Papa John's Can Finally Focus on Pizza Again

John Schnatter and the company work things out and now it's time for the pizzeria to deliver the goods.

Rich Duprey
Rich Duprey
(TMFCop)
Mar 12, 2019 at 1:02PM
Consumer Goods

Papa John's (NASDAQ:PZZA) founder John Schnatter has agreed to resign from the company's board of directors, which means that after more than a year of turmoil sparked by Schnatter, the pizzeria can finally get back to doing what it does best -- making pizza.

Schnatter has agreed to withdraw his nomination to the board of directors and will resign his seat once he's helped choose a successor, according to a filing with the SEC. He will retain his 31% stake in the business he created.

Male in red delivering pizza

Hedge fund Starboard Value has a lot of work to do to deliver on its promise to return Papa John's to health. Image source: Getty Images.

Burned by controversy

Schnatter built an international pizza chain with over 5,300 restaurants in all 50 states and in 46 countries that has consistently challenged rival Domino's for the title of the most popular pizzeria in the U.S. But controversy rose up around the business in late 2017 after Schnatter attributed Papa John's declining sales to National Football League players' kneeling during the national anthem and the NFL's handling of that situation. He then made comments deemed racially insensitive during a conference call with a marketing agency.

Schnatter subsequently stepped down as board chairman and gave up his position as CEO, but he railed at his successor and objected as the board sought to remove all connection to him, including removing his image from corporate marketing. Schnatter filed a lawsuit against Papa John's last year contesting his removal as chairman and accusing the board of failing to conduct an investigation into the conference call comments, which he contends the media took out of context. He also fought the "poison pill" defense Papa John's adopted to prevent him from acquiring control over the company.

This year, hedge fund Starboard Value took an activist role in the pizzeria, injecting $200 million into the business in the hopes of reversing the precipitous decline Papa John's was experiencing, much the way it had revived Darden Restaurants' Olive Garden chain. Papa John's then expanded its poison pill defense to include a new "acting in concert" provision, which required new board members, including Starboard's founder Jeffrey Smith (who had become Papa John's chairman), to vote in favor of the company's nominees.

Although Schnatter amended his lawsuit to include the new provision, as part of Papa John's settlement with him, the company has agreed to remove that language. Schnatter has also agreed to drop two lawsuits against Papa John's.

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

Customers fled the pizza shop

The latest moves should allow Papa John's to get back to business. The pizzeria spent $50.7 million last year in an attempt to limit the damage, whether through marketing, helping out franchisees with lower royalty payments, or paying for the legal work undertaken by the board's special committee assigned to deal with the issue.

Same-store sales at U.S. restaurants tumbled 8.1% in the fourth quarter and were down 7.3% for the full year. Revenue also plunged 20% in the quarter, dropping to $374 million from $468 million a year ago, and the company suffered a $13.8 million quarterly loss, or $0.44 per share. In the fourth quarter of 2017 the pizzeria earned a profit of $28.5 million, or $0.81 per share. Papa John's stock suffered similarly, losing almost 30% of its value in 2018.

Since Starboard's investment, however, shares have regained almost 18%. Still, the stock is currently trading at the same level it did in 2016, and remains some 50% below the highs it hit at the start of 2017.

Whether Starboard Value can help Papa John's reconnect with consumers the way it helped Olive Garden remains to be seen. There's only so much room to maneuver with a pizza chain's menu, and it's already been adding new specialty pizzas. It is also reaching out to social media influencers to help sell the idea that this is a new business.

Take a go-slow approach

There are literally tens of thousands of pizzerias consumers can choose from, in addition to the national chains. You can get just as much innovation at your local independent pizza shop as you'll find on Papa John's new menu. There will undoubtedly be a positive impact from the resolution and the fact the pizzeria is no longer in the headlines with allegations and recriminations, but Papa John's has a lot of work to do to repair the damage that's been done. Investors may want to take a wait-and-see approach. The stock is also not cheap at 27 times next year's earnings estimates and some 25 times the free cash flow it produces.

There should be plenty of time to see how well Starboard Value gets the pizzeria back in the dough.