San Diego San Diego's fabled Jack in the Box is a curious company. When it dreams big, it flops. When it dreams small, it succeeds -- often brilliantly.
Fortunately, it appears that recent bad corporate news will prevent the company from consummating its current big dream: national expansion. And the grim news will certainly inhibit, and hopefully crush, Jack's quest for acquisitions.
Current management -- which says it has delayed but not jettisoned those big dreams -- should look at Jack's history. In the 1970s, it flopped at national expansion. Its record at acquisitions is poor. A decade and a half ago, it bombed in buying a Mexican food chain, but the experience didn't keep it from buying another one early this year.
Jack's biggest problem is that it's stuck in the restaurant business. For many years, the industry has been having an unappetizing party: the Donner Party. With restaurants vastly overbuilt, cannibalism is widespread. Yet restaurant chains, particularly the fast-food variety, keep expanding, and Jack has been no exception.
The company's second big problem is its finances. In the past, when it dreamed big, it took on enormous piles of junk, or high-yielding, low-quality debt. Jack came to epitomize junk food and junk debt. Happily, that low-quality debt is no longer the cancer it once was, but Jack is still paying fat interest rates on money it has borrowed.
In the past, these problems have been offset by Jack's impressive product and service innovations. It was the first company to develop and then expand upon the drive-thru-only concept. It was selling tacos and other products when many of its competitors were sticking only to hamburgers.
By 1968, Jack had 300 outlets. It was purchased that year by St. Louis-based Ralston Purina. Jack's founder, Robert Peterson, and his sidekick, Richard Silberman, then took the proceeds and left fast food for banking. (Well, actually, Silberman eventually combined the two disciplines and went into fast banking or quickie money laundering. He boasted that he could launder loot lickety-split. Unfortunately, the feds were listening surreptitiously, and he was sentenced to prison.)
Ralston Purina decided to take Jack national. By 1979, Jack had 1000 outlets all around the U.S. But it also had logistical and marketing problems with the nationwide network. That year, it sold 232 restaurants in the Midwest and East and decided to concentrate in the West and Southwest. Smart move -- thinking small.
Then came a series of financial misadventures. In 1985, a group of private financiers plus the company's management amassed a pile of low-quality debt to buy Jack from Ralston. In 1987, Jack -- then named Foodmaker -- went public for the second time, laden with all that junk debt. In 1988, it went private again, and although it was burdened with low-quality debt, it took on even more to buy the Mexican chain Chi-Chi's.
In 1992, Jack went public for the third time in its history. By that time, Chi-Chi's was headed decidedly south, and Jack's balance sheet was in tatters. It was a case of big dreams and even bigger headaches.
Then came the E. coli bacterium crisis. In January of 1993, 600 people got sick from eating undercooked Jack burgers. Four died. It was late 1997 before all the lawsuits were settled. Immediately after the outbreak, Jack's sales plummeted more than 20 percent. Despite its weak balance sheet, the company righted itself by instituting food handling and cooking procedures that set standards for the industry.
But Chi-Chi's was still a drag. Jack sold it to an Orange County company that had gone into bankruptcy and was a repository for other ailing restaurant chains. Jack wound up owning 40 percent of the company, and for a while even managed it. Then Jack wrote off the entire debacle, taking yet another fiscal bath.
To stay afloat, the Orange County company, also laden with junk debt, has since sold off many of its restaurant properties. It is now named Prandium, Inc. Its stock sells for less than 50 cents a share. To its sorrow, it still has Chi-Chi's. Last year, the parent went into Chapter 11 bankruptcy again. Chi-Chi's is losing money as sales decline. The parent keeps dropping Chi-Chi's stores.
But with all its bad dreaming and bad luck of the early 1990s, Jack once again began thinking small, and its fortunes began turning up. It came out with one smart new food product after another, all accompanied by zippy advertising and promotion. Although hamburgers remained its basic business, Jack became more of an adult sandwich chain.
Jack's same-store sales growth (sales in outlets open at least a year) became the envy of the industry. Jack's stock soared from below $3 to above $30. McDonald's and Burger King, once wunderkinds, were floundering.
Jack's balance sheet improved. In the miserable mid-1990s, Jack had 4.5 times more debt than equity, or the value of shareholders' investment. Now debt is six-tenths of equity, although the company is still paying double-digit interest rates on much of that debt.
But Jack's happy times were doomed to end as industry cannibalism and concomitant price wars escalated. Despite all the introductions of creative sandwiches, "Hamburgers have always been the core of our business," says spokesman Brian Luscomb.
And, sadly, "The traditional hamburger chain is a road to nowhere," says David N. Allen of Palomar Equity Research. "It is so price-sensitive I don't see how very much money can be made in that business anymore."
Jack's management had seen the same thing coming and unfortunately reacted by thinking in cosmic terms. Defying its own history, it invaded the Southeast. It bought a Mexican chain. It said it would go national. Perhaps partly because it was focusing on these big questions, its basic business began to slip. Uncharacteristically, it lagged other chains' moves into salads and other health-oriented foods, notes Bud Leedom, analyst for Wells Fargo Securities.
On September 17 of this year, the house that Jack built revealed that it had termite problems. The company said its 2004 earnings would be the lowest since 1997. Its stock, which had already been slipping, plummeted well below $20. Jack admitted something analysts had known for some time: the Southeast invasion was a logistical loser. Although insisting it still wanted to become a national chain, it scaled back expansion plans sharply.
Happily, it returned to thinking small. It said it would concentrate on improving its products and services. To that end, it is readying an Innovation Center just north of its headquarters at Ruffin and Balboa. Everything is secret now. "We see a great opportunity to reinvent not only Jack in the Box, but fast food," enthuses Luscomb. That's hyperbole -- and a little bit like Nixon's secret plan to end the Vietnam War -- but actually, Jack is probably better equipped to pull it off than its competitors, including the much larger ones.
Jack intends to eschew chewing up competitors -- that is, it says it will avoid price wars. Don't count on that. "How can you avoid competing on price?" harrumphs Allen.
Whether it wants to or not, Jack will remain a regional chain. It has big shares of the California, Arizona, and Texas markets. It would be folly to invade new regions, diversify into the also-sated sit-down restaurant business, or buy another doggy chain. "They will have to wait it out until the price competition abates," says Allen. Jack is stuck in a lousy business, but it probably has the savvy to gobble up market shares from competitors.
Jack's financial history should be studied by another San Diego restaurant chain, Garden Fresh, which owns a string of generally successful soup-and-salad restaurants. On the last day of last month, Garden Fresh was purchased by investors who took it private. No doubt it will be brought public again, à la Jack twice, and more recently Petco. When Garden Fresh goes public again, check that balance sheet for junk debt before you nibble on the stock.