Red Lobster split seen as wrong recipe to boost Darden

Bloomberg NewsDecember 24, 2013 

NEW YORK -- Shareholders aren't happy with Darden Restaurants' plan to sell or spin off Red Lobster, which doesn't solve the biggest problem: finding more customers.

Darden, also the owner of Olive Garden and LongHorn Steakhouse, slid 3.5 percent last week after announcing it will separate the Red Lobster seafood chain. Raymond James Financial says a breakup won't create much value for Darden, which is trading at a discount to most of its competitors, according to data compiled by Bloomberg. The plan also falls short of activist investor Barington Capital Group's proposals for a bigger shakeup, including ways to profit from its real estate.

With Red Lobster's same-store sales declining, Darden instead should focus on luring diners to boost returns over the long haul, according to Albert Fried & Co. Some private-equity firms may see an opportunity to buy the chain and bring it back to health, Miller Tabak said. Acquirers in the U.S. restaurant industry typically pay about the equivalent of the target's revenue, implying $2.6 billion for Red Lobster, data compiled by Bloomberg show. As a standalone company though, it would trade at a discount to other chains, S&P Capital IQ said.

"The market is disappointed and saying, 'OK, this is just a concession,' " Sachin Shah, a special situations and merger arbitrage strategist at New York-based Albert Fried, said in a phone interview. "Step one really should be fixing the business. Right now, Darden needs to be aggressive in innovating and investing in the business and changing the mentality that Red Lobster is a mature, stagnant brand. That's how you create long-term value."

Rich Jeffers, a spokesman for

Orlando-based Darden, said the company is beginning work on a strategic plan for Red Lobster and picked Kim Lopdrup from its specialty restaurant group to lead the effort as chief executive officer of the chain.

Darden said the separation will allow Red Lobster's marketing and operating strategies to be more tailored to the chain of 705 restaurants. Darden hasn't yet decided whether it will sell Red Lobster or spin it off as a publicly traded company. It expects to close on any deal by the early part of fiscal 2015, which begins in late May.

While Darden is taking steps in the right direction, they're not transformative and "could result in only modest changes in performance," Sara Senatore, an analyst at Sanford C. Bernstein & Co., wrote in a Dec. 19 report. "Specifically, the value of a Red Lobster remains an open question."

Darden's plans for Red Lobster may not be enough on their own, David Tarantino, an analyst at Robert W. Baird & Co., wrote in a Dec. 20 report. The key to creating value for shareholders rests with Darden's ability to boost its operations, "and visibility to such improvement remains low."

The restaurant operator is trailing some of its rivals amid competition for customers who are eating out less. Since the U.S. recession ended in June 2009, the Bloomberg Industries index of North American casual restaurants has climbed 164 percent, versus only a 55 percent gain at Darden.

Darden's same-store sales fell in the past six months, and growth at Olive Garden -- its largest chain, accounting for more than 40 percent of revenue -- has slowed. While its smaller brands such as The Capital Grille and Eddie V's are seeing a pickup in revenue at restaurants open for more than a year, Red Lobster's same-store sales tumbled 4.6 percent in the quarter that ended in November after a 2.2 percent dip in the year that ended in May, according to data compiled by Bloomberg.

"This quarter was very bad" for Red Lobster, Bryan Elliott, an Atlanta-based analyst at Raymond James, said in a phone interview. "Its customer base is slowly dissipating."

Shareholder Barington Capital, which has been pressing for changes at the $6.7 billion company, outlined its proposals last week before the restaurant operator announced its own plan. The New York-based hedge fund suggested splitting Darden in two because having more narrowly focused companies would lead to better operational performance. It would involve breaking apart Olive Garden and Red Lobster into one company and the smaller, faster-growing chains into another.

Barington, which owns more than 2 percent of Darden shares, also said that creating a publicly traded real estate investment trust would unlock the value of the company's properties, which it pegs at about $4 billion.

Darden's plan "fails to address significant opportunities to enhance long-term shareholder value," Barington CEO James Mitarotonda wrote in an email Dec. 19 to Bloomberg News.

There may be private-equity firms that are willing to stomach the turnaround Red Lobster needs and also see value in its real estate, according to Stephen Anderson, a New York-based analyst at Miller Tabak. While Darden is probably too large for a buyout, Red Lobster is about the size financial buyers typically seek, he said.

Similar-sized U.S. restaurants have sold for 0.5 to 1.5 times trailing 12-month revenue, before accounting for any cash or debt, data compiled by Bloomberg show. Using the median multiple of 1, Red Lobster would command about $2.6 billion in a sale.

"Private equity might come in to make some changes to the brand, look for increased efficiencies and close some unprofitable locations," Anderson said in a phone interview.

If Darden doesn't receive any offers for Red Lobster and opts instead to take it public, it will probably fetch a lower valuation than peers as sales remain weak and customers continue to shy away from the rising cost of seafood, according to S&P Capital IQ's Jim Yin. A deal won't have much of an effect on Darden's valuation either, the New York-based analyst said.

Darden's enterprise value last week of $9.5 billion was equal to 7.4 times its trailing 12-month earnings before interest, taxes, depreciation and amortization. That's already lower than 86 percent of North American casual restaurants, data compiled by Bloomberg show.

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