The burrito appears to be unraveling. After nearly four years of tinkering with Baja Fresh, Wendy's International Inc. is ready to unload the struggling Thousand Oaks-based Mexican food chain.
Like its rivals, the nation's third-largest restaurant chain is shedding assets and giving up on a business beyond burgers.
But Dublin, Ohio-based Wendy's apparently had to be convinced to put Baja Fresh on the block. Nelson Peltz, the billionaire investor known for selling Snapple for $1.2 billion more than he bought it, filled the role of persuader. At the end of last year, Peltz's Trian Group bought a 5.5 percent stake in Wendy's and pushed the company to rid itself of subsidiaries.
Facing Peltz's pressure, Wendy's spun off Canadian coffee chain Tim Hortons Inc. last week and is pulling back from a long campaign to resuscitate Baja Fresh. The race is now on to see who will snatch up Baja Fresh's roughly 300 units. Nearly half are in California, where the first restaurant opened in Newbury Park 15 years ago.
Regardless of the suitor, interest is high in Baja Fresh because it remains one of the largest chains in the fast-casual dining segment and has the potential to recapture consumers it has lost as competitors entered the market. The segment includes restaurants with higher quality food than fast-food joints, but with quicker service than sit-down counterparts.
"I think they are going to regroup," said Stuart Morris, president of QSR Consulting Group Inc. in Coronado. "I wish I had the money to purchase it because I do think the payoff for whoever buys it, assuming they do things strategically, is big."
Exactly how the future parent of Baja Fresh will rejuvenate the chain is unclear. When Wendy's bought the chain in 2002 for $275 million, Baja Fresh was at the forefront of the fast-casual scene. Since then, the landscape has become crowded, making it harder for Baja Fresh to distinguish itself.
Ron Paul, president of food industry consulting firm Technomic Inc., said Chipotle has presented the greatest challenge to Baja Fresh. Chipotle added 80 units last year to Baja Fresh's four.
"It seems like Chipotle has a little more cache and is a little bit more like the Starbucks," Paul said. "They are convincing the consumer that they care about the consumer, (and) they care about the product. They have done a good job building the brand and building a great deal of loyalty."
With Chipotle's brand awareness increasing, Baja Fresh slipped from consumers' minds as Wendy's toyed with its image. Meanwhile, Baja Fresh has had to contend with another burgeoning rival in Qdoba Restaurant Corp., the upstart chain owned by Jack in the Box Inc.
Stephen Pettise, a franchise owner of three Baja Fresh units and restaurant marketing consultant at Golden Spike Resources Group, said Baja Fresh's buyer would gain from sharpening its brand image. As an example, he said consumers often have little knowledge about the restaurant's calling card its freshness or that it serves chips with all meals.
"Baja virtually makes everything fresh, but competitors muddied that water," Pettise said. "Baja was never able to turn that around and speak competitively of that benefit."
Baja Fresh's niche as a supplier of quality food at reasonable prices is being usurped or marginalized as restaurants reinvent themselves. In addition to its direct competitors, Greg Dollarhyde, former chief executive of Baja Fresh and current chairman of Pacific Island Restaurants Inc., said another strong challenge has come from the fast-food sector.
Companies like McDonald's, with its salads, and El Pollo Loco, with its burritos, have added to their menus to attract customers fleeing fast-food for high-quality dishes elsewhere. For their part, sit-down restaurants have been enhancing curbside programs to provide full-service meals without spending time at the table.
"Whoever is going to take over the company has an interesting positioning conundrum. Do you go cheaper and try to compete with the El Pollo Locos of the world?" Dollarhyde asked. "Or do you go after more quality? Baja Fresh already has the quality position in the marketplace."
Whatever role Baja Fresh plays in the years to come, it might have to play it on a smaller geographic field. Baja Fresh's problems mounted when it expanded from its California base, especially in the Midwest and South, where healthy Mexican food was unfamiliar.
Compared to ordering off Baja Fresh's menu, Todd Blue, president of real estate firm Cobalt Ventures LLC in Louisville, Ky., said consumers in middle America understand Qdoba's and Chipotle's assembly line model better. Cobalt Ventures shut down a Baja Fresh unit in Louisville after only a year due to poor performance.
"The problem was the translation from what is very much appreciated on the West Coast to a middle-America market," he said. Wendy's has since retrenched and shut down many feeble franchises opened outside the company's stronghold.
Whoever takes over Baja Fresh can learn a great deal from Wendy's geographic problems as well as other stumbles. When Wendy's bought Baja Fresh, it was praised as a smart acquisition to bolster the company's presence in the hot fast-casual market. Other fast-food companies followed Wendy's lead, with McDonald's Corp. scooping up Chipotle and Jack in the Box taking over Qdoba.
Wendy's didn't stop with the Baja Fresh purchase. At around the same time, Wendy's acquired Caf & #233; Express and Pasta Pomodoro to beef up their holdings similar to other multi-concept fast-food companies. Yum Brands Inc. lists Taco Bell and Pizza Hut among its brands, and McDonald's controls Boston Market in addition to its namesake restaurants.
From the outset, Wendy's had ambitious plans for Baja Fresh. The parent company had the goal of at least tripling Baja Fresh's units, 169 when the Mexican food chain was purchased, and build the chain to a nationally known brand.
But Wendy's became distracted. After all, Baja Fresh was still a small part of its business. Both it and Caf & #233; Express provided about $204 million in revenues in 2005, compared to nearly $3.6 billion at Wendy's and Tim Hortons. When its core burger chain failed to meet growth expectations, that became the primary focus for Wendy's.
The management team instituted a flurry of initiatives to improve Baja Fresh, including new menu items and interior designs. Last year, Brion Grube became chief executive of the chain. He replaced Bill Moreton, who had taken over for Dollarhyde in 2004.
Even with a steady management team, Baja Fresh might have run into the same problems. From the outset it didn't perform as well as anticipated.
Last year, Baja Fresh's same-store sales decreased 3.7 percent, an upswing from a 6.3 percent decrease in 2004. For those years, respectively, the Wendy's developing brands division, dominated by Baja Fresh, piled up operating losses of $24.3 million and $38.3 million. In the fourth quarter of 2004, Wendy's took a goodwill impairment charge of $190 million for Baja Fresh.
High costs were Baja Fresh's biggest problem. Baja Fresh did healthy sales volumes: a Baja Fresh unit generated an average of about $1.2 million in sales last year. That puts it just below Chipotle, at about $1.4 million per unit, but above Qdoba at about $1 million per unit.
"A $1.2 million brand should be fairly profitable. With their cost structure, it just didn't work out," Morris said.
Despite Baja Fresh's troubles, there is no shortage of potential buyers. Possible takers include private equity firms, rival restaurant companies and a team of Baja Fresh insiders.
Baja Fresh management is keeping mum on its future, except to calm the fears of franchisees worried about the fate of their nearly 160 units. Karen MacKenzie, a spokeswoman for Baja Fresh, said, "The brand has always operated very autonomously from Wendy's, so whatever happens in terms of a sale will have little to no impact."
Wally Butkus, a principal at Redding, Conn.-based Restaurant Research LLC, said a private equity buyout seems the most likely in light of a spate of such acquisitions recently. It's estimated that around 20 private equity restaurant deals have taken place within the last year involving many notable companies, including Fox & Hound Restaurant Group Inc., El Pollo Loco Inc. and Dunkin Brands Inc.
"I wouldn't think it would be a major chain acquiring it," Butkus said. "A lot of these chains are trying to focus on their core business. That is what Wendy's is trying to do."
However, Morris said an intriguing scenario would be Chipotle Mexican Grill Inc. coming away with Baja Fresh. Chipotle is flush with cash since its successful initial public offering last January and is seeding the country with its eateries.
"Eliminating a weakened competitor is the best means of winning the battle for market share and dominance," Morris said in an e-mail. "Chipotle could vastly increase its national presence by converting non-competing Baja Fresh units to Chipotle restaurants."
Over at Chipotle, spokesman Chris Arnold rejected the notion that the Denver-based 500-unit chain would gobble up Baja Fresh. "We have never used acquisition to fuel our growth in our 13-year history," he said. "We have always really focused on growing very organically, with a strategy that emphasizes quality over quantity."
Still, the general consensus is that Baja Fresh can get its costs under control, and that there are solutions to what ails the Mexican food chain. "It has loads of potential," Pettise said. "If the right buyer acquires Baja Fresh, they can turn this around within a year."
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