A Papa John's sale is no slam dunk

A report suggests bidders are backing off a complete purchase, which sent the company’s stock sinking, says RB’s The Bottom Line.
Photograph: Shutterstock

The Bottom Line

So much for the idea of a Papa John’s bidding war.

On Tuesday, the Wall Street Journal reported that one bidder, big Wendy’s investor Trian Fund Management, has backed off buying the chain.

Maybe the bigger part of the story, however, is that other potential bidders are only interested in partial investments, rather than an acquisition of the whole company. Previous reports have said that firms such as Bain Capital and Roark Capital have been interested in a bid.

That sent the company’s stock down more than 10% on Tuesday. It is down another 7% on Wednesday morning and has lost nearly all of the value it has gained since late September, when reports first indicated the chain was being shopped.

That bidders could be backing off a tech-savvy pizza chain that is at a theoretical discount is indicative of the challenges the sale process has in reaching a conclusion. Those challenges include the chain’s founder, a struggling franchisee base and intense competition in the pizza market, among other things.

Price could be a major factor. Stock in the Louisville, Ky.-based pizza chain rose 28% at one point this month after the initial sale reports. But while many of the listed buyers could have easily paid the $2 billion for the chain, its valuation multiple would likely mean a buyer would have to pay a near-record price for the company.

That’s not an easy sell. While restaurant M&A has flourished in recent years, buyers are exceedingly picky and typically shy about paying much for struggling concepts. Papa John’s system sales in the U.S. are down 5.9% so far this year, according to Technomic Transaction Insights, and more since company founder John Schnatter acknowledged using a racial slur during a conference call in July.

There’s also an issue with the company’s franchisees. Papa John’s operators have been closing locations since the controversy first erupted more than a year ago when Schnatter appeared to blame NFL player protests for the company’s weakening performance.

The chain’s franchisee association has hired high-powered franchisee attorney Robert Zarco to investigate causes of the company’s sales challenges—meaning that operators could well file a lawsuit in connection with the brand’s sales decline.

And then there is Schnatter himself. The former chairman still owns 30% of the company. While he has seemed interested in selling the company in the past, he has also been behind a campaign against the company and its management since his founder’s agreement was ended back in July.

Schnatter clearly wants a role with the company. That makes him the ultimate wild card.

And then there is the market itself. While there is a ton to like about Papa John’s—the potential for international growth, its technological savvy, its delivery capabilities, its quality positioning—it is still a damaged concept with a shrinking store base.

And it has major competitors in the form of Domino’s Pizza, Pizza Hut and Little Caesars. Domino’s is already the market’s 500-pound gorilla. Pizza Hut has the backing of the giant Yum Brands and is intent on regaining market share lost in recent years. And Little Caesars is quietly a strong competitor.

More to the point is this: A buyer could look at the chain, see a likely high valuation coupled with its weak recent performance and struggling franchisee base, along with the potential difficulty in getting any deal across the finish line, and may not want to bother. Or at least they’re only willing to go part of the way to limit their risk.

None of this is to say that the company won’t be sold—again, a buyer could look at the chain’s strengths and take a shot. It’s just not as simple as most situations.

If the company cannot find a buyer, Stifel analyst Chris O’Cull wrote in a note this morning that Papa John’s “needs to quell the chatter soon and provide a comprehensive turnaround plan.”

O’Cull believes the company needs to provide a longer-term lifeline than the royalty breaks it has given operators this year to keep them from closing units. And he said that middle management and support service workers “are struggling to remain engaged given they are probably reading the news headlines with some jitters about their job security.”

And he believes the company’s board should add directors with turnaround experience.

“The current board seems to be operating without a long-term plan,” O’Cull wrote, “which is problematic if they can’t find a buyer.”

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