Papa John's offspring takes root as publicly traded franchisee

Nation's Restaurant News, Nov 18, 1996 by Mark Hamstra

BIRMINGHAM, Ala. - Papa John's International Inc., one of the highest-flying publicly traded restaurant companies, has helped spawn a new stock issue by its largest franchisee.

Like parents who provide offspring with resources for success, Papa John's has given PJ America Inc. options to expand and seek its own fortunes in the public market.

On Oct. 25, PJ America sold 1.8 million shares of common stock in an initial public offering, which netted $17.9 million for the company. It plans to use the proceeds to repay debts, expand its current store base of 44 units and, possibly, acquire other franchisees.

PJ America's stock was priced at $12.50 per share and quickly climbed to about $20 - nearly half the $48.75 price commanded by PJI at the end of October. It trades on the Nasdaq National Market under the symbol PJAM.

Generally speaking, buying [stock in] a franchisee is less attractive than buying [stock in] a franchisor," said Mitchell Pinheiro, an analyst at Philadelphia-based Janney Montgomery Scott. "When you're the parent, you have the world at your feet. When you're a franchisee, your development is limited."

To fuel growth potential, PJ America acquired options on development rights to several new territories, including what could become the first development areas for Papa John's outside the continental United States - the Vancouver, British Columbia, market and Puerto Rico.

PJ America also was granted options on development rights to four California counties, Ventura, Kern, San Luis Obispo and Santa Barbara, and on development rights for the state of Utah. Papa John's currently has no stores in California or Utah. It also acquired rights of first refusal to develop certain areas in Illinois, Iowa and Louisiana.

PJ America expects to open nine restaurants in its current territories in fiscal 1997 and five in 1998 and to augment restaurant development by pursuing acquisition of other franchisees. Another 90 to 100 restaurants could be added in the four California counties and in Utah if development options on those territories are exercised, according to the company's prospectus. For granting those options, PJI received 225,000 warrants for the purchase of PJ America stock at $11.25 per share, about 90 percent of the stock's IPO pricing.

PJ America was formed by combining several Papa John's franchise groups operating in Texas, Alabama and Virginia. The companies reported combined sales of $23.1 million for the year ended last December, up nearly 64 percent from prior-year sales of $14.1 million. Full-year profits more than doubled before pro-forma adjustments, to $1.8 million, from $733,740 in fiscal 1994.

Through the first half of this year, the combined companies had sales of $14.1 million vs. sales of $10.2 million in the first half of 1995. Profits for the combined companies, before pro-forma adjustments, totaled $979,000 in the most recent six months, an 18.8-percent gain over year-ago levels.

Extra Cheese Inc., a 14-unit Papa John's franchisee based here, was listed as the acquiring entity. It forms the operational nucleus of PJ America. The companies it acquired included Textra Cheese Inc., which had five Papa John's restaurants in eastern Texas, and two Virginia-based franchisees that operated a total of 25 units in the Norfolk, Richmond and Virginia Beach, Va., markets.

Richard F. Sherman, longtime veteran of the chain-restaurant industry and a Papa John's International director for the last six years, is chairman of the newly formed company. Douglas S. Stephens, former president of Extra Cheese Inc., is president and chief executive of PJ America. Charles Schnatter, a senior vice president and director at PJI, serves on PJ America's board as a designated representative from PJI.

Papa John's International, which derives a little less than half its total revenues from company-owned restaurant sales, generated operating income of about 6.6 percent of total revenues through the first half of 1996, slightly more than the 6.1 percent generated in the first half of 1995.

Same-store sales at the Alabama and Texas restaurants increased 2.7 percent through the first half of 1996 compared with a 4.5-percent gain in same-store sales at the Virginia restaurants. Meanwhile, company-owned same-store sales at PJI grew 8.1 percent.

"In general, it is inevitable that events at a large franchisee spill over and affect the franchisor," said Bryan Elliott, analyst at Robinson Humphrey in Atlanta. He could not comment specifically on the PJ America situation because his company is part of a group led by Montgomery Securities and Alex. Brown & Sons that sold the PJ America offering. He said the Apple South-Applebee's International situation provided a good example of the public franchisee-franchisor relationship.

When Apple South, Applebee's largest franchisee, reported in September that it would not meet analysts' estimates for 1996 earnings, its stock fell 37.7 percent, to a 52-week low of $13. Applebee's stock tumbled almost immediately.