Darden Restaurants Is About to Destroy Red Lobster

Darden Restaurants (NYSE: DRI  ) is about to destroy more than $800 million of shareholder value. If it goes through with the spinoff of the Red Lobster chain without taking into consideration the complete nature of the problems with its operations, the restaurant chain will substantially and irreversibly hurt investors.

That's the claim being made by Starboard Value, the activist hedge fund investor that owns over 5% of Darden's stock and has been trying to finagle giving investors like itself a bigger say in how the company is being run. It has called for dividing Darden into thirds, with one third comprising the Red Lobster and Olive Garden chains that would eventually be spun off, a second third to hold its faster-growing concepts such as Capital Grill and YardHouse; and a third that would own all the properties and be converted into a real estate investment trust.

Joining Starboard in its quest to halt the seafood chain's spinoff is another hedge fund, Barington Capital, which doesn't necessarily endorse the division of the company, as its peer suggests, but does agree that releasing Red Lobster into the wild on its own will be destructive of value. It says Darden should put the divestiture on hold and take a more holistic view of the situation. Barington owns nearly 10% of Darden's outstanding shares.

Source: Starboard Value Investor Presentation, March 1, 2014.

The thrust of Starboard's charge lay in its accusation that the restaurateur has been less than forthcoming with investors. In a 108-page presentation filed with the SEC, the hedge fund calls out Darden's management for rushing the Red Lobster spinoff because:

  • It's a "hurried, reactive attempt" by the board to come up with quick fixes instead of solutions addressing underlying problems.
  • It's designed to benefit management, not shareholders.
  • It will stifle shareholder input, something management has long done with critics despite its claim the door is always open.
  • If management's not successful, and it has a history of not being so, anywhere from $581 million to $819 million in shareholder value will be irretrievably lost.

Starboard goes on to say management has mischaracterized the costs associated with the divestiture plan it devised. For example, where the board says it will be obligated to fork over substantial "make-whole payments" to bondholders as a result of the real estate transactions, the hedge fund says that's really only a worst-case outcome and the likely outcome would be that much less onerous merger covenants would get triggered. It also says management cherry-picked performance results against a group of unlikely peers to artificially show gains instead of against those that would be more appropriate that indicate value destruction over the years.

For its part, management contends the special meeting Starboard is calling for will be disruptive to the operations it says it cares about, though Starboard counters it's the chance to send management a message. As Darden Restaurants calls for investors to reject the meeting and change back their votes if they've already cast them in favor of it, it suggests the activist investors may have stirred up plenty of shareholder interest for its position and could signal that an even nastier proxy battle is still unfolding.

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9/18/2014 3:28 PM
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