OPINIONFinancing

Now an activist investor takes interest in Papa John’s

Legion Partners could push the company to refranchise company restaurants, says RB’s The Bottom Line.
Photograph: Shutterstock

The Bottom Line

Papa John’s is battling with its founder and former chairman, investigating a potential sale, working to keep franchisees from closing their restaurants, and changing its marketing strategy. Now there’s this: An activist investor has taken an interest in the company.

Legion Partners, a California-based investment firm, disclosed a stake of 1.7 million shares in the Louisville, Ky.-based pizza chain, calling the company “undervalued” and “an attractive investment opportunity.”

In a filing this week, the firm says that it has met with a special committee of the board of directors overseeing Papa John’s response to the controversy involving John Schnatter and came away “encouraged by the actions” the committee is taking.

Still, Legion says there are other potential paths to increasing the company’s valuation, which has taken a hit over the past year amid controversy, same-store sales declines and the dispute with Schnatter.

Those paths could include “strategic partnerships or improving operations as a stand-alone company.”

Legion also said that “meaningfully higher earnings power than the company has demonstrated historically is attainable through a combination of cost efficiencies and refranchising of company-owned locations.” In other words, Legion can be expected to argue in favor of the sale of company stores to franchisees.

To be sure, Papa John’s has a lot more company stores than its primary rivals.

Papa John’s operates 700 of the chain’s more than 3,300 U.S. locations, or about 21%. By contrast, rival Domino’s operates fewer than 400 of the company’s nearly 5,600 U.S. locations, or 7%. And Pizza Hut operates just 96 of the chain’s 7,500 U.S. restaurants, or just over 1%.

To get to the same levels of its rivals, Papa John’s would have to sell between 450 and 670 of its restaurants to franchisees.

Of course, that might not necessarily be the priority at the moment, given everything that Papa John’s is currently dealing with. And the prospect that the company could be exploring a sale might make that moot for the moment, as the apparent buyer would likely want a say in any refranchising strategy.

Not everybody, after all, is gung-ho about refranchising. Inspire Brands, owner of Arby’s and Buffalo Wild Wings and soon Sonic, has steadfastly avoided such moves even though it has franchisees eager to buy its company restaurants.

And Papa John’s franchisee base is stressed, after same-store sales declined 6.1% in the second quarter and more than 10% in July. Sales challenges following weak NFL ratings last year, Schnatter’s comments seeming to blame those weak ratings on protesting players, and his subsequent admission that he used a racial slur during a conference call, all hit franchisees the hardest.

The company is busy giving franchisees royalty relief in a bid to stem closures resulting from those sales declines. One analyst suggests as many as 250 could close in the coming months, absent a boost in sales.

That might not make this the best time to sell company restaurants to those franchisees.

Still, news of the activist provided another boost to Papa John’s stock, which had lost half of its value over the previous year. News of a potential sale process led to a spike, and the company’s stock was up more than 3% in premarket trading on Tuesday.

And then there’s Schnatter, who has argued that he regrets stepping down and has blamed the chain’s sales problems on existing management, notably CEO Steve Ritchie. He testified in a Delaware court in a trial over one of those lawsuits this week. Schnatter still owns 30% of company stock, and told CNBC he still wants a role in the company he founded.

Papa John’s, for its part, is working hard to move past the controversy. It is introducing new commercials without its founder and recently revealed a campaign aimed at convincing customers it is more than just John Schnatter. It has even tested a new logo that has eliminates the possessive apostrophe—Papa Johns.

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