Can Jack in the Box Find a Buyer for Qdoba?

In this segment from the MarketFoolery podcast, host Chris Hill and David Kretzmann of Supernova and Rule Breakers discuss Jack in the Box (JACK 2.63%). Its quarterly earnings beat was entirely overshadowed by word that it had tapped Morgan Stanley (MS 0.59%) to help it see if there's a good deal to be had for its Mexican food chain. Some of the reasons behind that decision, though, have our Fools scratching their heads. And the timing seems poor, too.

Chris Hill: Jack in the Box second-quarter profits came in higher than expected, which is fine. That's always nice. But I think what's really pushing the stock up 5% to 6% today is the news that Jack in the Box has hired Morgan Stanley to help explore the potential sale of Qdoba. Jack in the Box is the parent company of Qdoba Mexican Eats. I think they have, and I'm ballparking here, roughly three times as many Jack in the Box burger places as they do Qdoba Mexican restaurants. There are a couple things I don't understand about this.

David Kretzmann: Me too.

Hill: [laughs] I was hoping you were going to have all the answers.

Kretzmann: I wish.

Hill: Lenny Comma, the CEO at Jack in the Box, when he talked about hiring Morgan Stanley, he said of Qdoba relative to Jack in the Box, they have two different business models. Really? Because they're both restaurants. I understand that they're two different foods. How are they two different business models?

Kretzmann: That's a very good question. Yeah, I don't understand the logic there. They have a very loose definition of business model, because yeah, you're selling food. Jack in the Box is more your traditional quick-serve restaurant, or fast-food restaurant. Qdoba is more the fast-casual restaurant that emulates Chipotle. But at the end of the day, they're both selling food, customers are paying for the food the same way. So I don't see them being different business models as a very good reason to justify looking to spin it out.

Hill: If you go back three or four years, the story with Jack in the Box, in terms of whatever their quarterly earnings report was, basically went like this: same store sales at the burger places up 2% to 4%. Same-store sales at Qdoba up double digits, anywhere from 10% to, in some cases, closing in on 20% same-store sales growth. Qdoba was really carrying the water for this company for a long time. I guess I question the timing of this in part because, yes, same-store sales at Qdoba for this quarter and the last couple, not doing as well as Jack in the Box. But wasn't the time for this move a year ago, when Chipotle was on the ropes? If you're Jack in the Box and you're thinking, "OK, what's the maximum value we can get from spinning this off?" I feel like it was a year ago when Chipotle same-store sales were falling through the floor.

Kretzmann: Yeah. In the CEO comments you mentioned, he said it's become more apparent to them that Jack in the Box's valuation is impacted by having two different business models, and that's just a head-scratcher to me. That implies that Qdoba is bringing down Jack in the Box's value, because they have struggled in the past year. But a lot of restaurants, fast casual in particular, have struggled. But Qdoba's same-store sales grew 6% in 2014, almost 10% in 2015. Then, they only grew 1.4% in 2016, and they actually dropped in this most recent quarter. But that isn't out of the ordinary for virtually any restaurant that isn't Domino's. So this really seems like a case where they're ditching it at probably the worst possible time. I just don't understand the logic here. And in general, with a spin-off like this, where I don't think the business models are all that different, I think having this kind of diversification is actually a good thing over time because they'll have one concept that does well in certain quarters, like Jack in the Box now, you'll have some that do better like Qdoba a few years ago. It's like Chipotle being spun out of McDonald's worked so well for McDonald's, so let's do the same thing and spin out Qdoba. I have a hard time seeing the logic here, because the implication that Qdoba is pulling down the valuation of the overall business, it's like, a couple years ago, it was probably propping up the valuation when things were going really well. Now, suddenly that things aren't rosy for Qdoba, which isn't a Qdoba-centric problem, this is an industry problem, just makes no sense to have that be the main logic for looking to spin it out. The timing, I think, is really questionable.

Hill: And we touched on discounting before. When you look at Qdoba's results, the company talked about how they have been doing some discounting. But I think that goes right in line with what you were saying. When you look at restaurants in general over the last 12 months, it's not like Qdoba is the only one out there doing discounting trying to get people in the door. So, I don't know, it seems like they are ... I don't want to call it a panic move, because I don't have a good enough sense of this CEO and this management team to attribute that. So I'm not calling it a panic move. But it really does seem like they are not going to get the value out of this spin off that they would have gotten if they had done this, or even contemplated doing it, 12 to 18 months ago.

Kretzmann: Yeah, this really feels more like selling at the bottom. It's probably not quite panic mode, but yeah, if you were interested in spinning it off, the time to do it is when things are doing well. To McDonald's credit, Chipotle was knocking it out of the park, their growth was phenomenal, their numbers were phenomenal. So McDonald's probably maximized their value, to an extent, with Chipotle. Although I don't know if anyone at McDonald's really thinks that was the best decision, given how Chipotle has succeeded. I think, if anything, if I was Jack in the Box, I would first see, maybe we should shift the management or the strategy with Qdoba, reevaluate that before you jump to spinning it off or selling it as a solution. I think this kind of diversification makes sense. You see restaurants going out of their way to develop new concepts now, whether it's Buffalo Wild Wings, Chipotle, virtually every restaurant you can identify, even Red Robin, they have a fast-casual concept they're developing. So, this seems to be bucking the trend at a bad time, and the strategy doesn't make a whole lot of sense to me.