knowledge

of gap accounting and i was like all right well you're gonna have to hire a lot of accountants that can impact margins yeah i the it's i think operating margins uh will probably cap out somewhere in the 20 range uh yeah that's just a feature of this kind of business um if that that happen so if all that stuff works out they i think you're looking at an okay investment to be honest man yeah i'll run through my it's nothing like it's not going to be an insane investment even if that rosy scenario works out yes uh let me look at my my full case i have a little numbers on kind of what ryan's describing and this is kind of my glass half full thing if you get to 4 000 stores if you're at 1.7 million average unit volume which is just average store volume

which I think you could probably underwrite would rise, but I'm trying to be conservative here. Yeah. I mean, you could easily see that at 2.5 million. If you have that 29% contribution margin, like they usually have on their mature stores, that is $2 billion about an annual contribution profit. That seems pretty good. That's a lot. And then it seems like they convert that pretty heavily into cashflow. So it wouldn't be too much lower on cashflow. Operating cashflow. Operating cashflow. Which hopefully will be free cashflow. Hopefully free cash flow is a little closer to that over time. But yeah, Bear Case, Brad. Yeah. So Bull Case Chipotle and then Bear Case In-N-Out Burger. So I love In-N-Out Burger.

Whenever I go to the West Coast, always get it, but it never really found its way into my neck of the woods. So the Bear Case is for whatever reason that this culture is just, it really identifies with the Western United States and it doesn't really identify with other parts of the country which which brett and ryan have already kind of touched on as a potential risk already yeah i agree that's a good start for me yeah uh bear case for me they're they're not gonna yeah it doesn't work in certain parts of the country um perhaps the decision that the founder made in 2008 to kind of keep everything within the dutch pro system maybe that does maintain the culture which is hopefully what they're looking for but it limits how many new stores they can

open in the next or in the like close future so if you think they're going to get to that 4 000 stores really quick it might take longer than you think um which is obviously going to infect probably the returns uh at least in the closer term uh yeah i don't know i'll let you put some numbers on it but listen it's 20 times sales probably a thousand times free cash flow yeah um i mean yeah let's look okay remember that the market has about seven billion dollars 7.3 billion when we're talking if they get to 4 000 stores if they get to 1.7 million dollars in aub and that's sustainable again i'd say you could probably assume it's higher and if they sustain a 29 contribution margin across the country which again i maybe would be worried about because you

know they might not be as popular in certain regions if you get to that that's two billion dollars in annual contribution profit how what's your cash flow yield on the stock on your cost basis if you're buying it like if you get to that maturity which is what in 2030 2035 and you're going to be diluted by probably 30 over that time period by looking at their s1 so what are we doing here i mean i mean come on like uh and then it happens to ipos though they just shoot out you you know it happens stock goes crazy yeah the other i'll just let's get to the more or less interesting yeah brad more or less interesting i'm i'm gonna go with more interested i think and and i'm gonna preface this with uh the ipo did get a little bit crazy uh so i'm gonna probably

be pretty patient but i see this is kind of like another comparison is yeti um just really really cult-like following and and people identify with it and it gains traction everywhere and And I think they have something here. I mean, five drive-thru lanes, pretty hard to fathom for me not ever being there, but I'm going to go with more interested. All right, Ryan? 100% more interested in the business. I actually really like the business.

I think everything checks out. But this is not how you make money. Like as an investor, I just, I have no way to underwrite this at 20 times sales. Yeah. And I'm definitely less interested on from the stock right now. I mean, I think, and obviously we could be wrong. They could go insane and we could look foolish and it's just could be a hundred billion dollar business. But yeah, I mean, I doubt that.

I mean, it seems like you're coming up against a lot of base rates here. I mean, if you're paying four times 2030 contribution profit and a rosy assumption yeah you'll probably make money but that's a really rosy assumption that's 2030. yeah yeah a lot has to go right here i'll say i like the business model or whatever you want like i said the operations check out i have concerns governance wise i think we may some of us may disagree on that but i i i have some concerns um i would look i would just look at and see whether you're now i don't know management's important also also it's an ipo like uh when's what's i haven't touched an ipo ever and i don't plan on starting now yeah i always

wait six months research what a lock-up period is um all right that's gonna do it for dutch bros brad what do we got two weeks from now yeah so i own olo and we are going with a an olo compliments slash substitute slash front of me. Toast, more of a small, medium business focus within the restaurant world. So I'm excited to dig into that one to see how it compares. Get into payments again, should be fun. Another IPO. So we'll be a fun business. I'm assuming the valuation is probably aggressive, but we'll be fun either way. That's going to do it for this episode. Thank you all for listening. Remember, we are not financial advisors. Anything we say on this show is not formal advice or recommendation. Ryan and I are general partners at

Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next time.