ANALYSIS: Grote's got Donatos Pizzeria back, but now what?

Dec. 21, 2003

In May 1999, McDonald's Corp. announced it bought Donatos Pizzeria, a 143-unit chain it called the "gold standard" for pizza in America. With his signature, founder Jim Grote made every American businessman's dream a reality: start a company, grow it and sell it to an industry giant for a wad o' cash.

Four-and-a-half years later, on Dec. 15, McDonald's announced it sold Donatos Pizzeria—back to Grote, and for a price many believe was below what McDonald's paid him for it. Somehow, in McDonald's eyes, the now-182-unit chain had turned from "gold standard" to fool's gold, yet Jim Grote had won again.



Yet it's happened before in the pizza business, and on an even larger and more surreal scale. Recall the tale of the rise and sale and sale and sale of California Pizza Kitchen.


Steve Coomes, Editor

in 1985 by lawyers Larry Flax and Rick Rosenfield, CPK grew to 25 units by 1992, when the pair sold the majority of the company to PepsiCo for $100 million (60 times cash flow at the time). The men split $40 million cash, retained 24 percent of the company and stayed on as its co-CEOs.

C'mon, everybody, pull your jaws out of your laps.

But then, as only a company with more money than restaurant experience would do, PepsiCo tried to pump a quick and syrupy-sweet return out of its absurd investment by rushing to grow CPK. In only four years it added 65 units to the system, but the rapid expansion left many of them unhealthy.

By 1997, CPK was a bleeding wound on PepsiCo's balance sheet, but instead of suturing the gash, PepsiCo chose to amputate CPK.

Flax and Rosenfield balked, however. Shrewd lawyers that they were, the men pointed out a clause in CPK's original sale contract saying the pizza chain could not be sold prior to 2001 without the co-founders' approval. Hog-tied, PepsiCo had little choice other than to write off $90 million in bad debt (talk about pizza heartburn) by transferring CPK's ownership to investor group Bruckmann, Rosser, Sherril & Co. Flax and Rosenfield not only retained their 24 percent ownership in the deal, they split $8 million cash.

Three years later, CPK had 100 units, and Flax and Rosenfield took the company public. To show their confidence in CPK, each exchanged his $450,000 annual salary for 90,000 shares of CPK stock. Upon its August 2000 offering, each man's stock was worth $13.5 million. Two months later it was worth $32 million.

Some guys have all the luck.

Same as it ever was

The similarities in CPK's and Donatos' stories are striking.

In each case, small companies were acquired by larger firms, which then assigned the small company leaders overly ambitious goals. In the end, neither PepsiCo nor McDonald's realized their aims.

Under watch of their respective soda and burger parents, CPK and Donatos needed to grow quickly enough to produce a good return on investment. But that rapid pace of expansion ultimately punished product quality and saw operations neglected. In Atlanta alone, Donatos opened and closed 23 stores (10 percent of its system at the time) under McDonald's leadership. CPK suffered fewer unit losses, but repairs to the overall system—not to mention its reputation—were necessary after PepsiCo cast it off.

Bottom line: Both pizza machines were running fine when their new corporate owners slipped behind the wheel. However, each vehicle was at least a little worse for the wear once the founders got the keys back.

Stand by your men

Interesting, too, are the similarities between CPK's and Donatos' founders. All three men pound the pulpit of product quality tirelessly, and all believe in "A" location real estate. (Poor site selection cost two top CPK officials their jobs this year.) Even more conservative is Grote's real estate approach: Buy the ground, too, if you can.

Now the question becomes, "Will the future of both companies align as similarly as their pasts?"

For CPK, the answer is a little clearer, since it's not had an ownership change in more than three years. Despite solid restaurant performance, its stock has endured a bumpy ride due to the company's struggle to produce attractive earnings. Quite simply, Flax and Rosenfield have a cost-control battle on their hands, and that hurts per-share profitability.

Same-store sales are flat, but holding largely steady as customer counts remain healthy. Expect ongoing operational tweaking to come as the two men work on the company, but don't expect the changes to be short cuts that damage the customer experience.

At Donatos, a long-term comparison between life before and after McDonald's surely is underway. Officials say they aren't planning to add new units in 2004, which tells me Grote believes something needs fixing or changing now. If word on the street is correct, its products need some attention.

As an inventor and founder of his own namesake food slicing and application equipment company, Grote naturally is an analytical thinker. I expect he'll lean heavily on that engineer's cognition to help him decide which of Donatos' handful of dine-in and/or delivery-carryout concepts bodes best for its future. Its multi-faceted pizzeria concept, for example, is highly innovative and yields high-dollar sales. But it's expensive to construct and requires a sharp, detailed operator to master its many components. The profitable balance lies somewhere in between dine in and delco—and clearly beyond this pizza reporter's grasp.

Perhaps Donatos' spokesman Tom Santor described the company's near-term outlook best, if not all that definitively: To "maximize the performance of the restaurants we have, and then step back and decide what to do for the long-term. ... But it's not as if we're going to go busting off in some new direction just because of the change" in ownership.

Clear as mud, right?

Topics: California Pizza Kitchen , Commentary

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