In the hypercompetitive restaurant industry, the last thing a chain needs is a public-relations black eye and subsequent pullback in advertising activity. That's what happened to pizza chain Papa John's (NASDAQ:PZZA) after ousting founder and former CEO John Schnatter from his position as chairman of the board over the summer of 2018. To say the least, the stock has had a rough go of it. Shares have tanked 49% since the start of 2017.

It would be easy to simply blame Schnatter for Papa John's struggles as of late, and there's no doubt the pizza company's image has suffered as a result. Activist investor Starboard Value thinks the chain can rebound, and it backed that up with a recent investment and a couple of additions to the board of directors. The fact is, though, that Papa John's woes are stemming from internal factors, not external ones.

Check out the latest Papa John's earnings call transcript. 

Another turnaround story in the making?

Papa John's fourth-quarter 2018 preliminary results sum up the type of stretch the company has been having. Comparable-store sales (a combination of average store foot traffic and guest ticket size) fell 8.1% in the fourth quarter in North America, capping off full-year 2018 comparable declines of 7.3%. Things haven't improved much to kick off the new year. January comps are reportedly down another 10.5% from a year ago.

That should be cataclysmic news for a restaurant operator, but shareholders are taking some solace in the fact that the company just inked a deal with activist investor Starboard Value. The news concludes a multi-month review of "strategic options" the board of directors was exploring as it mulled over life without its founder. But why Starboard, as opposed to an outright sale? (Burger King parent Restaurant Brands International was apparently interested in a purchase, for example.) 

Starboard has experience in the beleaguered restaurant department. The investment group took on Olive Garden years ago, with Starboard's head honcho, Jeffrey Smith, chairing the board of Olive Garden parent Darden Restaurants as it oversaw the company's turnaround strategy. Smith is now getting appointed to Papa John's board and will become the new chairman. Two other board positions were added as well, one an independent seat -- former CEO of Pinnacle Entertainment Anthony Sanfilippo -- and the other for Papa John's new CEO, Steve Ritchie.

In addition to the new board seats, Starboard is also purchasing newly created preferred stock for $200 million, with the option to buy $50 million more by the end of March 2019. The new shares reportedly dilute Schnatter's ownership in Papa John's from 31% to 26%. The company plans to use half of the proceeds to pay down debt and the other half for "operational flexibility" as it tries to chart a rebound.

A pizza on a table with a slice being pulled from it.

Image source: Getty Images.

Wait and see, the industry's crowded

Is the coup by Starboard and Papa John's new management team going to work? Maybe, but it's a risky move that not every investor out there should bet on. The restaurant industry has been riding a decade-long wave of expansion since the financial crisis of 2008, as consumers have continued to be generous in their eating-out habits. As the money has flowed into restaurants, competition has been especially fierce.

That shows up in the numbers for 2018. Although the U.S. Census Bureau reported a massive 6.2% increase in overall spending on eating out over 2017, industry research group TDn2K has been reporting average location comparable-sales increases of only about 1%. The reason? Restaurant chains are opening up more locations than consumers can fill up.

Thus, Papa John's problems aren't completely internal -- although rivals like Domino's Pizza (NYSE:DPZ) have been taking advantage of Papa John's self-inflicted wounds to maximize their own growth. Domino's, the world's largest pizza chain, reported a 6.3% comparable-store increase during the third quarter of 2018 (its last report as of this writing), a stark contrast with the high-single-digit decline at Papa John's. Domino's has also been trolling its peers with crazy offers like giving out rewards points for any pizza purchased starting Super Bowl weekend through April 2019.

Meanwhile, Papa John's just recently relaunched its rewards program. To put it simply, the chain is behind the curve. Not only is it battling an old PR nightmare, but its biggest competition is riding momentum. Will a turnaround be possible? Maybe. But it will no doubt be a gut-wrenching ride, one that most investors should sit out and leave to the big boys to handle -- at least until the company can stem the bleeding comparable-sales metric.