3 Reasons Why Darden Told Investors to Take a Hike!

Source: Wikimedia Commons

On March 3, 2014, management at Darden Restaurants (NYSE: DRI  )  released a presentation which provided the details behind the company's planned spin-off of its Red Lobster operations. For months, activist investors like Barington Capital Group have pressed Darden to get rid of Red Lobster and Olive Garden.

After Darden told investors that it would keep Olive Garden while spinning off Red Lobster, Starboard Value, which has a 5.5% stake in Darden, pressed management to put the divestiture plan to a vote. Barington, which also believes that the company isn't maximizing its potential, backed Starboard's suggestion. With the release of this presentation Darden laid out its rationale for its plan and effectively told these activist investors to deal with it. Here are three of the selling points put out by the company:

Darden has effectively maximized shareholder value in relation to peers
Although Darden has reported bad and worsening comparable-store sales figures from Red Lobster and Olive Garden, its long-term performance has been strong, especially in comparison with its peers.

Source: Darden Restaurants

As we can see, Darden has posted, in aggregate, a comparable-store sales decline of 3.2% from the start of its 2009 fiscal year through the second quarter of its 2014 fiscal year. At first glance, the company's performance looks anything but good, but it did do much better than its rivals. The Knapp-Track, which measures the comparable-store sales of casual-dining restaurants, shows a cumulative loss of 8.7% (excluding Darden's performance) over the same time-frame. This suggests that, while the company isn't doing so hot it's done a better job of preserving value than its peers did.

The following chart also shows how well Darden has fared when pitted against some of its larger competitors:

Source: Darden Restaurants

In the chart, we can see that Darden's restaurant chains draw in significantly more revenue per location than their peers with the exception of The Cheesecake Factory (NASDAQ: CAKE  ) . Only the company's small Yard House chain came close with $8.2 million per location versus The Cheesecake Factory's $10.4 million, while its LongHorn Steakhouse sat at a low $3 million.

However, even this was enough to surpass the $2.8 million in revenue per location booked by Chili's of Brinker International  (NYSE: EAT  )  and the $1.8 million reported by Ruby Tuesday (NYSE: RT  ) . Bloomin' Brands (NASDAQ: BLMN  ) beat out LongHorn Steakhouse's revenue per location with $3.2 million from its Outback Steakhouse.

Source: Darden Restaurants

From a margin perspective, the difference is even clearer. Although Darden does not present shareholders with its restaurant level margins for each location, its aggregate margin of 24.2% beat out its peers. At the bottom of the list was Ruby Tuesday with a restaurant level operating margin of 22.2%. Brinker was just slightly better at 23%, while Bloomin' Brands came in with a margin of 23.8%. The best performer besides Darden was The Cheesecake Factory with a restaurant-level operating margin of 23.9%.

Darden's exploring menu options and revamping its locations
Aside from delivering relatively good results, Darden hopes to change its current business model. Instead of spinning off its Olive Garden chain along with its Red Lobster chain, it plans to retain Olive Garden and change both its menu and physical appearance.

The company's new menu includes crab-topped chicken, salmon bruschetta, a smashed chicken meatball sandwich, and pappardelle pescatore. To top things off, the company's Olive Garden chains will have a more-modern look. Personally, I think it looks like the chain's interior will look less Italian, and it will fall in the footsteps of Chipotle Mexican Grill.

Source: Darden Restaurants

Debt could be a major concern under another plan and other plans are sub-optimal!
Management at Darden is also afraid that any alternative division method would expose investors to too much risk and result in credit concerns. In its presentation, management claims that a good portion of its debt would have to be placed on the surviving company if Olive Garden and Red Lobster were spun off together.

If LongHorn Steakhouse was also included in the transaction, the surviving company (which would consist of only its Specialty Restaurant Group) would likely have to assume all of the business's debt. At nearly $2.5 billion as of its most recent quarter, the company's debt load would probably depress the share price of the surviving Darden company considerably.

Investors also suggested spinning off the company's real estate assets in the form of a REIT, or real estate investment trust. The company would receive tax benefits and, in turn, gain higher margins so it could deliver a better return to its shareholders. The company maintains, however, that since its real estate is best suited for restaurants this plan would result in more concentration than investors would like. This, in turn, would likely imply a depressed share price for the business.

Foolish takeaway
Based on the evidence provided in Darden's presentation, it looks logical that management plans to spin-off just Red Lobster. However, the Foolish investor should keep in mind that the company's findings are based on loose assumptions and strongly rely on its past performance. In truth, any of these factors can change going forward.

For this reason alone, shareholders should not automatically assume that Darden's decision to spin off Red Lobster by itself is optimal. However, it is safe to assume that management effectively told shareholders it will do what it considers best and that shareholders can either trust their judgement or talk with their feet.

 

The Motley Fool's Best of the Best
There's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.


Read/Post Comments (7) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 08, 2014, at 1:58 PM, mikejones wrote:

    I work for darden and rumor is CEO Clarence Otis is out of a job come Monday morning.

  • Report this Comment On March 08, 2014, at 2:35 PM, BuffettJr89 wrote:

    Hmm... That's very, very interesting Ajsurace! Thank you very much for that information! I will keep an eye out for any news pertaining to this and report on it immediately! I hope you have an excellent weekend!

  • Report this Comment On March 08, 2014, at 3:57 PM, handsoffmytea wrote:

    If it weren't for "The Fools'" articles hitting yahoo, many of us would be without a clue regarding this whole Darden scenario. Believe me when I tell you, the general consensus around Red Lobster is that they cant WAIT to be rid of Darden.

    I dont speak for everyone, but from what I've been hearing (and experienced) Darden is a lousy owner. This split is like an uncontested divorce. Good riddance, DAR.

    I do find it ironic that their newest aquisition, Longhorn Steakhouse, is their best performing concept. They havent had time to strip them down, yet.

    Red Lobster will recover. It will bring all it can to its guests. It WILL deliver quality and value. Once the shackles of Darden Restaurants are a thing of the past.

  • Report this Comment On March 08, 2014, at 6:25 PM, Tommylee2 wrote:

    Darden is giving Olive Garden and Red Lobster the "Kiss of Death."

    It is a shame as both are, or at least were, great eating establishments until Darden went crazy with menu's and pricing. As a family of four, it is seldom that we can afford any of their restaurants now because it usually costs us at least a hundred dollars including tip, or more when the four of us go. Do these people not realize that a hundred dollars is about a week's groceries for many households and that is without any frills?

    People loved the original O.G. and R.L. for their atmosphere, their menu and their prices but now that Darden has decided that bottom line means more than customer satisfaction, folks are not going there like they used to. That is a shame, as they really did serve good food at both places once upon a time.

  • Report this Comment On March 08, 2014, at 7:45 PM, aztar wrote:

    Combine the restaurants and place smaller versions of themselves in smaller towns with decent population. There are not many restaurants in these areas and seniors will flock to them. After all old money keeps the economy going.

  • Report this Comment On March 09, 2014, at 9:42 AM, Howdie wrote:

    The only place listed in the article that I would even think of eating is the Yardhouse. The food and service are good; and of course they offer good bear (not just Sam Adams, the Budweiser of craft brew.)

    But, if they try to compete by cutting costs and reducing quality like those other places, I'll stop going.

    I really believe any chain restaurant with over 50 locations is pretty lame and is going to suffer quality issue.

  • Report this Comment On March 09, 2014, at 1:57 PM, mannyd wrote:

    RED LOBSTER AND OLIVE GARDEN ARE PLAYING THE SAME GAME THAT CHART HOUSE ON SHELTER ISLAND IN SAN DIEGO PLAYED. YOU GO IN, THEY TAKE YOUR RESERVATION AND INFORM YOU THERE WILL BE A 15 MINUTE DELAY AND YOU CAN SIT IN THE BAR. WHEN IT COMES TIME FOR YOUR MEAL YOU FIND THE DINING ROOM EMPTY. THIS PLOY TO SELL DRINKS IS A TURNOFF TO MOST PEOPLE. I HAVENT GONE BACK TO OLIVE GARDEN SINCE THE LAST TIME. (OVER A YEAR AGO). IF THEY CANT MAKE IT ON FOOD PROFIT THEY SHOULD GIVE IT UP.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2862511, ~/Articles/ArticleHandler.aspx, 10/23/2014 11:14:13 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement