Hedge Fund Tries to Anchor Darden Restaurants

Private equity firm hopes to reel in more investors with its call for an early shareholders meeting.

Feb 25, 2014 at 4:47PM

It's been full speed ahead for Darden Restaurants (NYSE:DRI) with its proposal to sell or spin off its Red Lobster seafood chain. Having been pushed to action by hedge fund Barington Capital Group, which owns around 2% of the restaurant operator's stock, Darden has been moving forward with the single-minded purpose of shedding the underperforming concept.

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And since propelling the chain to do something, Barington, along with fellow hedge fund operator Starboard Capital, has been doing all it can now to pull back on the reins and get the restaurateur to stop. Both private equity firms complain Darden's plan is a half-baked maneuver that will damage shareholder interests rather than increase value, and Starboard now says it will push for a shareholder meeting ahead of the fall's annual gathering to get the plan halted.

With the economy still not fully shaking off the recession, mid-tier dining concepts have come under extreme pressure as the middle class sees its purchasing power erode. Dining at either extremes, however, continues to do well. You have high-end restaurants pushing sales higher, along with those at the other end, such as the fast-casual concepts, continuing to balance quality and price to great effect. It's those concepts in the middle that are feeling the pain.

Ruth's Hospitality Group, which owns the Ruth's Chris Steak House, Mitchell's Fish Market, Columbus Fish Market, Mitchell's Steakhouse, and Cameron's Steakhouse concepts in the full-service dining industry, reported earnings last week that handily beat analyst expectations by $0.03 per share, with sales up 2.5% for the year even though they slipped 3.6% in the fourth quarter. Analysts note that its revenue growth rate has exceeded the industry average of 4.2%. Bloomin' Brands' also had its Bonefish Grill land higher sales, with a near 1% increase in comps while Darden's own fine-dining Capital Grille enjoyed same-restaurant sales growth of 6.7% last quarter, the best of all its concepts.

Similarly, fast-casual leader Panera Bread enjoyed 16% revenue growth as sales hit $661 million, and systemwide comparable net bakery-cafe sales increased 1.1% in the quarter. Chipotle Mexican Grill saw revenues surge almost 21% year over year, with comps up 9.3%.

Aside from Red Lobster and Darden's other struggling concept, Olive Garden, Ruby Tuesday, DineEquity's Applebee's, and Brinker International's Chili's continue to struggle with staying relevant, let alone afloat. It's one reason I'm not convinced Barington's own proposal to spin off Red Lobster and Olive Garden together as a separate company is the right one. It correctly argues the seafood chain isn't healthy enough to survive on its own, but adding in a second ailing chain won't give it much buoyancy, either.

Which is why Starboard has been telling Darden to simply slow down and take a holistic view of how it can best improve operations, but so far, the restaurant operator has ignored those pleas and says it's reviewed the options and its own plan is best.

In an open letter to fellow shareholders yesterday, however, Starboard challenges that notion and says Darden's separation plans will destroy shareholder value, and it's moving ahead quickly to get a deal done before shareholders have a chance to consider it at the annual meeting. As a result, the hedge fund is calling for a special meeting, and is asking investors to support the move, since it needs approval from at least half of Darden's investors.

Barington says it "strongly supports" Starboard's efforts, but Darden maintains its headstrong ways, responding that its actions "deliver on this responsibility" to deliver shareholder value. Besides, it says the spinoff doesn't need shareholder approval.

Starboard is trying to get Darden Restaurants into port to have a say in how the restructuring works, while the chain operator is pushing the throttle forward. With enough investors concerned about the future of the company, the hedge fund may just be able to anchor the restaurateur to heeding shareholder concerns. 

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