Sunday, November 27, 2011

Checking the Fact Checkers on Herman Cain and Godfather’s Pizzas

Jay Rasking 10-14-11

Full Article:

An article printed by called Did Herman Cain turn around Godfather’s Pizza? did not check the facts. In fact, it found no facts and therefore printed opinions instead:

Pizza is Cain’s biggest selling point. He says his track record running Godfather’s Pizza, a chain that once billed itself as “the cure for the pizza emergency,” shows he has the ability to run the country. The 620-store chain was on the brink of bankruptcy when he arrived in 1986, he says, and he “turned it around with common-sense business principles.”

A PolitiFact examination of Godfather’s, based on interviews with industry analysts and company officials, shows Cain is largely correct. The chain wasn’t literally preparing paperwork for bankruptcy, but it was widely considered troubled. Cain changed that by uniting the franchisees, overhauling the chain’s advertising, and getting his team focused on its core mission: pizza.

Ms. Holan immediately catches Mr. Cain in a lie. “The chain wasn’t literally preparing paperwork for bankruptcy, but it was widely considered troubled.” There is a big difference between a company widely considered troubled and a company near bankruptcy. Almost every large company in the United States at one point or another has been widely considered troubled. It is not unusual for a company that does not meet financial expectations, to be widely considered troubled. Being widely considered troubled does not mean a company is going bankrupt or anywhere near going bankrupt. Here are the facts about Godfather’s Pizza.

The company had been among the fastest growing pizza chains in America and a great success from its start in 1973 until 1984, two years before Pillsbury appointed Cain as a manager. According to the N.Y. Times (May 19, 1985):

IN 1973, William M. Theisen’s Omaha beer parlor, Wild Willy’s, was doing a booming business with the pizza place next door: Through a passageway between the two establishments, bar patrons were able to order pizza to go with their beer – and even Mr. Theisen became hooked on the thick, rich pies. Soon, he and his neighbor joined forces to form Godfather’s Pizza – and when the 27-year-old Mr. Theisen bought out his partner shortly afterward, he was full of big plans for his favorite pizza.

Within 10 years, he turned Godfather’s into the country’s third-largest pizza operation in sales, behind pizza Hut and Domino’s. It became a chain of nearly 900 company-owned and franchised restaurants with more than $300 million in annual revenues, including $121 million from the company-owned outlets alone. Trade journals ranked it No. 1 in sales growth for fast-food chains in 1977, 1978 and 1979. It had one of the highest returns on investment in the fast-food business between 1979 and 1982. In those years, 641 restaurants were added.

On September 27, 1983, Donald M. Smith and Chart House incorporated purchased 800 Godfather Pizza Restaurants for $306 million dollars.

Two years later, Pillsbury Inc. bought the franchise for an undisclosed amount. Herman Cain was put in charge of Godfather on April 1, 1986. Thus Cain took over a company that had been worth $306 million two and a half years before. Two and half years later on Sept 20, 1988, Cain and his management group bought the company for about $30 million...

The real question that the fact checkers did not discover or investigate is how did a company worth $306 million, 30 months before Herman Cain was put in charge, come to be worth $30 million, 29 months after he was put in charge? The question is how did the company lose 90%, some $276 million, in value during this time and how much of this loss occurred while Cain was running the company? Cain naturally apportions all the blame to his predecessors and claims the company was near bankruptcy when he took over. The real question thus becomes how much Godfather’s Pizza was really worth when Cain started running it.

Until 1984, Godfather’s Pizza was one of the most profitable Pizza Chains in America. It was still making profits in 1984, Although, at that point, the new owners of Godfather’s Pizza, Diversified Foods, made some errors and the financial picture becomes complicated.

As noted, Chart House bought 800 Godfathers Pizzas in Oct 1983. Chart House which already owned 375 Burger King units among its 517 hamburger, steak, barbecue, and Mexican restaurants in 30 states became Diversified Foods Inc. after buying Godfather Pizzas.

While Godfathers did expand to 900 restaurants in 1984 and sales grew to $365 million from $340 million in 1983, profits according to Donald M. Smith, new president of Diversified Foods Inc., plummeted from 121.8 million to $18.6 million. This was due to the disastrous introduction of a pan pizza. The Los Angeles Times reported:

The company blames the earnings drop in part on the costs of product development–especially its multimillion-dollar entry into the pan pizza market, which one restaurant analyst called an “overwhelming disaster.”

Despite the setback, things were not looking that bad for Godfather’s Pizza. On September 14, 1984, the Wall Street Journal reported:

Godfather’s currently is rolling out a new deep-dish pizza that is expected to replace the current variety by next month. Management itself admits the old product, which the company hastily introduced earlier this year, was too costly to prepare, inconsistent from store to store and “too doughy, too buttery and too rich.” In tests, Godfather’s says consumers preferred its new, lighter pizza 4-to-1 over Pizza Hut’s deep-dish version, and the pie is far easier to make. Mr. Smith says advertising expenditures to promote the new pizza will rise, as the company tries to woo back customers.

If Diversifoods succeeds in overcoming its difficulties with Godfather’s, the company hopes to go after Pizza Hut and other competitors with a vengeance. To compete over the long term, Godfather’s must increase the number of markets where it has as many or more stores as its competitors, Mr. Smith says.

That potential is very attractive to some investors. Michael Culp, an analyst at Prudential-Bache, notes that while Pizza Hut currently has more than 4,000 stores in this country, Godfather’s has fewer than 1,000. “They can open a couple thousand of these restaurants over the next few years” if they can raise volume and get profit margins in line, he says. Mr. Culp thinks 75% to 80% of Godfather’s annual growth will come from physical expansion...

This is an investor’s analyst saying in the Wall Street Journal that Godfather’s Pizza could be competing with the largest Pizza company in America Pizza Hut over the next few years. This is 18 months before Cain took over. It is a month before David M. Smith offers a management buyout to stock holders, a $525 million dollar offer to buy the nearly 900 Godfather Pizzas plus 525 other restaurants held by Diversified Inc. The offer was terminated soon thereafter and the board of directors got rid of Smith on Jan 3, 1985.

Moving ahead about six months, problems continue, but the outlook for Godfather’s Pizza is still optimistic about ten months before Cain takes over. A May 19th, 1985 New York Times article describes the troubles:

Its operating earnings plunged 94 percent in 1984, to $978,000. Late that year, some franchisees, rebelling against management, started withholding royalty fees. In February 1985, Concept Development Inc., the chain’s largest franchisee with 125 restaurants, filed a $44 million suit against Diversifoods, charging that it “diminished Godfather’s name and market recognition,” causing “the chain to splinter into a noncohesive group of independents.”

Despite this, the assessment for the future is positive and there is no talk of bankruptcy. The article notes that things were getting back on track:

Despite its problems, however, Godfather’s is now trying to regain its wings as a highflier. John M. Creed, who replaced Mr. Smith as Diversifoods’ president in January, says that the chain has shelved any expansion. It has dismissed about 25 percent of Godfather’s corporate staff and is closing unprofitable stores. It is introducing new products, such as thin-crust pizza and pizza by the slice, and it is starting to offer home delivery.

Diversifoods has hired a new president for Godfather’s – its third since January – and under Henry V. Pettis, Godfather’s is now trying to foster the kind of strong ties with franchisees that Mr. Theisen used to build the company. And that seems to be working. Mr. Creed said that many franchisees were beginning to pay royalty fees again.

These actions, Mr. Creed said, should enable Godfather’s to break even by the end of the year, “with the potential to make money.”

In other words, Godfather’s Pizzas had record profits in 1983, a small profit in 1984, and according to the company president in May of 1985 would break even in 1985 “with the potential to make money”.

In August of 1985, Pillsbury bought Diversified Foods Inc., including 873 Godfather’s Pizzas plus 375 Burger Kings and some other smaller restaurant chains, for $390 million dollars. It is difficult to say how much Pillsbury paid for the Godfather’s Pizzas and how much they paid for the other restaurants. In 1983, Godfather’s had done $340 million in sales and had sold for $306 million, in 1984, it did 365 million in sales, and in 1985, it did $325 million in sales. While sales had dropped 5% from 1983 to 1985, it is hard to see why this should have caused a drastic change in the company’s value.

Most importantly Pillsbury was showing commitment to the franchises’ future According to an August 20, 1985, N.Y. Times article, “Pillsbury Keeping Godfather’s Pizza”:

Sales at Godfather’s, the nation’s third-largest pizza chain, after Pizza Hut and Domino’s, slipped badly last year as the company tried unsuccessfully to roll out a deep-dish pan pizza. A Pillsbury spokesman said: “We understand the pizza business. We have the nation’s No. 1 frozen pizza in Totino’s and we’ll bring the resources to Godfather’s to make substantial improvement there.” Godfather’s owns 209 restaurants and franchises an additional 664 restaurants.

They had cause for optimism. In official filings, Diversified Foods had done these projections for the future of Godfather’s Pizza:

For the years 1986 through 1990, the strategies developed figures for three different scenarios: an aggressive plan, a moderate one and an aggressive one without Godfather’s.

In 1986, Diversifoods would have earned about $59 million with Godfather’s and $47 million without it in cash flow. Fifty-nine million dollars yields a 15% pretax return. The $12 million difference between keeping and dumping Godfather’s expands from there.

By 1990, Diversifoods could have been grossing cash flow of $146 million under the best circumstances with Godfather’s, $116 million with Godfather’s under moderate conditions and only $116 million in the best case without Godfather’s.

In terms of cash flow, Pillsbury could make back its investment by the end of the decade.

Earnings per share make a similarly convincing case to keep Godfather’s. Based on a best-case scenario including Godfather’s, Pillsbury paid about 10.6 times next year’s earnings. But without Godfather’s, Pillsbury’s purchase price would be a far less economical 13.2 times.

But it is pretax cash flow that really matters in an acquisition. And in those terms, Pillsbury should be getting more than 20% returns on its invested capital in three years.

Not only was Godfather’s Pizza not anywhere near bankruptcy when Pillsbury Inc took it over, but they had projections showing that the company would be making profits of up to $12 million (59 – 47 million) in 1986 and expanding profits up to $30 million (146 – 116 million) in 1990.

Within five months there was more reason for optimism. Pillsbury settled the lawsuit with Concept Development Inc., the franchise owner that had sued Diversified Foods for mismanagement for $44 million dollars. Pillsbury agreed to buy 18 more Godfather’s Pizzas from Concept Development for $2 million dollars.

Godfather Pizzas was never in danger of bankruptcy, but it did have serious management problems in 1984 and 1985. However it made a small profit in 1984, probably had a small loss in 1985 and was expected to return to making good profits from 1986 to 1990. Then Herman Cain took over.

While we cannot precisely tell the value of Godfather’s Pizza at the time Cain took over, we can give a ballpark estimate based on facts presented in Rick Telberg’s Sept 15, 1985 article, How Pillsbury ‘stole’ Diversifoods for just $390 million, published in National Restaurant News. He writes:

If projections developed by Diversifoods Inc. executives prove true, then Pillsbury Co.’s $390 million payment for the Burger King franchisee and Godfather’s Pizza franchisor will look like a firesale bargain in a few years.

According to internal business plans Diversifoods furnished Pillsbury during secret negotiations, the big packaged-foods marketer acquired the ailing restaurant conglomerate for about six times next year’s gross cash flow.

The norm, if there is any in the restaurant business, is about seven times cash flow, a price established, more or less, by Denny’s Inc.’s $734 million management buyout in January.

In addition, the projections suggest that Pillsbury would have been foolish to dump Godfather’s. In each of three possible scenarios, a Godfather’s divestiture would have reduced Pillsbury’s returns on the deal.

Besides, there are few companies capable of acquiring Godfather’s that would also have the deep pockets needed to wait for a turnaround. And, if Pillsbury sold Godfather’s, the company could have armed a potential enemy, blocking its long-stated desire to enter the pizza business.

Pillsbury’s acquisition ended one of the saddest sagas in the restaurant business–the brief life and painful death of Diversifoods.

Diversifoods was formed in January 1984 through the merger of Burger King franchisee Chart House Inc. of Lafayette, La., and Godfather’s Pizza Inc. of Omaha.

But almost as soon as the ink was dry on the deal, valued at about $700 million...

If just after buying Godfather’s Pizzas for $309 million, the company was worth 700 million, Godfather’s Pizza represented 309/700 of the worth of the company, about 44%. Taking 44% of the purchase price of $390 million by Pillsbury, we get 171.6 million. However, we do have to take into account that Godfather’s Pizzas revenues dropped 5% from 1983 to 1985 and profits were marginal in 1984 and 1985. We can take away another 10% to account for that, bringing us to a value of about $155 million. We should also take into account the loss of around 100 out of 873 stores when Pillsbury settled its lawsuit with the renegade franchise owners Concept Development Inc. While this represents 12% of the franchise, we may assume they had slightly better than average units and take away another 15%. This still leaves us with a value of roughly $130 million as the value of Godfather’s Pizzas when Herman Cain took over in April 1986. The figure $130 million also seems about right for a company projected to potentially make $12 million in profits the following year, rising to $30 million five years later.

In a January 2, 1985 article in Nation’s Restaurant News we read, “Analyst Tami Preston said that Alex. Brown & Co. has valued the Burger King division of Diversifoods at $150-$155 million.” Even if we assume a huge 15% increase in value eight months later, at the time Pillsbury bought Diversified, that brings the value of the Burger Kings up to a maximum of $180 million. Substract the $180 million for the Burger Kings from the $390 million total price, we get $210 million for all the non-Burger King restaurants. Godfather’s represented over 900 of the 1100 remaining units at Diversified. Besides Godfather’s, there were 65 Luther’s barbecue restaurants, 55 Chart Houses and Moxie’s gourmet Burger restaurants. If we assume that the 900 Godfather’s were only worth half as much as the other 200 restaurants, that still gives us around $140 million for the Godfather’s and $70 million for the others...

1 comment:

Bullseye said...

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