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We don’t normally disclose our “bottom line” in terms of our position (long or short) in companies that we write about, and the caveat on our website allows us that flexibility. However, this situation is sufficiently liquid in terms of trading volume, and adequately controversial in terms of the investment community’s dialogue that we are 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 and change this morning. 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. You can read the rest of our argument here:

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.

Our thoughts:

We have no particular reason to defend John Schnatter. We’ve met him a couple of times, 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, and all the rest) and potential strategic buyers (such as Restaurant Brands, (QSR) must be working around the clock to evaluate the potential here. Buffalo Wild Wings (also troubled) went private at a higher price than PZZA trades at, and QSR (for example) paid 18x trailing 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 PZZA 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, and  don’t need a lot more aggravation. This was not part of their original “job description”. We have no knowledge of the degree of “cronyism” that exists on this Board, but with John Schnatter owning 30% of PZZA, it is safe to say that this Board has not been especially adversarial.  No doubt, however, that at least some of them could be painted, by attorneys, as not being independent enough. The easiest exit,  individually and colllectively,  to approve a sale at a reasonable price, 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 4500 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 is one obvious way to ramp up the pressure to “do something”.

John Schnatter, himself, has no choice. Unfair as the current public reports might or might not be, Schnatter has a $500M asset that is becoming worth less every day. He can earn back his good name over time, but it won’t help if his $500M has become 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 and decide that it is everyone’s interest for him to move on.

Can you imagine, also, 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 already so widely publicized, every potential buyer on the planet is already in touch with Goldman Sachs and the rest, and investment banking fees will run into the tens of millions of dollars. CYA consulting is a profitable business, and “asset light” :), just like franchising.

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 PZZA 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 tangible and significant is really done.

Let’s see what happens here……..

Roger Lipton

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