Late last year, Jack in the Box announced a deal to acquire Del Taco for $585 million. In the process, it invented a new term: “Synergy-adjusted multiple.”
Synergies are savings in corporate overhead and other expenses that can be generated following a merger, and in this case they made the deal between the two “challenger brands,” as Jack in the Box put itself and Del Taco, look quite favorable.
That multiple, according to Jack in the Box, was 7.6 times trailing 12 months EBITDA, or earnings before interest, taxes, depreciation and amortization. The idea: Ignore the actual valuation Jack in the Box is paying for Del Taco. Improved profitability from expected cost savings arising from the combination of the two companies would make that acquisition much more desirable than it appears. A 7.6 multiple for a fast-food brand with drive-thrus is quite good.
In reality, the multiple was much higher: 15. John Gordon, a restaurant consultant out of San Diego, noted that Del Taco’s 2021 EBITDA was $38 million, and $575 million is 15 times that number. Give the company credit for $15 million in those “synergies,” or cost savings resulting from the combination of the two chains, and the “synergy-adjusted multiple” was in reality 10.8x.
Yet these synergies are taking some time to come to fruition. Last week, the company said it expected earnings per share this fiscal year, which began in October, would be a full $1 below Wall Street expectations. Investors hit the stock hard. It declined 16%.
While much of the earnings guidance shortfall was due to weak corporate store margins and technology investments, the apparent “synergies” that made the Del Taco deal so desirable in the first place will not arrive until the 2024 fiscal year.
“The synergies that we’re anticipating and the G&A (general and administrative) cost reductions aren’t taking hold meaningfully yet in 2023,” CEO Darin Harris told investors. “We do expect to achieve meaningful G&A reductions in 2024. It’s just the integration process is stretching mostly beyond [fiscal year] 23.”
That deal also puts Jack in the Box under some pressure to unload corporate locations. Jack in the Box recently announced plans to sell 300 Del Taco company-owned locations to franchisees.
That may be tougher than it seems. Rising interest rates, shrinking margins and an uncertain economic environment have conspired to make the franchising market more challenging. That could make it difficult for the company to sell those locations. Most likely: Jack in the Box sells the Del Taco locations at a low price.
“The Del Taco acquisition being so much more expensive than first advertised is indicative of the pressure Jack in the Box is under,” Gordon said. “Now it is necessary to refranchise approximately 300 Del Taco company units in a down M&A market with considerable store margin pressure and higher interest rates.”
Valuation multiples are almost always in the eye of the beholder. We once reported on an acquisition multiple publicized by the seller of some restaurants, only to be told the next day by the buyer that the multiple in reality was a lot lower. Buyers generally want the multiple to appear lower so their shareholders believe they got a deal. Sellers want a multiple to appear higher so they look like they got out at the right time.
We do not necessarily question the wisdom of a Jack in the Box-Del Taco combination. Both brands are in a tough spot on their own. They compete against much larger restaurant chains that have been able to invest heavily in technology and marketing.
It’s notable that Jack in the Box made a play for Del Taco not long after Harris took over as CEO from a predecessor who sold another Mexican brand in Qdoba. The simple fact of the matter is, Jack in the Box may be better off in this market as part of a larger group, rather than as a stand-alone concept.
The company might have been better off not resorting to made-up terms in its argument for such a combination.
Instead, the company will have to find those synergies to justify their argument in favor of the combination, and that could lead to overly aggressive cuts in corporate overhead that may hurt one or both brands. It will also have to argue these at the same time that it argues its efforts to spur growth at its flagship Jack in the Box are taking hold. In other words, the Del Taco deal made two relatively simple brands that much more complex.