Papa John's (Pzza)—Should You Be Long Or Short This One?
Roger is an investment professional with decades of experience specializing in chain restaurants and retailers, as well as macro-economic monetary developments. He turns his background, as restaurant operator and board member of growing brands, into strategic counsel for operators and perspective for investors.
An archive of his past articles can be found at RogerLipton.com.
I don’t normally disclose our “bottom line” in terms of our position (long or short) in companies that I write about. However, Papa John’s is sufficiently liquid in terms of trading volume, and adequately controversial in terms of the investment community’s dialogue, that I am happy to go on record here that we are long the stock. We bought it at $51 last Wednesday, and have averaged down at $47. This is what can legitimately be called a “special situation” or a “non-correlated” investment. Our rationale follows:
We said last Wednesday, before Forbes came out with their scathing description of John Schnatter’s “management style,” that this company is in play and is cheap enough to attract a private equity fund or a strategic buyer.
While John Schnatter apparently hired attorneys to help him regain his “reputation,” if not his formal corporate standing, reports came out over the weekend that systemwide sales may be running down double digits in the wake of the recent disclosures. Meanwhile, the Board of Directors installed a “poison pill” structure that prevents an unfriendly takeover without Board approval.
We have no particular reason to defend John Schnatter. We’ve met him a couple of times but have never had a conversation with him. However, we suspect that the criticism of his “management style” could be a bit overdone. Consider that starting with nothing he built a major retail company with 4,500 franchised locations around the world, made a lot of money for shareholders and almost a billion dollars for himself. If you or I had anything like the scale of success he has enjoyed, the celebrity status, access to world class athletes like Peyton Manning, Jeff Gordon and all the rest, it’s hard to say that we would be less confident, arrogant, or strong willed.
At this point, what are the various “players” in this case study likely to do? The private equity firms—Roark, Catterton, Apollo and all the rest—and potential strategic buyers (such as Restaurant Brands International (QSR) must be working around the clock to evaluate the potential here.
Buffalo Wild Wings (also troubled) went private at a higher price than Papa John’s trades at, while QSR (for example) paid 18x EBITDA for Popeye’s a little over a year ago. QSR, while already leveraged, could no doubt borrow a couple of billion dollars more to buy Papa John’s and there are very few franchised brands, available at an acceptable price, that are large enough to “move the needle” for QSR. So, there are buyers out there.
The Board of Directors is in the middle of a mess. They are subject to criticism for past actions, and inactions, individually and collectively don’t need a lot more aggravation. This was not part of their original job description as directors. We have no knowledge of the degree of “cronyism” that exists on this board, but with John Schnatter owning 30% of the company, it’s safe to say the board was not adversarial in any way. No doubt, at least some of them could be painted by attorneys as not being independent enough. The easiest exit for each of them is to approve a sale, just as long as Schnatter is not involved in the bid.
The franchise community must up in arms. Can you imagine what the phone and email lines look like coming into Louisville from 4,500 stores around the world. Whether sales are down double digits or not, and we suspect that they are in fact currently running down over 10%, the franchisees must be apoplectic over the situation. We suspect that more than a few of them have blocked bank accounts so that royalty fees cannot be automatically accessed. That could certainly ramp up the pressure.
John Schnatter has no choice. Unfair as the current public reports might or might not be, Schnatter has a $500 million asset that is becoming worth less every day. He can earn back his good name over time, but it won’t help if he becomes worth a lot less. While his first instinct, upon reflection of the way his board treated him, was to fight back, a little bit of time will allow reality to set in.
Can you also imagine how many calls are coming in from the investment banking community, offering to help? A firm will likely be hired, to manage the “process,” possibly for no other reason than protecting the board from criticism. This situation is too widely publicized and very potential buyer on the planet is already in touch with Goldman Sachs and the rest of the bankers.
The outcome: We expect a deal to be done sooner rather than later. The buyers are out there, the price is reasonable enough, we suspect ending up between $60 and $70 per share if Papa John’s is taken private. Schnatter has little practical choice, so his stock will be sold, with the approval of the board, and he will step completely aside. The company could potentially remain publicly held, even if Schnatter sells his stock. A new CEO would be hired and the recovery could begin. Chipotle (CMG) hired a new CEO and the stock has gone from $260 to $460 before anything is really done.
Let’s see what happens........