Maybe restaurant executives should start ignoring activist investors.
On Monday, Jack in the Box announced a $575 million purchase of Del Taco. The deal makes sense, and not just because both brands sell tacos. “We know a thing or two about how to make a legendary taco,” Jack in the Box CEO Darin Harris told analysts, according to a transcript on the financial services site Sentieo.
Both companies are in California and operate in similar markets. They are both underdogs in their respective markets. And they could both use the boost that can come from such a combination. This is a consolidating restaurant market—more than half of the deals this year have been strategic brand combinations—and it’s making less sense for mid-sized brands to stand on their own.
But here’s the thing: Jack in the Box not long ago owned a limited-service Mexican brand that was an underdog to a much larger and better-known competitor and operated in roughly similar markets.
More than four years ago, Jack in the Box sold Qdoba for $305 million. At the time, Jack in the Box was under growing pressure from activist investors, who apparently dislike any concept of owning any assets whatsoever.
What makes Del Taco so much of a better fit than was Qdoba? “It’s a like-minded brand with complementary culture, similar guests or complementary guest profiles and operating model and also complements our current geography,” Harris said.
Harris was not with Jack in the Box when the previous deal was done. He also has the benefit of four years of watching the restaurant industry consolidate with growing speed. And he doesn’t have the looming threat of a proxy fight from opportunistic activists to influence his decisions.
For years, restaurants looked to unload assets. Running restaurants cost too much in the form of capital and so companies sold them to franchisees. Most of the largest fast-food brands are more than 90% franchisee owned now, including McDonald’s, a brand that not long ago held onto its corporate restaurants with an almost religious fervor.
Much of that was driven by activist investors who watched other restaurants succeed in ditching capital costs.
They’ve also focused on pushing companies to sell ancillary brands that underperformed or distracted management, mimicking a successful strategy employed by McDonald’s in the early 2000s, when the brand spun off Chipotle and sold off a bunch of small concepts it had acquired in the 1990s.
Yet the ditch-all-assets strategy was waning in 2017. Already, companies were consolidating. Restaurant Brands International—the company so many activists loved—bought Popeyes Louisiana Kitchen that year. The next year Arby’s would buy Buffalo Wild Wings to create Inspire Brands purely to get out ahead of this trend.
Smart executives were already realizing that they would need to grow larger. Most consumer-oriented industries have already been going through this consolidation phase—notably hotels. The influx of new technology would create an environment in which companies would need to get bigger to get the economies of scale they would need to work with delivery companies, fund mobile app development and experiment with things like robots and artificial intelligence.
Yet, fearing the activist, Jack in the Box opted to focus on increasing profitability at all costs so it could send money back to shareholders. The company made big cuts to corporate overhead in the years after the Qdoba sale.
The aftermath, however, was not necessarily kind to Jack in the Box management. Franchisees, angered by the cost cuts, particularly to marketing, staged an almost unheard-of revolt, calling for the firing of then-CEO Lenny Comma in 2018 and then filing multiple legal actions against the company. Comma retired last year and was replaced by Harris.
In the year since then, Harris has spent a lot of time more or less undoing the actions of the previous few years. The company hired new executives, including C-level marketing and operations executives. It created a franchise sales team. It started buying up restaurants from franchisees to encourage development. It repaired relations with operators. Now it’s buying a brand that is about the same size as the one sold more than four years ago in Del Taco.
We do not necessarily blame Comma for those moves. When activists get interested in a company, its CEO is almost always shown the door shortly thereafter.
Too many of these activists, however, follow the same tired playbook of pushing cost cuts and asset sales without any sense of where things in the restaurant industry are truly headed. In 2017, they were pointing in a direction that should have called for Jack in the Box keeping Qdoba.