Papa John’s Auditor Swap Is Not a Good Look

In today's Market Foolery, host Chris Hill and Motley Fool analyst Ron Gross look at big retail mix-ups, pharma mergers, and shady restaurant news. Pfizer (PFE -0.12%) dropped $11.5 billion to tuck Array BioPharma (ARRY) and its cancer drugs under its belt. Target (TGT 1.28%) had multiple tech snafus in a row this weekend, but the company assures customers and investors that it wasn't hack related. Papa John's (PZZA 0.66%) parts ways with their old auditor -- an auditor that had some sharp words about the Papa John's style of financial reporting.

Also, the hosts answer a listener question: Is it OK to sell a dud that you know will be a dud for years, then put that money into something more promising? Tune in to find out more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on June 17, 2019.

Chris Hill: It's Monday, June 17th. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio, Ron Gross.

Ron Gross: How are you doing?

Hill: I'm good! I think we both had a good Father's Day.

Gross: It was really nice!

Hill: Our respective Father's Days were good.

Gross: The weather was looking bad and it turned out wonderful.

Hill: Yeah. Although am I the only one who napped on Father's Day?

Gross: The only one? Maybe the only one in this room. Clearly not the only one.

Hill: It's always a good day when you can nap. We've got retail news. We've got restaurant news. We're going to dip into the Fool mailbag. We're going to start with the Deal of the Day, and that is Pfizer buying Array BioPharma in a deal worth nearly $11.5 billion. Array BioPharma -- if you're a shareholder, congrats! That stock's up close to 60% on this buyout. They do a bunch of things. I'm assuming that Pfizer bought Array for the cancer treatment portfolio.

Gross: Absolutely! It's continuing a trend. We've seen it lately with Merck, Eli Lilly, Bristol Myers, several acquisitions in the cancer space. Array specifically has two drugs in their pipeline that focus on metastatic -- easy for me to say -- melanoma. I think that is the primary reason that Pfizer got interested here. Obviously, an $11 billion price tag, as you said, a 62% premium. Pretty steep price to pay. But cancer is really where a lot of these bigger companies are going, moving away from the heart medicines and some of the other things from the past, and focusing on cancer. And I've also seen a lot of acquisitions in the gene editing space, gene therapy as well, looking toward what the future of medicine will be.

It's a big deal. It won't add to earnings anytime soon. I think we're looking at 2022. Typically, when you see an acquisition of, let's call it a normal company, a non-biotech company, you love to see the company say it will be accretive, additive, to earnings immediately, sometimes not immediately, maybe a year. In this case, it's biotech. They're not profitable, they won't be profitable for a while. This is not going to add to anything for a while. But obviously, Pfizer thinks it's worth the price.

Hill: Don't you think that Pfizer went big with the offer? There's a little bit of debt that they're assuming as part of this $11.5 billion, but Array was not a tiny company. They were probably to the tune of a $5 to $6 billion market cap before this buyout. So, I'm assuming that even though they're not profitable, Pfizer saw enough good things that they thought, "Let's make this quick! Let's go in!" And as you said, Maybe there's a little bit of keeping up with the Joneses here with the other deals you mentioned with Merck and company.

Gross: Now, it's very difficult to properly value biotech companies, especially when they're in the clinical trial phase or have maybe one or two drugs in the marketplace. It's hard to know what the right number is. But they came to the hoop. They wanted to get this done. I don't think they were nickel and diming. They paid what appears to be a very fair price to, as you say, just make this happen and move forward as a combined company.

Hill: Whoever you are listening right now, however your weekend was, your weekend was probably better than Target's. On Saturday, Target suffered a global point-of-sale machine outage for more than two hours. That quite simply means the cash registers were not ringing. They had more problems on Sunday, where Target locations could only accept cash or gift cards. If he weren't out of the country, Jason Moser's head would be exploding because this goes directly against the war on cash. Target says this is not a security issue. This is not a hack. This is an internal technology issue.

Gross: And they say the two things are unrelated. That's a double whammy. That's a bad two days, to have two technology-related issues not only impacting sales but impacting people's opinion of how Target is taking care of business here. Target's in the age where they're spending heavily on technology to compete with the likes of Amazon for same-day fulfillment and increases to their online business. It doesn't give you a lot of confidence, really, when you see that they just keep continuing to have these problems. They're unrelated, they fixed it quick, the credit card thing theoretically has nothing to do with them; it was the credit card processor. But it doesn't instill confidence.

Hill: It really doesn't. I have to believe we're going to hear more about this story. To your point, I get the urge. I think this is the right instinct on the part of Target management and in particularly their communications team, to come out as quickly as possible with some explanation, particularly when the 2013 data hack at Target is probably still fresh enough in people's memories that they had to get out as quickly as possible and say, "Here's what this was not." That's fine, they did the right thing there. But to your point, I'm not even a shareholder and I want to know more about what happened here. Is this a vendor with some faulty tech? Also, if you're a retail analyst, and you're looking at this saying, yes, they had the problem in the past, in the same way that Home Depot had problems -- pretty much every big retailer has had some sort of tech issue. But I look at this and say, OK, well, I want to learn more about exactly what this was. Maybe I don't own shares of Target, but I own shares of Walmart or Amazon or something else. I want to make sure this isn't going to happen elsewhere.

Gross: For sure. From the credit card perspective, that seems to have been a problem with their vendor, NCR, who had an outage at one of their data centers. I don't think I can fault Target for that, except, make sure you're partnering with the correct people. The not being able to make purchases for two hours on Saturday is a bigger thing. It seems like that's their issue. They'd better get their ducks in a row. Investors only can handle this every literally blue moon. If it's still fresh on people's minds each time another thing happens, people are going to walk.

Hill: You look at all the investments that Walmart has made in e-commerce, and I would argue that they are decently ahead of Target in that regard, even though Target has bumped up their e-commerce sales each quarter to a nice degree. But look, just think about the average person who works during the week. They're doing a big Target run on Saturday. Again, this is a point of sale thing. You know there are just tens of thousands, arguably, of people who are going through their Saturday routine, they're getting all their stuff. And it's not until they're ready to leave and pay -- well, I guess, pay then leave, right? -- that they figure out this is going on.

Gross: That's annoying. But now, from a stock perspective, let's give them the benefit of the doubt and say they do get their act together and this doesn't continue to happen. Only trading at 14 times or 15 times earnings. That's compared to Walmart at 22 times, Costco in the 20 times somewhere, all the dollar stores trading around 20 times. Theoretically a cheap stock if they continue to put up good comp sales and increase those online sales that you just mentioned. This could be an interesting play.

Hill: Papa John's is in the news today because the pizza chain dismissed KPMG as its auditor and hired Ernst & Young. Earlier this year, KPMG said that Papa John's did not maintain effective control over its financial reporting. Just at first blush, this doesn't appear to reflect well on Papa John's. Does it?

Gross: No. But I can imagine -- well, I shouldn't say I can imagine. They're probably not auditor shopping. That's what this looks like. You're not going to give me a favorable opinion, I'm going to go elsewhere. It looks, on the face of it, sleazy. If it's true, it actually is sleazy. That's why I can't believe it actually is the case.

It'll be great to see what the auditor opinion looks like next time it comes around to see if that material weakness is mentioned. But if it's not, it could be just that Papa John's has not gotten their act together, because you would expect them to correct the problems that their previous auditor identified. Either way, I think we'll probably not see that called out again in the next audit report. It looks a little weird, especially with all that Papa John's has been through over the last year with all the controversy. They don't need any more controversy. Just make pizza.

Hill: See, another example of you being more charitable than me. I'm not going to accuse Papa John's management of anything nefarious here. I will simply point out, however, that the last couple of years, this is the gang that couldn't shoot straight. Similar to Target -- and I hope and expect we will get more information about what happened with Target -- I expect we're going to get a little bit more color on what happened here. I hope it's nothing nefarious, but it wouldn't surprise me if there was something that hinted at, "No, we're doing a little bit of shopping. We want someone who's going to give us the benefit of the doubt," even though just from a stock standpoint, from a running-the-business-well standpoint, they haven't really earned the benefit of the doubt lately.

Gross: No. One other thing, though, that does give me a little bit of comfort is the big investment and the involvement by Starboard Value, which I used to know very well back in my hedge fund days. Quality folks. Not going to do anything nefarious. Not going to do anything to hurt their investment or hurt their investors. I think this is probably OK.

Hill: Get Shaquille O'Neal out front and center. Back in March, for those who missed it, Shaquille O'Neal joined the board of directors, took ownership of a bunch of franchises. That's such a great rebranding opportunity. Come on, make that happen!

Our email address is [email protected]. Question from David Burton, who writes, "I'm a relative newcomer to investing and have found The Motley Fool podcasts to be invaluable. Thus, I became a member of your Stock Advisor service." Welcome! "Learning every day, keep up the great work. I often hear the guidance, to not sell when a stock falls and to hold it for an extended period to ride out the drops, which seems sound in general, but I keep asking myself, if I don't believe a stock will recover as fast as other investments are likely to grow, then is it not wiser to accept a loss and reallocate the capital to a stock that is likely to grow faster? I have shares of Swedbank that have been hit by a money laundering scandal.

"They lost 35% of their value within two months. The underlying business is likely to recover, as it is a well-capitalized bank that I believe in for the long term. But for the next two to three years, I believe the stock price will struggle to beat the market. I could hold and eventually not realize a loss, but is it not wiser to sell the stock at a loss and move my capital to other stocks that I believe are likely to grow faster in value than my current holding? Your perspective would be greatly appreciated." Great question!

Gross: Yeah, for sure! I feel like he actually answered his own question in a roundabout way. Whether a stock has a gain or a loss on it is absolutely irrelevant to whether you hold that stock or not. It all is about the future. And in this particular case, it sounds like, A, I'm not sure you want to be an owner of a company involved in money laundering. You've got to think that through. B, it sounds like he's saying he thinks it's going to be dead money for the next two or three years, or if not completely dead, certainly not market-beating money. At any given time, you want your portfolio to be allocated in a way that gives you the best fighting chance of beating the market. If you're admitting, for lack of a better word, that this piece of your portfolio will not beat or will be dead money, there's absolutely nothing wrong, at all, with selling it and reallocating that capital to something that you do think will perform better.

Hill: Every case is individual. One other thing to consider is, obviously, what sort of cash on hand do you have? It is the sort of thing where, if you have cash on the sidelines that you're looking to deploy, then it makes it at least a little bit easier to say, "OK, I'm just going to leave this here. I'm going to park it. I'm not going to worry about it. I'm going to allocate that other cash." But yeah, I think part of it depends on the time horizon. As you said, when you're highly confident that it's dead money for a couple of years, then maybe what you do is, you pair the sale with the sale of a stock that has a gain, and you minimize your taxes.

Gross: Oh, that's a good idea, too! You also want to look at what you think the potential of that investment will be after the dead money period ends. It's really all about average annual total return when you get down to it. If that's not going to earn you a lot of money for two or three years, and then in year four, you're going to get a pop of 30%, then divide that 30% by the three years it took, and you're earning 10% or less on that investment. Maybe you could do better elsewhere.

Hill: I kind of want to know more about the money laundering.

Gross: [laughs] Yeah, that's interesting!

Hill: Ron Gross, thanks for being here!

Gross: Thanks, Chris!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery! The show's mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!