3 Reasons the Red Lobster Spinoff Won't Save the Company

Darden is gung-ho about spinning off Red Lobster into a separate company, but that won't help fix these three blatant problems.

Mar 29, 2014 at 2:03PM

The U.S. economy, which is largely driven by consumer spending, grew by 2.6% in the fourth quarter according to a report issued this past week by the U.S. Commerce Department. By comparison, in the fourth quarter Red Lobster, a casual-dining restaurant chain made famous for its seafood entrees and owned by Darden Restaurants (NYSE:DRI), posted an 8.8% decline in same-store sales.

The troubles at Red Lobster have been apparent for some time now -- it's not as if these same-store sales declines simply popped up one night like a stray animal on the porch. In an effort to stem this decline and simultaneously focus its efforts on freshening the Olive Garden brand, Darden announced less than three weeks ago that it planned to spin off Red Lobster.

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Source: Darden Restaurants.

Will Red Lobster be fileted?
The move is being made for a number of reasons on Darden's part. First, by spinning off Red Lobster the idea would be that a simpler management structure (i.e., not having to report to Darden) may result in a better chance of a focused turnaround. Second, spinoffs in nearly all sectors have helped unlock shareholder value in recent years since shareholders find it easier to decipher how a company's components make money with ease. Finally, it could help remove some of the vitriol directed at Darden's management by disgruntled shareholders.

Making matters even more difficult for shareholders who oppose the spinoff and want Darden to tackle Red Lobster's problems from within, the New York Post this week reports that Darden amended its corporate bylaws making it much tougher to unseat existing board members and giving it the ability to delay its annual meeting which had previously been scheduled for September or October. 

Ultimately, in my view, this spinoff is akin to putting a Band-Aid over a gaping wound. It's likely a moot point for investors unless the chain address three key issues.

It's not courting a younger audience
First and foremost, Red Lobster is doing an awful job of courting a younger generation of diners. As I opined last weekend, Red Lobster has been losing foot traffic to just about every other major competitor, especially those that have embraced technological advancements that the younger generation has gotten so used to.

Both Buffalo Wild Wings (NASDAQ:BWLD) and Brinker International's (NYSE:EAT) Chili's have taken on tablets as a test to see if it improves sales and table turnover. On the surface it's an ingenious idea as it lets the patron order their beverages right away and pay immediately so they're not left waiting for the server. It also makes the younger generation feel right at home since many have grown up using tech-based products. The move makes complete sense for Buffalo Wild Wings which naturally attracts a younger crowd, but it could be quite the boon for the family oriented Chili's.

No company has embraced the tablet movement more so than DineEquity's (NYSE:DIN) Applebee's which is set to roll out 100,000 new tablets later this year. By putting the convenience of beverage, appetizer and dessert orders in the hands of customers while still allowing servers to handle the main course orders Applebee's anticipates that it'll be able to improve customer satisfaction without impacting the consumer-server relationship that brings its core customer back to the restaurant time and again.

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Red Lobster, on the other hand, doesn't have many, if any, aspects that the younger generation would find appealing. No tablets, television, electronic devices. and so on. These devices have become commonplace in restaurants ranging from Chili's to even McDonald's, but it's proving enough to discourage a younger audience and even families with children to some extent from eating at Red Lobster.

It's failing to deliver menu items people actually want
Another big problem is that Red Lobster simply isn't giving the customer what they want to eat – and if they are they're doing a terrible job of advertising that fact.

Menu innovation is one of the biggest drivers of customer traffic in the food industry. Although specials bring in cost-conscious consumers, it's the breadth of menu options which speak to even the pickiest eaters that tends to build a consumer base that keeps coming back. In October 2012 Red Lobster debuted a bevy of new non-seafood menu items across 40 of its locations designed to attract a new breed of customer or bring back its core customer who had strayed from the business. Clearly that barrage of new items hasn't worked as planned.

The biggest obstacle Red Lobster has to overcome is a move toward healthier eating. While fish is itself a fairly good source of nutrition, its bounty of pasta dishes is drawing the ire of health-conscious consumers across the U.S. Instead, Red Lobster is seeing their business eaten up by casual dining establishments like Chipotle Mexican Grill (NYSE:CMG) which offers customers fresh ingredients, in many cases from local farms, and a wide array of entrees to keep their caloric intake low. And even in the instances where Red Lobster has introduced healthier meals, I haven't seen or heard about these new options via advertising. Long story short, Red Lobster sorely needs to rework its menu.

Its exterior image is stale
Lastly, image is everything in the restaurant business, and Red Lobster's exterior image is also in need of an overhaul. Although the company has renovated select restaurants in the Northeast, it's going to need to go the extra mile and continue to renovate and redesign the exteriors and interiors of its restaurants to make them more inviting.

McDonald's, for example, is hardly what I'd classify as a dining restaurant, but it witnessed its sales soar after it redesigned its interior to make it more family friendly and entertaining. The point being that Red Lobster's current image isn't drawing in new customers and it certainly isn't courting that younger generation that's more than willing to spend their hard-earned cash. Until the company addresses this issue, same-store sales could very likely continue to sink.

The Red Lobster spinoff certainly looks poised to divert attention away from its miserable recent performance, but it's certainly not a long-term solution to saving the brand.

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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of, and recommends Buffalo Wild Wings, Chipotle Mexican Grill, and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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