Photo by Andy Boyd

"Wet envelopes of cat food."

Since its founding in San Diego in 1951, Jack in the Box has sold tacos. Indeed, the Jack taco has consistently been the chain’s most popular product, even though one customer tweeted that it was a “wet envelope of cat food.” The Wall Street Journal quoted a customer saying of Jack tacos: “There are two kinds of people: those who think they’re disgusting and those who agree they’re disgusting but are powerless to resist them.”

Despite its hypnotic taco, the company can’t seem to run a Mexican restaurant — at least not to Wall Street’s satisfaction. On March 21, Jack completed the sale of its Qdoba chain of Mexican restaurants to Apollo Global Management, a private equity buyout firm. The deal was for $305 million in cash, with Jack making a prepayment of $260 million to retire debt.

On the surface, it would appear that Qdoba had done reasonably well under Jack, the fast-food hamburger chain. Jack bought it for $45 million in 2003. From $45 million in 2003 to $305 million in 2018 appears to be a good return. In 2003, Qdoba had 85 locations in 16 states, with revenues of $65 million. When the sale was announced late last year, Qdoba was the second-largest Mexican fast-casual chain, with more than 700 locations in 47 states, the District of Columbia, and Canada and with systemwide sales of $820 million. That is good growth.

But then there are Wall Street and its “activist investors.” These are money changers in the temple who believe they know more about running a business — any business — than executives who have been at it for many decades. It matters not if the business is a steel mill, brothel, candy store, tire manufacturer: Wall Street thinks it knows the business best.

In 2016 and 2017, Qdoba had problems. In 2017, its same-store sales (sales in stores open at least a year) declined 3 percent. Restaurant traffic dropped off, although price increases were successful and catering returns rose. This happened during a period in which fast-food chains generally were having troubles with higher wages and a declining demand for fast-food options. Even Chipotle, the Mexican chain that stormed to the head of the pack and became a Wall Street darling, ran into troubles: a norovirus outbreak, a huge data hack, lawsuits, and Wall Street sniping.

Then came the Wall Street attack on Qdoba: Two activist funds bought significant stakes in the company: hedge funds Jana Partners and Starboard Value. The former, which earlier had tried to get Qualcomm to break itself up, had lost more than half its assets in two years as its performance waned. Starboard had taken over the restaurant chain Olive Garden, complaining that its pasta lacked saltiness. Starboard ousted the entire board of the parent company, Darden Restaurants.

Jack stock was weakening at the time this was going on. Management said that it might not be wise to run two different kinds of businesses: fast-food outlets and sit-down restaurants. But the stock bounced up on the revelation that Jana and Starboard were lurking. Wall Street is all about stocks going up. It doesn’t care if top management is all thumbs or the books are being cooked. It just wants rising stocks.

Then Jack hired a Wall Street firm, Morgan Stanley, to study what it should do with Qdoba. The outcome of the so-called study was foreordained: Morgan Stanley would recommend a sale of Qdoba. It did. Jack wrote down the value of Qdoba by $3.6 million. The sale was set up and reported to the media. No one was surprised when Reuters wrote, “Morgan Stanley & Co. L.L.C. is serving as financial adviser” on the deal. Hmmm.

Now for the bad — but totally unconfirmed — word. The publication thestreet.com said back in December that “it is also a serious possibility that Jana Partners and Starboard will stick around to try and pressure Jack in the Box to sell itself to a private equity firm once the Qdoba sale is complete. A number of fast-casual chain restaurants have come under pressure by activists to sell themselves.” I couldn’t get anything out of Jack on that.

Jack’s previous stab at Mexican restaurants was a disaster. In 1968, founder Robert Peterson sold the company to Ralston Purina. But Jack’s management was unhappy, and in 1985 the company piled up $381 million of low-quality (junk) debt to buy itself back from Ralston.

Three years later, Jack bought Chi-Chi’s, a Louisville-based Mexican chain for $230 million. The rationale was that Jack was a fast-food outfit and Chi-Chi’s featured sit-down restaurants. That was supposed to be intelligent diversification, but as you have probably noticed, it is the opposite of the company’s strategy to sell Qdoba now.

To buy Chi-Chi’s, Jack had to take on even more junk debt on its balance sheet. I can remember Jack Goodall, then Jack’s chief executive, telling me he was conservative and disliked debt, but he thought Chi-Chi’s was such a prize that it would throw off a bundle of cash to help work off the debt.

But then things turned south, and not south of the border. Studies came out that Mexican food was very fatty and a health risk. Chi-Chi’s lost money before taxes between 1991 and 1993. Management admitted it wasn’t keeping up with consumer taste changes. Jack, which had almost gone bankrupt because of the deadly E. coli outbreak in 1993, plunked Chi-Chi’s into an Orange County company that included a couple of other dyspeptic restaurant chains. Jack owned 40 percent of this agglomeration, and Goodall headed both companies, each of which was loaded with junk debt. The Orange County outfit went bankrupt but kept operating.

Chi-Chi’s went on, but in 2003, the Pittsburgh area suffered one of the worst outbreaks of hepatitis A in American history. It was traced to a Chi-Chi’s; 4 died and 660 others contracted the disease from eating green onions at a Chi-Chi’s in a mall. Chi-Chi’s this time sold its assets out of bankruptcy to another restaurant chain, which wound up selling some of them to a real estate investment trust.