Jack In The Box: Thinking Outside the Box
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Thinking Outside The BoxJuly 29, 2011 Prepared By: Ryan Fusaro [email protected] In The Box Investment ThesisJACK is comprised primarily of the 5th largest quick service burger chain, Jack In The Box2nd or 3rd largest player in most markets Improving SSS trendsTicker: “JACK” Stock Price: $22.72 Recent Valuation Multiples:7x EV / 2012e EBITDAThe company also owns a hidden asset in Qdoba, the 2nd largest fast-casual Mexican food chainStrong growth potential and white space oppor
Transcript of Jack In The Box: Thinking Outside the Box
Jack In The Box Investment ThesisJACK is comprised primarily of the 5th largest quick service burger chain, Jack In The Box
2nd or 3rd largest player in most marketsImproving SSS trends
The company also owns a hidden asset in Qdoba, the 2nd largest fast-casual Mexican food chain
Strong growth potential and white space opportunityValue of business being completely ignored by the market, despite contributing ~18% of restaurant EBITDA
In addition, JACK collects an attractive rental income stream for which the market ascribes little to no value
Owned and below-market leasehold propertiesReal estate business worth up to 60% of current enterprise value
JACK is currently in the midst of a system-wide refranchisingstrategy which should result in a significantly more attractive,royalty-like business going forward
Strong potential exists for operating margin expansionOperationally-minded and economically motivated investors own ~11% of the business
Businesses trades at a meaningful discount to its estimated intrinsic value
Significantly undervalued on a sum-of-the-parts and private market basis
Ticker: “JACK”Stock Price: $22.72
Recent Valuation Multiples:
7x EV / 2012e EBITDA
Capitalization:Equity Market Value: $1.1bnEnterprise Value: $1.5bn [email protected]
A Brief History of JACK
Jack In The Box was founded in 1951 by Robert Peterson, a Californian businessmanIn 1968, Peterson sold JACK to Ralston Purina as part of a broader corporate roll-up strategyPrivate Equity interests purchased the JACK franchise for $435mm in an LBO / MBO transaction from Ralston in 1985The investment group that purchased JACK subsequently re-IPO’d the business in 1992In 2003, JACK acquired Qdoba Mexican grill for $45mm, in order to expand its footprint and become a nationwide chain
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Business Overview
5th largest quick service burger chain in the US2200 system-wide units,
~60% franchised
~52 % EBITDA(1) ~11% EBITDA(1)
(1) EBITDA % exclude distribution revenue
(2) Source: JACK 2010 10-K/A
Jack In The Box is comprised of two distinct restaurant concepts, along with a real estate business
~37% EBITDA(1)
2nd largest fast-casual Mexican food chain in the US549 system-wide units,
~60% franchised
Collects ~$125mm (and growing) in rent checks from franchisees Owns 874 buildings (2)
232 on leased land624 on owned land
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Jack In The Box Overview
As JACK’s original line of business, Jack In The Box has a 60 year operating history and is currently the 5th largest QSR hamburger chain in the US, with a number two or three position in most of its major markets
(1) Pre G&A costs, Source: 2010 JACK Company Presentation
2220 total units, ~60% franchised
Collects 5% royalty fee and ~3.5% net rent spread on franchised store sales
Comprises 80% of JACK store count, ~82% of restaurant EBITDA and ~65% of current enterprise value
Average Unit Volume (AUV) of $1.3mm
~$6.19 average check
Improving SSS growth trends despite 70% of store count being located California and Texas
After declining sharply for 6 straight quarters beginning in Q309, JACK’s SSS trends have stabilized, turning positive in Q111 (+1.5%)
Management guidance points to 1-3% SSS trend growth going forward
Strong ROIC characteristics~23% cash-on-cash return for newly opened company operated store units(1)
Great brand recognition
Strong potential to expand geographical reachPresence currently limited to 19 states
Qdoba Overview
Acquired by JACK in 2003 for ~$43mm, Qdoba is currently the second largest fast-casual Mexican food chain in the US behind Chipotle Mexican Grill. Qdoba is largely a hidden asset, as investors have consistently failed to give JACK any consideration for the value of the business
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549 total units, ~60% franchised
Comprises 20% of JACK store count, ~18% of restaurant EBITDA and ~22% of current enterprise value
Collects 5% royalty fee and 3.5% net rent spread on franchised store sales
Average Unit Volume (AUV) of $923k
~$10 average check
Very strong SSS growth trends6% SSS growth over prior 3 quarters
Management guidance points to 4-6% SSS trend growth going forward
Extremely popular concept with long growth runway~10% annual unit growth potential for the foreseeable future
Management sees potential for 1800-2000 total units
Strong ROIC characteristic
~20% cash-on-cash return for newly opened company operated store units (1)
Diversified geographical footprintStore base is spread out over 43 states with minimal single state concentration
Based on recent market prices, investors are currently getting this attractive business for free
(1) Pre G&A costs, Source: 2010 JACK Company Presentation
System Overview
While the total number of Jack In The Box units in the system should be fairly stable going forward, Qdoba is poised for continued healthy expansion and should grow as a percentage of total system-wide stores
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Total Unit Count (1) 515 604 696 842 1022 1250 1340 13721464 1682 1900 2118
2005 2006 2007 2008 2009 2010 Q1 11 Q2 11 2011(2) 2012(2) 2013(2) 2014(2)
Jack In The Box 2049 2079 2132 2158 2212 2206 2213 2220 2239 2272 2305 2338% Franchised 25% 29% 33% 39% 46% 57% 61% 62% 65% 74% 82% 91%Growth Rate - 1.5% 2.5% 1.2% 2.5% -0.3% 0.3% 0.3% 0.9% 1.5% 1.5% 1.4%
193 248 305 343 353 337 348 328 349 389 429 469Qdoba 250 318 395 454 510 525 542 549 590 655 720 785
% Franchised 77% 78% 77% 76% 69% 64% 64% 60% 59% 59% 60% 60%Growth Rate - 27.2% 24.2% 14.9% 12.3% 2.9% 3.2% 1.3% 7.5% 11.0% 9.9% 9.0%
(1) Based on end of year totals for fiscal years ending September(2) Assumes constant growth of 33 (18 co. owned) units for JIB and 65 (20 co. owned) units for Qdoba per mgmt. guidance for FY 2011 Note: YTD JIB 7 new co. owned units, 9 new franchise units, 114 refranchised, 1 closed YTD Qdoba 11 new co. owned units, 19 new franchise units, 22 repurchased, 6 closed
Forecast
JACK’s Real Estate Business
JACK also owns a substantial amount of wholly-owned real estate assets as well as long-term, below-market leasehold assets from which it derives a healthy rent roll from its underlying franchisees. Since revenues from this segment are rolled up into franchise sales, few investors give JACK credit for its real estate portfolio
Generally earns a net 3.5% rent spread on franchise sales
Generated rents of $128mm in Fiscal 2010
Sublease expense of $78mm derived a net rental income of ~$50mm in 2010
As JACK continues to refranchise its system and rents additional property to its franchisees, this income stream should continue to grow materially over time
JACK’s Refranchising Strategy
In 2005, JACK set out to refranchise its entire hamburger chain store base, taking the percent of franchised units from roughly 30% to 70-80% by 2013
JACK has executed well on this strategy thus far, refranchising ~850 units since 2005 for total proceeds of $350mm
Through 2014, JACK has the potential to refranchise an additional 686 units for estimated proceeds of ~$215mm (1)
Total proceeds through the end of the program, including franchise fees, should total $770mm, or roughly 70% of JACK’s current market cap
12(1) Analysis estimates $315k per unit in proceeds, beneath historical average and management guidance
Source: JACK 10K
Refranchising is an Attractive Strategy
Refranchising will serve to convert JACK from a capital intensive, low-margin restaurant business into a high-margin, high-multiple brand royalty business with the following attractive characteristics:
Revenues comprised primarily of royalty and rent checks from franchisees
Less volatile, more stable and predictable earnings streams
Low capex requirements
High free cash flow
Recurring revenue base
Highly scalable model
No commodity risk or exposure
Potential for 40-60% EBITDA margins
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JACK’s Re-Imaging Strategy
Beginning in 2006, JACK also embarked on a large scale re-imaging project, whereby it set out to renovate the entirety of Jack In The Box units in order to bring them up to date and make them more appealing to consumers
Re-imaging objectives:
Remodel and revamp existing stores and modernize their look
Grow SSS and profitability through increased traffic and interest post-renovation
JACK has spent an estimated $200mm on its re-imaging program, or nearly 20% of its current market cap since 2006
Re-imaging program is set to be complete at the end of 2011, which should boost free cash flow trends as capex largely reverts back to maintenance levels (~40-60mm/yr)
Remodeling and construction at renovated stores has lead to a temporary decline in business at certain locations, which shouldreverse as the work is finished on these units, thereby improving overall sales
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Peer Analysis
JACK’s trades at a significant discount to its quick service peers as the company has historically been a low-margin, capital intensive restaurant business
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However, as JACK transitions its business into a higher quality franchise model and highlights the value of its Qdoba concept, investors should award JACK a higher multiple
(1) Consensus Wall St. estimates for peer EBITDA
Source: Bloomberg
Sum-Of-The-Parts Analysis (“As Is”)
On a sum-of-the-parts basis, analysis suggests that JACK shares are currently worth between $38-$44, for an upside potential of 69%-94%
Said differently, at current levels you are essentially buying the Jack In The Box franchise along with the company’s real estate assets at 7.7x EBITDA and getting the entire high-growth Qdoba franchise for free
(1) Real Estate multiple implies 8%-9% cap rate
(2) Assumes refranchising of 86 units in second half of FY11, 200 JIB units in years 2012, 2013 and 2014 to bring total franchise % of JIB to 90%
Average gain of $275k, discounted at 3%
(3) Assumes net franchising fee of $32.5k, 218 new JIB franchise units per year, 40 new Qdoba franchise units per year
Business 2012e EBITDA Low EV Multiple(1) High EV Multiple(1) EV Low EV High(data in mm's, except for share price)
Jack In The Box $111 8x 9x $888 $999Qdoba $25 12x 14x $300 $350Real Estate $79 11x 12.5x $869 $988
Add: PV of Refranchising Gains (2) 203 203Add: PV of Franchise Fees (3) 24 24Add: Cash 15 15Less: Debt 389 389Equity Value 1910 2190
Shares Outstanding 49.7 49.7Implied Price 38.4 44.1
Current Price 22.72 22.72
% Upside 69% 94%
Upside Potential: What Might Qdoba be Worth in the Future?
Additionally, given its relatively low current unit count, extremely popular concept and potential for significant expansion, Qdoba’s long-term value has the potential to be significantly higher than what it is today
18(1) Analysis assumes Qdoba sales grow 4% to 959k/unit and EBITDA margins of 9.5% and 47% are reached on the company
operated and franchise units respectively (see margin analysis on pg. 22)
Enterprise Value
700 800 900 1000 110011 384,722,030 447,224,855 509,727,680 572,230,505 634,733,330 12 419,696,760 487,881,660 556,066,560 624,251,460 692,436,360 13 454,671,490 528,538,465 602,405,440 676,272,415 750,139,390 14 489,646,220 569,195,270 648,744,320 728,293,370 807,842,420 15 524,620,950 609,852,075 695,083,200 780,314,325 865,545,450
Potential UpsideTo Current EV Estimate
700 800 900 1000 110011 23.31% 43.34% 63.37% 83.41% 103.44%12 34.52% 56.37% 78.23% 100.08% 121.93%13 45.73% 69.40% 93.08% 116.75% 140.43%14 56.94% 82.43% 107.93% 133.43% 158.92%15 68.15% 95.47% 122.78% 150.10% 177.42%
Total Unit Count
Total Unit Count
EV /
EBIT
DA
Mul
tiple
EV
/ EBI
TDA
Mul
tiple
Why Is The Stock Misunderstood?
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Dynamic nature of business obfuscates true underlying valueRe-imaging program, refranchising efforts, multiple operating units and other moving pieces cloud consolidated financials and createdifficulty ascertaining core earnings and intrinsic value
Misperception of business modelJACK still trades as a capital intensive restaurant business as opposed to a high margin royalty business despite its ongoing refranchisingefforts
Qdoba’s small size leads to underappreciation of franchiseAs a small component of JACK’s total sales, Qdoba receives very little attention and is thus largely ignored by the investment community
Incomplete sell-side coverageRestaurant analysts covering JACK tend not to give the company credit for its real estate assets
Evaluating Strategic Transactions
Given JACK’s significant misunderstood, hidden and potential value, coupled with its depressed valuation in the marketplace, management should begin considering strategic alternatives in order to close the gap to estimated intrinsic value present in JACK shares
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Margin Improvement
While JACK does not disclose store-level and franchise level EBITDA margins, they can reasonably be estimated to be ~7.5% and 39% respectively, versus typical restaurant and franchise level margins of ~10-12% and 50-60%, respectively. If JACK were to close to margin gap with its peers by as little as 50% (1), its shares would be could be worth considerably more than the previous estimate suggests
On a sum-of-the-parts basis, analysis suggests that “fixed” JACK shares are currently worth between $44-$50, for an upside potential of 94%-122%(1) “As Is” margins estimated to be 39% for franchise business, 7.25% and 8% for JIB and Qdoba Company Operated units, respectively,
based on pro-rated G&A and franchise costs
(2) “Fixed” margins estimated to be 47% for franchise business, 9.25% and 9.5% for JIB and Qdoba Company Operated units, respectively
Business 2012e EBITDA Low EV Multiple(1) High EV Multiple(1) EV Low EV High(data in mm's, except for share price)
Jack In The Box $138 8x 9x $1,104 $1,242Qdoba $30 12x 14x $360 $420Real Estate $79 11x 12.5x $869 $988
Add: PV of Refranchising Gains (2) 203 203Add: PV of Franchise Fees (3) 24 24Add: Cash 15 15Less: Debt 389 389Equity Value 2186 2503
Shares Outstanding 49.7 49.7Implied Price 44.0 50.4
Current Price 22.72 22.72
% Upside 94% 122%[email protected]
Qdoba Spin-Off
Highlight and unlock the inherent value of the Qdoba franchise which is not being fully reflected in today’s share price
Given the different growth potential and trends between Jack In The Box and Qdoba, the two businesses deserve vastly different earnings multipleswhich a separation would allow investors to properly assign
Upon separation, Qdoba would be one of only two publicly listed, fast-casual Mexican food chains, representing a unique and scarce pure-play asset which would attract passive investors as well as strategic acquirers
Allow management of both companies to dedicate the proper amount of focus to growing and improving each segment with minimal distraction
Give investors a choice as to which of the two business they prefer to own
Streamline business and simplify financial statements to enable deeper analytical work on each segment
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Today, Qdoba is essentially a hidden asset that many investors are not even aware JACK owns. A full or partial spin-off of Qdoba is something that JACK management should strongly consider for a number of strategic reasons, including:
Precedent Transaction: Chipotle Spin-Off
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In January 2006, McDonalds spun-off its majority holding in rapidly growing Chipotle Mexican Grill to a much anticipated IPO. At only ~500 Chipotle units versus ~30k McDonalds units, management sought to spin-off its interest in CMG in order to “highlight Chipotle's performance and unique characteristics”, which were “overshadowed by the larger McDonald's global business.” (1) Since the divesture, both stock prices of both MCD and CMG has risen sharply, while JACK’s share price has stagnated
System-Wide Units (at Fiscal Year End)
2006 2007 2008 2009 2010Chipotle 581 704 837 956 1084Qdoba 318 395 454 510 525
(1) McDonald’s CEO Jim Skinner, Businessweek: “Chipotle's IPO: One Hot Tamale?, September 2005
JACK is also a Prime LBO Candidate
Good “core” free cash flow characteristics that are temporarily depressed and masked by re-imaging program and should rebound strongly in Fiscal 2012
With re-imaging nearly complete, a financial buyer is essentially getting the ~200mm in capital improvements JACK has already put in place for free
Shift to brand royalty and real estate business should provide more stable cash flows over time
Refranchising proceeds act as dividends and provide an additional revenue source through which to finance the transaction
Relatively low debt with ample interest coverage1.5x net debt / EBITDA with staggered maturities
Real estate assets provide downside support
Potential for significant margin improvement in core businessG&A costs are significantly elevated relative to QSR and fast-casual peers
Given Wall Street’s short term focus, JACK’s transformative refranchising plan and scaling up of Qdoba franchise may be better executed in the private market
PE firms can IPO the business after completion of refranchising program and once Qdoba develops increased scale 25
Over the 18 months, private equity firms have made a number of acquisitions in the restaurant industry(1), given its free cash flow characteristics and opportunity for margin improvement. JACK shares many of these qualities and is an attractive buyout candidate as well
(1) 3G Capital acquisition of Burger King at 8.8x EBITDA, September 2010
Apollo acquisition of CKE Restaurants at 6.6x EBITDA, April 2010
What Price Would a Financial Sponsor be Willing to pay?
At a price of up to $40 per share, a financial sponsor could still earn a mid teens IRR
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Return calculations assume 20% equity contribution, 5 year term, 9x exit multiple, 389mm long term debt at exit, $139mm terminal restaurant EBITDA, 7.5% interest rate and complete monetization of real estate assets for proceeds of $900mm, along with previously stated operational improvements
(1) Return scenario also assumes $55mm in annual FCF and $200mm from refranchising during 5 yr period which is used entirely to pay down new and existing debt
Price Paid 34.10 35.24 36.38 37.52 38.65 39.79% Premium 50.1% 55.1% 60.1% 65.1% 70.1% 75.1%Total Return 197% 174% 152% 132% 113% 95%IRR 24.3% 22.3% 20.3% 18.3% 16.3% 14.3%
Transformative Real Estate Transaction
In light of JACK’s refranchising strategy which will result in vastly lower company operated restaurant units, JACK now has less of a need to own its own buildings, creating the opportunity for the company to monetize some or all of its real estate portfolio
JACK owns ~875 buildings on either owned or leased land(1)
JACK also has long-term leasehold assets which it sublets to franchisees at an attractive spread
Valuing JACK’s real estate assets is somewhat difficult given the mix of wholly owned and leasehold real estate assets, coupled with limited financial disclosures
Book value of $965mm
Applying a conservative cap rate of 8-9% to JACK’s current rent rolls, its real estate assets appear to be worth up to $988mm or 66% of the company’s current enterprise value
Numerous Loopnet Jack In The Box property listings (land and building) and precedent sales suggest prices ranging from $1mm-$2mm for JACK properties
Potential exists for separation of real estate assets into separate entity and subsequent REIT conversion or alternative transaction to create a more efficient capital structure, shield future taxes and unlock the inherent value of the company’s assets
(1) Source: JACK 2010 10-K/A
Shareholder Interests Are Being Well Represented
William Stiritz
13G filer since November 2009
Personally owns 5.5% of shares outstanding
Intimate knowledge of Jack In The Box
Proven history of unlocking value at various companies
Streamlined conglomerate Ralston Purina in 1980s and 1990s by divesting a number of non-core businesses, including Energizer, EverReady and Jack In The Box, amongst others
Recently led announced spin-off of Post Foods from Ralcorp
Blue Harbour Group
Owns 5.8% of shares outstanding
Well-known activist investor, might look to cut expenses, improve margins or spin-off units
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With active shareholders controlling ~11% of the company, passive shareholders of JACK receive, at no cost, the benefit economically motivated investors with a history of unlocking value pushing for change at JACK on their behalf
Conclusion
Combination of two somewhat unrelated but attractive restaurant concepts - Jack In The Box and QdobaRefranchising of entire Jack In The Box concept should result in a higher-margin, high-multiple royalty like business modelQdoba concept offers strong growth potential, which investors are currently getting for freeValuable real estate assets not properly accounted for in share priceBusiness transformation creates temporarily depressed free cash flow, resulting in deeply undervalued stockPotential exists for margin expansion and meaningful profitability improvementOperationally centered investors own 11% of the company and are working hard on behalf of shareholdersSpin-off of Qdoba unit and / or sale of business to financial or strategic buyer represent catalysts for unlocking shareholder value
Upside potential: 69-122%
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