Tag Archives: PZZA

RESTAURANT STOCKS – Recent Change in Analyst Ratings – SHAK, DNUT & QSR Downgraded, TACO & PZZA Initiated with BUY, LOCO and DPZ Initiated at HOLD

RESTAURANT STOCKS – Recent Change in Analyst Ratings – SHAK, DNUT & QSR Downgraded, TACO & PZZA Initiated with BUY, LOCO and DPZ Initiated at HOLD

Jim Sanderson downgrades SHAK to Neutral, Bill Chappell downgrades DNUT to Hold, Eric Gonzales downgrades QSR to Sector Weight, Todd Brooks Initiates TACO and PZZA at Buy, initiates LOCO and DPZ at Hold

This summary is planned to be a regular feature of Roger’s Review, along with a “heads up” prior to  next week’s reports. We welcome commentary from readers as to how these features can be more helpful.

Roger Lipton




While the valuation of PZZA seems high at 49X’21 EPS estimates and about 23x trailing EBITDA, these measures are against results that are still depressed from results just a few years ago. A substantial operating turnaround is now well established and it seems likely that systemwide unit growth will resume. There are a number of operating levers that can help: continued higher sales should expand franchising margins and encourage unit growth, re-franchising (especially with improved results at the stores currently operated by the Company) could generate a lot of cash, leveraging the current strong balance sheet could allow for a larger stock buyback or special dividend. It seems that there are a lot of ways to win by owning PZZA at these levels. Especially compared to its peer group of largely franchised QSR companies, PZZA seems undervalued relative to the higher earnings and cash flow that seem likely. For the same reasons, a private equity (including 14.4% owner, Starboard Value) or strategic buyer (at a premium price) could surface at any time.


Since our last update in November, 2019, Papa John’s business has improved significantly. For the first time since 2017, the North American division, as shown below has turned in five consecutive quarters of positive same store sales. While that may pale in comparison to Domino’s streak of 43 positive quarters of same store sales, it is a remarkable achievement for the company after comping negative for almost two years. In Q2, the company saw its two-year same store sales turn positive for the first time in 10 quarters. Though it is hard to delineate how much of the improvement the last nine months has come from the pandemic and the shutdown of thousands of competing restaurants, rather than internal organic improvement, it is important to understand that the company already had three consecutive positive same store sales quarters BEFORE the pandemic hit. Business has been so strong in ’20 that the company has hired over 30,000 new employees this year.

Recall that 11.1% of the 5,360 worldwide number of locations are company owned, as are 18.2% of the 3,286 North American units. The in-house delivery capability is also an important strategic asset.

New Products

While the pandemic has no doubt been a big factor in the turnaround in same store sales, the amount of new product innovation that has been occurring since Rob Lynch became CEO is unprecedented. The company has launched six new products in the last year alone. The company launched a garlic parmesan crust in November, which was the first ingredient added to the original pizza dough recipe in the company’s history. The company has also added, “Papadias”, Jalapeño Popper Rolls and the successful “Shaq-a-Roni” pizza, which was a collaboration with board member and franchisee Shaquille O’Neal. According to Mr. Lynch, in 2021 the company is going to have “the biggest launch we’ve ever done”. This will be the “Epic Stuffed Crust” pizza. Results in test markets has been encouraging. These new products are clearly resonating with customers and helping to drive the resurgence in the pizza chain.

Franchisee System Health Improved Substantially

There were several other encouraging signs that the franchisee system is healthy and can begin to grow again.

Franchisee stores have outperformed company owned stores recently, which is unusual. Franchisee owned stores rarely outperform company owned stores because a higher percentage of Company-owned stores are located in more heavily penetrated markets. The average annual unit sales for Company-owned stores is $1.05M compared to only $840K for a franchise unit. It is especially noteworthy that, as the table just below shows, in the last two quarters franchise owned units have outperformed Company-owned units by 700bps each quarter, no doubt indicating that the chain is picking up a significant number of new or lapsed customers. The company has said that, in the last two quarters, North America median unit profits have been the “highest in years.” E-commerce now accounts for approximately 70% of all orders, which also helps overall profitability and increases marketing dollar efficiency.

The company recently ended its “We Win Together” program that was started in Q3 2018 to help support franchisees after same store sales collapsed in the wake of the John Schnatter scandal. As a reminder, the program was a two-part program that provided royalty relief in the form of lower royalties, royalty-based device incentives and targeted relief. The second part was the agreement to make investments in marketing and brand initiatives to support the long term strength of the brand. Over the last nine quarters, these initiatives cost Papa John’s over $100M. While the plan was always scheduled to end in Q3 2020, the fact it was not extended shows how successful it was in getting the franchisees through a very tough period. We also believe it created a lot of goodwill among the franchises which is important if the company wants to continue to grow, both inside the US and internationally.

Royalty Relief Subsides


Franchise Unit Growth May Resume

It is logical that the dramatic improvement in AUVs and profitability would generate a new level of enthusiasm within the franchise system. PZZA has in fact signed a significant new franchise agreement in September. On September 10th, Papa John’s announced its largest traditional store development agreement in North America in over 20 years. The agreement is with HB Restaurant Group, which already owned 43 restaurants in the Mid Atlantic region. The agreement calls for HB to open 40 new stores in Philadelphia and southern New Jersey between 2021 and 2028. After shrinking the store base in North America for years, the company reported net unit growth of two in Q3 ‘20. This is important because at 3,142 stores, the company has less than 50% of the store base of both Domino’s (6,239) or Pizza Hut (6,653). This means that the company has a significant amount of potential growth ahead of it in North America and could now begin to grow again. It is interesting that Pizza Hut recently closed 700 stores in the US, obviously lessening the competition somewhat.

Re-Franchising is a Potential Earnings “Lever”

It is important that the company owns significantly more stores than its peers, Domino’s and Pizza Hut being virtually entirely franchised, obviously  providing an opportunity for re-franchising. Papa John’s owns approximately 600 stores compared to around 125 for Domino’s and 23 for Pizza Hut. The company could lower its ownership base to only 2-3% of the total North American store base (similar to Pizza Hut and Domino’s), by selling 530-540 stores to franchisees. This would improve margins, reduce debt and most likely result in a higher multiple of cash flow. Domino’s has stated it wants to grow its US store base by 2,000 units to over 8,000, which shows the huge growth opportunity in North America for Papa John’s. Internationally, Domino’s and Pizza Hut have more than 5X the number of restaurants of Papa John’s.

Substantial Margin Improvements is Possible

The eight consecutive quarters of same store sales declines from 2017-2019 caused a 700bps decline in the operating margin between 2017 and 2019. General and administrative expenses were deleveraged by 530bps over this time. This has resulted in G&A costs as a percentage of system wide sales to be significantly higher than any of the company’s highly-franchised peers. However, the large increase in same store sales over the last two quarters has helped the company generate significant expansion in margins.

For the nine months ended September 30, operating income margins expanded by 220bps and pre-tax margins have expanded by 360bps. According to SEC filings and conference calls, the improvement in margins is a direct result of operating leverage due to the 20%+ same store sales increases the last two quarters. While we expect a moderation in same store sales increases in the coming quarters, the recent results highlight the significant operating leverage inherent in the business model. In 2016, the EBIT margin was 9.6% or DOUBLE the current margin. We see no reason that a combination of continued positive same store sales (driven in part by continued innovation), accelerated unit grow and the sale of several hundred company stores to franchisees could eventually drive margins back to those levels.

As we noted earlier, Papa John’s G&A as a percentage of system wide sales is significantly above its peer average. The combination of selling a significant number of stores to franchisees, restarting North America franchisee unit growth and the continued expansion of international units should help drive this ratio closer to its peers.

Significant Improvement in Finances

The improvement is sales has significantly improved the company’s finances. For the nine months in 2020, the company generated $169M in cash from operations, which compares favorably to the $50M the company generated in 2019. The company also received $29M in proceeds from the exercising of stock options due to the higher share price in 2020. As a result, the company has a cash balance of $140M compared to $28M in 2019. The company also announced a $75M stock buyback. It is particularly noteworthy that the long term debt is much lower than at other franchised chains. Dunkin’ Donuts, Restaurant Brands, Domino’s, Wingstop have carried debt at 5-6x times EBITDA. PZZA, on the other hand is carrying long term debt, net of cash, of only about $200M, a much lower multiple of depressed EBITDA of  $78 (’18) and $72M (’19), an improved $108M for nine months of ’20 and an aspirational pre-crisis $205M in ’17.

In February 2019, with the company struggling financially after the Schnatter scandal, the company issued $252M worth of Series B Preferred Stock convertible at $50.02 per share (5M shares) to Starboard Value LP. In connection with the investment, the Papa John’s Board of Directors was expanded to include Jeffery Smith, the CEO of Starboard and Anthony Sanfilippo, the former CEO of Pinnacle Entertainment. This Preferred Stock, if converted, will increase the shares outstanding by approximately 13%. In addition, the preferred has a 3.6% coupon that is costing the company about $10M a year in dividends. In February 2022, the coupon goes up to 5.6% ($14M in dividends) and in February 2024 the coupon increases to 7.6% ($19M). The preferred is redeemable by either party in February 2027.  While the deal Starboard negotiated nine months ago looks pretty sweet today, the original 3.6% coupon was not terrible at the time and the conversion price was almost 20% above market.

CONCLUSION: Provided at the beginning of this article



We published our analysis on October 22nd, showing almost all the publicly held restaurant companies, comparing their current valuations to those before the pandemic. That chart is provided below, with prices updated to midday on 11/9. Based on the 2/15/20 (pre-pandemic) estimate of 2020 earnings, and today’s estimate of 2021 earnings, it appears that Papa John’s (PZZA) while still carrying a very high multiple of earnings and EBITDA, is valued more reasonably today than ten months ago.

Let’s take a more complete fundamental look at Papa John’s.  Back on February 15th, PZZA was selling at $66/share. Trailing EPS, for calendar 2019, had been $1.17/share. This previously troubled multi-thousand unit international franchisor was beginning to turn around. The table just below shows the turn to positive comps in the second half of calendar ’19, after the management change, the new product effort and the introduction of Shaquille O’Neal as a corporate spokesman.

As the following table, as provided by Bloomberg LP, shows: earnings per share had turned slightly positive in Q3’19, dramatically so in Q4, but still far below the earnings power from a few years ago. By February 15th, before the pandemic hit, expectations were no doubt for continued same store sales progress and more earnings recovery. Still, the system was far from healthy as several quarters of low single digit comps don’t begin to compensate for the high single digit negative comps that went on for eighteen months. It is worth noting, however, that international sales (about 30% of the 5300 unit system) were nowhere near as weak during the tough times, apparently not so much concerned with the drama surrounding John Schnatter’s departure. It is also worth pointing out that about 600 domestic units are company owned, providing operating leverage, right now on the upside, to corporate results.

In any event, back in February, before the pandemic came into view, the expectation was for continued positive comps and EPS in the area of $1.40, up from $1.17.  PZZA, at $66/share was therefore trading for about 47x expected EPS, a fairly high P/E, but this is mostly the case when earnings are depressed and investors are anticipating a recovery.

Today, at $83, PZZA is trading at about 37x calendar 2021 consensus EPS. Adjusting for the the fact that calendar 2021 is farther out from today than 2020 was in February of ’20, the comparable multiple is about 39x expected EPS, about 18% less than back in February.

Just as we did in the case of Wingstop, the current question becomes: Is Papa John’s better or worse off today, as a result of the Company’s position in a post-pandemic world.

As the table above shows, the comps have been dramatic, both in North America and internationally. The EPS progress, after the first quarter, has been dramatic. Earnings have also showed dramatic improvement so far this year, with expectations of further progress next year. The Company has said that the  third quarter was the last of the financial support provided to franchisees. Most importantly, free cash flow has been $134M in the first nine months of ’20, $67M in the third quarter alone.  Cash and cash equivalents was $140M at 9/30, up from $28M at 12/31/19. Long term debt was unchanged in the last nine months, at $340M (including $20M current portion), relatively modest in this day and age from franchisors, considering that EBITDA this calendar year should be on the order of $150M. PZZA has a current dividend yield of just over 1% and has recently authorized the repurchase of $75M of common stock.


The pandemic has been productive for Papa John’s, accelerating the improving trends that were already in place. New products have been successfully introduced, marketing has been increasingly effective, operational improvements have been implemented, John Schnatter’s departure and the following management transition are now firmly in the rear view window. The strong  same store sales trends seem firmly in place and newly satisfied customers will likely (if the Company has their way) remain loyal. Earnings can still be considered depressed, especially with the upside leverage from 600 Company operated locations. The balance sheet could be leveraged further, to the benefit of shareholders. Among the (largely) franchised operators, the reward/risk ratio for PZZA seems better than most.

Roger Lipton

Note: The numbers in the table below were calculated as a “first look”, to be refined further as individual situations are reviewed. For example, the PZZA numbers below shows it undervalued by 34%, while the refined analysis above shows the s tock still undervalued but by a more modest 18%.



Papa John’s (PZZA) reported its third quarter, ending 9/29, the first under the leadership of new CEO,  Robert Lynch. It is safe to say that Lynch, in place only for two months at the moment , had nothing to do with the reported fundamental results. The results, Adjusted, along with Lynch’s excellent reputation, were sufficiently encouraging to take the stock up about 10%. The adjusted earnings per share was $0.21 vs. $0.19 a year earlier, but the most important aspect was that the comp sales have bottomed out, up 1.0% in North America and up 1.6% internationally.

Robert Lynch arrives at Papa John’s with great credibility, and will hopefully provide the consistent and informed leadership that has been lacking over the last two years. Franchisees, who have been undoubtedly in distress, are no doubt encouraged by Lynch’s arrival, and will support him every way they can.

Our object here is to reflect on the current valuation relative to the current EBITDA run rate, and we will accept the non-recurring nature of Adjustments as the Company suggests. We will compare today’s valuation with that of Papa John’s, at its peak in late 2016. In evaluating the stock at this point, it seems to us a comparable situation to that faced by Chipotle, which fell from grace about four years ago, brought in new management about two years ago, and the stock, CMG, has outraced the earnings recovery to make new highs.


At the end of 2016, the market value of the equity was $90/sh. X 37.7M shares outstanding, or $3.39B. Adding the $300M of long term debt provided an enterprise value of $3.69B. This was 17.8x the EBITDA for calendar 2016 of about $207MM


Today, at the end of 2019, the market value of the equity is $61/sh. X 31.6M shares outstanding, or $1.93B. Adding the $346M of long term debt provides an enterprise value of $2.28B. This is about 19.8x the apparent Adjusted EBITDA for the year ending 12/31/19. This, by the way, is in the same range of EBITDA multiples that other large scale publicly traded franchise systems sell for.


We view Papa John’s rebound at least as probable as that achieved by Chipotle. There are lots of differences to be sure. Chipotle is largely company owned, Papa John’s franchised. Chipotle had food borne illness problems, Papa John’s had leadership/political problems. There was a leadership crisis at both companies with both founders, Steve Ells and John Schnatter losing credibility for very different reasons. The QSR industry is more competitive than ever, but PZZA had the scale to compete two years ago, and there seems to be no major reason why they can’t regain most, if not all, of their previous market share.


The following charts show the revenue and earnings statistics, and the stock price performance, per Bloomberg, for CMG over the last five years. You can see that revenues and earnings peaked in calendar 2015, the stock turning down at the end of 2015 as the food borne illness issue arose. You can see that the stock bottomed in late 2017-early 2018, just before Brian Niccol arrived as the new CEO. The stock moved almost immediately from about $250 to $400, before Brian had learned where the bathrooms were (especially since headquarters was moved from Denver to San Diego, at a cost of over $100M). Be that as it may, Chipotle has made great strides, in all kinds of ways, and the stock recently hit a new all time high above $800. It is worth noting that the $13.88 eps estimate for 2019 is still below the $15.43 high in 2015. So….that’s Chipotle.

Now we have Papa John’s. The following charts shows the earnings statistics and the stock price chart.

The stock price peaked in late 2016, with earnings reported at $2.55 in 2016, no doubt expected to be higher in 2017 than the $2.61 reported. In any event, the stock has bottomed in 2019, with PZZA under the control of interim management. It is interesting to us that the Enterprise Value at the bottom, this year, was very close to the 17.8x trailing EBITDA at the end of 2016. With the stock price up from the 40s to the low 60s, the Enterprise Value of about 19.8x the trailing Adjusted EBITDA does not seem outrageous to us. In fact, valuations in terms of Price to Earnings or Enterprise Value to EBITDA are almost always highest at the bottom of a cycle, when earnings and EBITDA are depressed, and the stock price is hope for some sort of recovery.


The current price of PZZA seems to reflect a very small portion of a potential recovery. There are no certainties, of course, but Robert Lynch is a qualified leader, the Company has a strong enough balance sheet to support an extended recovery period, if necessary, and the franchise system has little choice but to make every effort to do their part. Unit growth has been mostly international in recent years, those sales trends never suffered as much as those in North America, so that third of the worldwide 5,000 unit system should continue to provide unit growth. Overall, we think it likely that the run rate of EBITDA will increase materially over the next two to three years, if not sooner, and the stock price could move in lockstep.

Roger Lipton


Starboard Invests $200-250M, into Papa John’s – is PZZA a Buy or Sell?

Papa John’s is all over the news again. After PZZA bottomed last Friday at $38 and change, on expectations of disappointing North American sales in Q4 and January (down 8.1% and 10.5% respectively, now announced). Observers were apparently taken by surprise yesterday morning, Monday,  when it was announced that Starboard Value LP has invested $200M in Papa John’s, with the possibility of $50M more, into a preferred stock convertible at a 22.5% premium to the average price over 10 days ending 2/15/19. Parenthetically, franchisees are allowed to purchase $10M worth on the same terms. This will provide Starboard with a stake equal to 11-15% of Papa John’s equity. Starboard will also be entitled to two Board seats, including Jeffrey Smith, CIO of Starboard. Steve Ritchie, PZZA’s new CEO, joins the Board as well.

We have written a number of times on this situation over the last six months. We liked PZZA in the high 30s, suggested lightening up in the low 50s. Lastly, on December 10th, with the stock at $45 and change, we speculated that a deal was in the offing, with Schnatter having lived through a cooling off period and having hired an investment banking advisor.

We think PZZA is a good bet again (at $43 and change), with more upside potential than downside risk, both in the short term and longer.

  • Starboard has an excellent reputation, having invested in Darden, modifying the Board of Directors, and helping to implement some operating initiatives. Their involvement provides a floor under the stock, both short and longer term.
  • While the disappointing sales in Q4 and January are a material negative, it is sometimes overlooked that there are 1,700 franchised stores internationally (1/3 of the system), and their sales were down nowhere near as much as in North America, down 2.6% for Q4 and flat in January.
  • John Schnatter’s influence is diminished materially, with a Board expanded by two new independent Directors plus CEO Steve Ritchie, and his stock ownership diluted by 11-15%, to be closer to 25% than the current 31%.
  • There are still hundreds of billions of dollars of private equity capital looking for a home and we believe there is sufficient potential at PZZA to justify a price at least in the low 50s, even with the recent sales trends. Starboard will end up paying close to $50 for their stake.
  • We think the chances are perhaps 50-50 that another suitor will emerge relatively soon, since the stock is more likely to firm up than decline substantially from this level and a competing investor knows that. In essence, the time to move is now !

We indicated months ago that we own this one. Though the stock is up over 10% in the last two days, we are sticking with our position. Greed has replaced Fear.

Roger Lipton




We have written several articles regarding Papa John’s since John Schnatter left the company, the first written on July 23rd, when PZZA closed at $46.56. We outlined why it was in the interest of all stakeholders : current management, franchisees, board of directors, stockholders, debt holders, and “even John Schnatter” to arrange a going private transaction.

On August 8th, when PZZA closed at $38.94, after the dismal Q2 was released with North American comps down 6.1%, including July down about 10.5%, we said “it is pretty early to be overly concerned about a collapse of a franchise system that was doing rather well for many years until about nine months ago. This situation could obviously change if the current negative sales trend is not, at the very least, stabilized”.  We concluded: “We feel that sales will more likely stabilize than deteriorate…..especially during Q4 when….YTY comparisons get easier as well. We expect that the most important stakeholders in this equation, specifically John Schnatter …….will come to a rational conclusion that toned down rhetoric is in everyone’s best interest…..there is a great deal of P/E capital looking for a home, and the valuation of the Company supports PZZA as a buyout candidate.”

On October 9th, with PZZA closing at $54.90, after several P/E firms had expressed interest, including Nelson Peltz’ Trian Fund, and comps had apparently stabilized, we said “while PZZA is still statistically cheap relative to other franchising companies….there are some unique uncertainties here”…one of which, and the most important now today…..”to what extent John Schnatter, who owns 30% of the stock will muddy the waters” We suggested investors take partial profits since “we doubt that a deal will be done at much more than $60 per share, and the process could drag on for months. Should a transaction be delayed, or not seem likely, due to continuing weak sales or Schnatter’s requirements, PZZA could fall back to the high 40s.”

Schnatter’s resistance in various forms over the last two months continued to be in place, and when press reports indicated that Trian has lost interest, PZZA came down from $57 on 11/7 to $45 and change..


It  was announced late Friday that John Schnatter has engaged a financial advisor “to assist him in reviewing the financial prospects of the Company and in assessing alternatives for increasing shareholder value.”

We consider this critical in terms of the possibility of a private equity deal, especially with PZZA trading back in the mid 40s. While we have suggested that a transaction would be in the interest of all stakeholders, including John Schnatter,  a “cooling off” period has obviously been necessary for Schnatter, company founder, with emotions playing an important role over a decision relative to his $500M stake. The challenge of satisfying Schnatter, the founder and previous face of the company, and the owner of 30% of the stock, has obviously been an important stumbling block in getting a deal done.

We believe private equity buyers will  be far more interested and Trian could even come back to the table,  now that the stock is back in the 40s and with investment bankers now advising Schnatter. There is a huge difference between the two price ranges, compounded by the fact that Schnatter’s stake  (and his personal future role) could be far more negotiable. We consider the stock to be attractive at the current level.

Roger Lipton




Papa John’s reported Q2, dismal, as expected. You don’t need us to rehash all the operating details. Everyone knew the results would be poor, that the Company and their founder, namesake, and largest shareholder are having a protracted battle. The questions revolve around how much damage has been done in terms of sales, profits, reputation and future potential. There is widespread speculation that PZZA is a takeover candidate (including by ourselves), and debate continues as to whether the current problems can be overcome or whether the competition (including Domino’s) is just too tough and whether the brand is beyond repair. We refer our readers back to our previous report on PZZA, datedJuly 23rd, which outlined why all the major stakeholders: current management, franchisees, board of directors, stockholders, debt holders, and even John Schnatter, would be best served by a going private transaction, and the current financial parameters could still support that process.

The earnings release and the Conference Call updated observers on the results to date, sales trends through July, guidance for all of ’18 was adjusted downward, operating initiatives were described to rectify the sales trend, and management strongly defended their decision to move aggressively ahead without John Schnatter as corporate spokesperson. Suffice to say that there is a great deal of work to be done to deal with a 4,600 unit franchisee system, including redirection of a marketing effort in an industry segment that is always highly promotional. On the other hand, PZZA has competed, and grown successfully, for many years, and it was less than twelve months ago that the brand was widely admired. We encourage our sufficiently interested readers to fill in further details from the full earnings release and Conference Call transcript. We are trying to provide here a timely interpretation of the most important issues, and present a reasoned conclusion as to how the situation plays out.

Among the most important issues: Sales Trends, Unit Growth Prospects, Debt Covenants

The Same Store Sales Trend

First quarter systemwide North American comp sales were down 5.3%, International comp sales were up 0.3%. In the second quarter, North American same store sales were down 6.1%, International comp sales were down 0.8% so there was a sequential deterioration of about one point. North American comp sales in July (from 7/2 until 7/29) were down approximately 10.5%. When questioned on the Conference Call about the Q2 sequence into July, Management said: “the cadence of comps through Q2 were consistent with the 6.1% Q2 decline….after the July 11 article…we saw a precipitous drop of roughly 4% from the trend…we do think we have stabilized a number there…it’s very early into Period 8…but we do think we have experienced the significance of the decline…have provided our outlook based on the infancy of what we have seen and that’s why we have re-guided to a negative 7-10% for the year.” Our interpretation is that the -7 to -10% implies an assumption that the July negative 10.5% range continues or even worsens to the mid teens in H2. Management, of course, hopes that comps firm up and the year’s result is closer to the 7 than 10. International comps are now expected to be between from -2 to +1% for 2018, several points worse than previously indicated.

Unit Growth

Among the changes of guidance from management, net global unit growth has been adjusted from a positive range of 3-5% to a range of flat to 3%. Virtually all the unit growth continues to be international, and those sales have been far less affected than domestic locations. There was quite a bit of discussion on the Conference Call about unit closings and royalty relief. Management indicated that they are working with franchisees, as always, to alleviate financial problems at specific situations. With the current sales trends, margins are naturalized squeezed for all operators, unit growth can be expected to be slower and closings can even increase. While it is natural to be concerned about the rate openings and closings, there has been very little indication (so far) of wholesale franchisee disillusionment. Internationally there has been steady unit growth with hardly any closings. In the more mature North American market, there were 79 locations closed in H1’18 (42 in Q2), but 44 new locations opened in H1, for a net reduction of 35 on a base of over 2700 units.

Our conclusion here is that it is pretty early to be overly concerned about a collapse of a franchise system that was doing rather well for many years until about nine months ago. This situation could obviously change if the current negative sales trend is not, at the very least, stabilized.

Bank Covenants

The Leverage Ratio is defined as outstanding debt divided by consolidated EBITDA for the most recent four quarters. The Interest Coverage Ratio is defined as the sum of consolidated EBITDA and consolidated rent expense, divided by the sum of consolidated interest expense and rent expense for the most recent four quarters.

Per the 10Q filing for the second quarter, the actual leverage ratio and interest coverage ration in Q2 were 3.4 to 1.0 in each case. The Permitted Leverage Ratio was not to exceed 4.5 to 1.0 at the end of Q1, subsequently decreasing to 4.25, decreasing over time to 3.75. The Permitted Interest Coverage Ratio is not less than 2.75 to 1.0, with no indication that it is structured to change. As the 10Q says:

“We were in compliance with all financial covenants as of July 1, 2018. Based on our revised lower financial forecast, we plan to work with the banks within our Credit Facility to evaluate options with the covenants to mitigate the possibility of violating a financial covenant in the future. If a covenant violation occurs or is expected to occur, we would be required to seek a waiver or amendment from the lenders under the credit agreement. The failure to obtain a waiver or amendment on a timely basis would result in our inability to borrow additionalunds or obtain letters of credit under our credit agreement and allow the lenders under our credit agreement to declare our loan obligations due and payable, require us to cash collateralize outstanding letters of credit or increase our interest rate. If any of the foregoing events occur, we would need to refinance our debt, or renegotiate or restructure, the terms of the credit agreement. ”

On the conference call, management indicated that the leverage ratio is expected to be in excess of 4.0 (stilll OK) at t he end of ’18, no doubt based on the assumptions most recently provided, including N.A. comps negative in the 7-10% range.

While we can’t know the exact definition within all the above ratios, both ratios will no doubt narrow if the second quarter (and July) trends persist, or get worse, and it makes sense that the Company negotiate potential adjustments to the current credit agreement. The bottom line here is that there is still substantial operating cash flow, EBITDA, and free cash flow, by any definition. Absent a very substantial additional decline in sales, the credit situation should be controllable. This, in our mind, seems a compelling reason for all parties involved to negotiate an amicable parting of the ways between the Company and John Schnatter. Even Schnatter’s recent statement that he has the interest of all stakeholders leaves opoen his departure as an acceptable solution once the current emotional atmosphere cools.


We feel that sales will more likely stabilize than deteriorate, followed by at least modest improvement, over the course of Q3 and especially during Q4 when new marketing efforts should take hold and the YTY comparisons get easier as well. We expect that the most important stakeholders in this equation, specifically John Schnatter, current management and the Board of Directors will come to a rational conclusion that toned down rhetoric is in everyone’s interest. Meanwhile, there is a great deal of P/E capital looking for a home, and the valuation of the Company supports PZZA as a buyout candidate. We continue to believe that, over the next six months to a year, there are more ways to win than lose from these levels. If the Company remains publicly held, the stock could rebound sharply with just a stabilization of sales, let alone resumption of positive comps. Chipotle stock is up over 200 points since they hired a new CEO, and sales have yet to improve meaningfully. There’s lots of press coverage right now regarding PZZA, but this too shall pass, and nobody died or went to the hospital with this situation.

Roger Lipton




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



As background for the following piece, readers may want to peruse our basic descriptive piece, dated 3/27/18, available here:


It’s hard to miss the news that John Schnatter, founder, largest shareholder with 29% of the equity, and company spokesperson, has resigned from the Company. The circumstances have been widely documented in all kinds of press reports, and we believe have been amplified by the fact that everything in America is “politically charged”.

Opinions vary widely as to what the future holds for the Company and the stock. There are lots of obvious reasons why customers could shy away from the pizza, further weakening the sales trend that already turned down in Q1’18 and further penalizing the stock that is trading at 22x calendar ’18 estimates of earnings. Though the dividend yield is 1.75% at the current stock price, some could question whether a new CEO will maintain the dividend when earnings are down sharply, especially when long term debt is over $500M against negative equity as a result of stock buybacks. Uncertainty is always a substantial negative when evaluating the desirability of owning a particular stock.

The argument has been made perhaps no other consumer products company has been so dependent on the image of its founder, “Papa John” Schnatter who has consistently appeared on TV, with Peyton Manning and others, touting the “Better Ingredients, Better Pizza”. Observers have recalled that Steve Ells, Howard Schultz, Dave Thomas, and Jimmy John have been the face of their Brands, but not to the extent of Papa John.

However, we suggest that the “face” of PZZA has more been “Better Ingredients, Better Pizza” than the personality of John Schnatter. How long it takes PZZA to rebound from this PR nightmare is anybody’s guess, but nobody died (as with Jack in the Box), went to the hospital (as with Chipotle) or lived through the operational problems at Starbucks when Howard Schultz had stepped aside. Jimmy John’s sandwich shop have continued to prosper even after Jimmy’s hunting habit was criticized by the anti-gun lobby.

At Papa John’s, to the contrary, even after same store sales turned down by 5.3% in Q1’18, not only did nobody die, and we never heard that the product had deteriorated, the stores were dirty, delivery service was poor, or there was negligence from an operating standpoint. The delivery pizza business has always been competitive, especially in light of Domino’s technological lead, so the PR problem relating to the NFL, and the delay of rolling out a new campaign could well have cost a few points of same store sales performance. As for the latest press coverage relating to Schnatter’s inappropriate remarks, the reaction of his Board, and his own attitude toward the episode,  we believe it will fade as the 24 hour news cycle moves on. Ninety days from now, the concern at Papa John’s will be about new products, new marketing, how the search for a new CEO is coming along, and technological innovation that can help catch up with Domino’s. One can argue that the departure of John Schnatter will work out for the best in the long run because the brand will no longer be so dependent on a single personality’s reputation.

Meanwhile, the stock, while not what we would consider dirt cheap, is selling at a much lower valuation than its peers. There are over five thousand stores in 45 international countries and territories. The long term debt at $568M is only a little over 3X trailing twelve months EBITDA. Other well established franchise companies are carrying debt at 5-6X EBITDA, so PZZA could be leveraged further to buy back common stock or taken private at a premium to the current price. The current enterprise value at 12.5X trailing twelve month EBITDA and 22X calendar ’18 estimated earnings (even if those estimates come down) is materially cheaper than peer asset light franchising companies such as DNKN (17.9X and 26.0X), QSR (20.5X and 23.9X), DPZ (25.6 and 33.7), and WING (42.5X and 61.2X). DIN and JACK are selling at comparable multiples as PZZA but have had operating issues. YUM’s valuation is also comparable but is much more comples, with three brands, very dependent on China for future growth, and has an enterprise value fifteen times as large with 45,000 (9X that of PZZA) systemwide restaurants.

In summary, we think there are a number of ways to win here, and there is enough substance to avoid much downside risk over the intermediate to long term. There are hundreds of billions of dollars of private equity capital looking for a home, and everybody loves “asset light”, “free cash flow” stable situations.  Anything can happen in today’s environment that sometimes allows for outsized stock moves in unexpected, and sometimes irrational direction. Aside from possible short term volatility, we think there is more upside potential than downside risk with PZZA (“Better Ingredients, Better Pizza”) at this time.

Roger Lipton