Shares of Papa John's (NASDAQ: PZZA) continue to rise in the aftermath of activist investor Starboard Value injecting $200 million into the pizzeria and having the hedge fund's founder Jeffrey Smith take on the role of chairman of the board.
Many believe that Smith, who is credited with engineering the turnaround at Olive Garden following the ouster of the entire board of directors at Darden Restaurants (NYSE: DRI), has the skills to fashion a resurgence at Papa John's.
Image source: Getty Images.
But the pizza chain is not the Italian restaurant, which suffered mostly from execution issues (which is why Smith's action plan included such minutiae as salting the pasta water).
Papa John's has seemingly much bigger problems in that its reputation has been damaged by the actions of John Schnatter, its former chairman and founder. Schnatter purportedly made racially insensitive comments and blamed the National Football League for falling sales. While the latter point suggests there were issues prior to the various brouhahas that resulted in Schnatter resigning his position with the company (he still owns 30% of the company's stock), sales plunged in the aftermath. Winning back consumer trust will not be as easy as tweaking Papa John's pizza sauce.
Sticking with a winning formula
Yet Starboard's Smith is expected to use the same formula at the pizzeria that he did at Olive Garden: Overhaul the menu, its marketing, and its operational performance. In announcing the investment and his elevation to board chairman, Smith extolled Papa John's pizza -- calling it "the best product in the space" -- its franchisees, and the board for taking decisive action.
Cost-cutting is not as much of a priority at Papa John's as it was at Olive Garden, but there is only so much space to maneuver with a somewhat limited menu. People aren't going to a pizzeria for a new chicken, fish, or pasta dish, like they could at the Italian food chain; they want pizza, and there are only so many ways to innovate.
Pizza is also somewhat more competitive than casual dining. While there are only a handful of national pizza chains, there are almost 42,000 independent pizzerias, making Papa John's turnaround more of a challenge. Customers can always go to their local pizza joint if they don't want to patronize one of the national chains. Better messaging might not be enough to persuade customers to return.
Moreover, rival Domino's (NYSE: DPZ) is already the industry leader, and made a point of trying to capitalize on Papa John's woes by attracting more customers with the promise of free pies. It has also greatly improved its digital presence, an area where Papa John's was seen as leading, and Domino's has maintained consistently high rates of comparable-store sales growth, logging 30 consecutive quarters of gains.
Similarly, Yum! Brands (NYSE: YUM) is also hungry for a turnaround with its Pizza Hut chain after years of languishing. Its efforts may finally be starting to pay off with comps flat year over year in the fourth quarter as well as for the year, a sign that the chain may have finally stabilized. Meanwhile, Papa John's 2018 comps were down 7.3%, making the hill it has to climb much steeper.
Money well spent?
The pizza chain will use Starboard's $200 million investment to pay down some of its debt. In return, the hedge fund is buying a newly designated Series B convertible preferred stock with an option to purchase up to $50 million more. Franchisees are also being given an opportunity to buy a total of $10 million of the convertible preferred stock on the same terms as Starboard.
Most of Papa John's efforts need to go toward repairing its image. But because this is not a quick-fix solution, something Starboard Value acknowledges, it may not be a battle it can easily win. It also suggests investors can bide their time before deciding whether the Papa John's turnaround will work.
More From The Motley Fool
- 10 Best Stocks to Buy Today
- 3 Stocks That Are Absurdly Cheap Right Now
- 5 Warren Buffett Principles to Remember in a Volatile Stock Market
- The $16,728 Social Security Bonus You Cannot Afford to Miss
- The Must-Read Trump Quote on Social Security
- 10 Reasons Why I'm Selling All of My Apple Stock