Del Taco Restaurants Inc. (TACO, Financial) is a fast-food restaurant brand based in the United States that specializes in American-style Mexican cuisine, including tacos, fries, burgers and shakes. Ed Hackbarth and David Jameson launched the first Del Taco in Yermo, California in 1964. With a menu of 19-cent tacos, tostadas and fries and a 24-cent cheeseburger, the company made a bold start, making $169 on the first day. Del Taco grew rapidly during the 1970s, with 50 restaurants open by 1977 and 100 by the end of 1978. The menu expanded in tandem with the expansion in the number of eateries.
In 1988, Del Taco merged with Naugles restaurant chain to increase its geographic reach, and the company currently operates 600 stores in 16 states, making it the second-largest Mexican fast-food company in America by the number of restaurants.
On Dec. 6, American fast-food restaurant company and rival of Del Taco (on the cheeseburger front at least), Jack in the Box Inc. (JACK, Financial), announced a deal to acquire Del Taco for $575 million, which converts to $12.51 for each Del Taco share. Here's why I think the deal is a good thing for both companies.
The business combination is likely to be value-accretive
Jack in the Box is a San Diego-based burger restaurant brand that competes directly with McDonald's Corporation (MCD, Financial) and Burger King, the two most popular fast-food chains in the country. Given the strong presence of Del Taco in key geographic areas, Jack in the Box will be ideally positioned to expand and gain market share following the completion of the deal to acquire Del Taco. Jack in the Box will benefit from Del Taco's Mexican food specialty and its drive-thru presence, as nearly all its locations have a drive-thru facility.
Del Taco reported revenue of $124.3 million for the third quarter, up 2.9% year-over-year, driven by a 1.8% increase in system-wide comparable restaurant sales, a 1.6% increase in company-operated sales and a 2% increase in franchise comparable sales. At the end of the quarter, the company had net debt of $102.3 million.
The number of acquisitions among fast-food chains has been on the rise recently as large-scale restaurants are attempting to gain economies of scale to fund technological changes and manage costs. These chains are relying on strategic mergers and acquisitions in order to grow and expand, and the deal between these two companies is coming at a time when both these restaurant chains are struggling to grow meaningfully due to competitive pressure from larger peers. The deal, which is expected to be closed by the end of the first quarter of next year, is likely to help alleviate some of these concerns.
Del Taco's stock price jumped 66% last Monday to $12.51 after the deal was announced, which is understandable given that Jack in the Box has agreed to pay that amount to close this deal. Once the transaction is complete, Jack in the Box will have more than 2,800 outlets across 25 states, and according to company officials, the business combination will save around $15 million by the end of fiscal 2023 through supply chain revamping and digital efficiencies.
Takeaway
Del Taco reported eye-popping growth in its early days, but growth has decelerated in recent years due to competitive pressure and disadvantages resulting from a lack of sufficient scale. With the company's debt increasing in recent years amid single-digit revenue growth, the strategic deal with Jack in the Box appears to be a sensible move for Del Taco shareholders. The deal could end up saving millions of dollars in operating costs as the two companies will focus on eliminating overlapping business units while also benefiting from scale advantages.
Jack in the Box is currently valued at a forward earnings multiple of 12.46 in comparison to the sector average of 15, and if this deal creates long-term value for shareholders, it would be rational to expect its earnings multiples to converge with the sector average.
