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'Take-and-bake': Will investors buy Papa Murphy's story?

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Franchisees Sue Papa Murphy's as Pizza Chain Prepares for IPO
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Franchisees Sue Papa Murphy's as Pizza Chain Prepares for IPO

Papa Murphy's, which is set to go public this week, isn't your garden-variety pizza shop. It operates and franchises restaurants built to sell pizzas that are, as would be expected, made in the store. But then its work ends. That's because Papa Murphy's is about "take and bake" -- customers buy at the counter and then handle the baking at home. It doesn't have any ovens.

While that's the most obvious differentiator from Domino's (DPZ), Pizza Hut and most others, the Vancouver, Wash.-based company likely would prefer to focus on another aspect of its food: the "fresh" factor. Papa Murphy's is so serious about this that its ticker symbol is going to be FRSH.

If Papa Murphy's ultimately sells 6.7 million shares at $13, the high end of the projected range, it would raise about $87 million. Including that float, around 17 million shares will be outstanding after the IPO.

Even if it trades above its offering price at first -- and that's no guarantee with the rocky performance of new issues recently -- the question is how Papa Murphy's will fare after the initial buzz fades. There's ample room to be skeptical. Unlike Zoe's Kitchen  (ZOES), a small Mediterranean-themed operator that's held on to its gains in its first two weeks as a public company, Papa Murphy's has a more difficult case to make.

Not 'the next Chipotle'

In fact, the debut of Potbelly (PBPB) comes to mind as potentially having more in common with Papa Murphy's. When the sandwich seller went public on Oct. 4, 2013, its shares surged ahead -- and then drifted lower and lower, to the point where it's now at about half of its peak. It's no sure thing that Papa Murphy's will follow the same path, but it's also not certain investors will race toward a pizza shop, especially one that doesn't even do the cooking.

One of Potbelly's problems is standing out in a sea of sub and sandwich sellers, an issue that will undoubtedly have some impact on Papa Murphy's in the pizza realm, even if anyone who likes pizza is almost certain to approve of the taste they'll find after baking gets done. The chain thinks it can get to 4,500 U.S. stores, and it might over time, but the pizza market is crowded and competitive. A report in PMQ Pizza Magazine, citing industry data, estimated the nation had almost 71,400 pizza restaurants last year, producing sales of $37 billion.

Last year, Papa Murphy's had sales of $786 million. Systemwide comparable-store sales rose 2.8% after a 2.9% increase the previous year. Meanwhile, corporate revenue, on a pro forma basis, was around $87 million in 2013. There's nothing wrong with that necessarily, but Papa Murphy's isn't ideally situated financially as it prepares to list. It's had losses for the last three years, and it arrives on the market with $170 million in debt outstanding, although some of that will be paid back with the IPO proceeds.

Also not in Papa Murphy's favor is that it's facing a lawsuit filed by a group of franchisees who allege the company hasn't been entirely truthful in its franchising documentation. Plus, the take-and-bake option isn't wholly unique; it can be found at a few other chains, such as Figaro's, or obviously at your local grocery store.

The company isn't profitable so there's no implied price-to-earnings ratio, but we can make a quick comparison to similar stores based on its sales. If Papa Murphy's prices the offering at $13 and trades there, it would have a price-to-sales ratio of around 2.5, exceeding public competitors Domino's, Papa John's (PZZA) and Pizza Inn (PZZI). That puts it more in line with the fast casual subgroup.

Growth rates

Should investors decide to treat it as a growth name, all that will be fine. But if they focus on the industry landscape and the fact that Papa Murphy's already has a sizable footprint, they might not be overly eager to give it a premium. Papa Murphy's, which started in 1981, had 1,418 stores at the end of 2013, with 95% of them franchised. While that's up from 841 stores in 2004, it's been a steady expansion rather than a torrid one. The chain has stores in 38 states -- none in the Northeast -- along with Canada and the United Arab Emirates.

It's not all dim, of course. The optimistic angle here is that "craft" and "better" pizza are getting notice, with Chipotle (CMG) and Buffalo Wild Wings (BWLD) putting money into the space, while Pizza Inn has started up the custom-pizza chain Pie Five. That trend should benefit the Papa Murphy's story, especially since it's also invested in a concept called Project Pie. Additionally, though Papa Murphy's isn't yet profitable on the bottom line, its margins on earnings before interest, taxes, depreciation and amortization are above 18%, a strong comparison to other public pizza sellers.

As Papa Murphy's builds out, there's little doubt it will find customers willing to try it at least once. But will they keep wanting to do their own baking in large numbers, after paying about $16 per average transaction to do so? Whether they do will be the key determinant to this stock's future.

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