Activist Investors to Darden: Don't Throw Red Lobster Overboard!

Activist investment firms Starboard Value and Barington Capital are up in arms over Darden Restaurants'  (NYSE: DRI  ) plan to spin off Red Lobster. While the activist investors feel that Darden should be broken up, they also content that throwing Red Lobster out to sea, so to speak, isn't the answer. These investors own a combined 7.5% stake in the company and are demanding that their voices be heard at a special meeting before the spin off takes place. Darden Restaurants management, however, stands behind its proposal to spin off Red Lobster.

The question for this Fool becomes, who is right and what's a Fool to do?

A history of underperformance
The most frustrating thing for Darden shareholders has been the stock's performance since 2010. For more than four years, shares have been stuck in a $30 to $55 range, mostly in the low $40s. Investors have been left owning a company with a stagnant share price. The only saving grace has been the company's high dividend yield; shares of Darden currently yield of 4.3%. But since the company is already paying out 86% of its earnings, I don't expect the dividend to go much higher.

Starboard's history
Starboard Value is certainly taking a proactive approach. It recently released a detailed presentation opposing the Red Lobster spinoff. This follows the firm's history of investing in underperforming companies and looking for ways to increase shareholder value. Starboard has been an active investor for more than 12 years. During that time, it has added or replaced 115 corporate directors on about 40 companies.

Starboard's argument
Starboard says now is the worst time to spin off Red Lobster. This is mainly due to Red Lobster's poor performance. Restaurant traffic, same-store sales, and margins have all deteriorated. Starboard has a point. If Red Lobster were spun off, investors would not actually be lining up to buy shares in a struggling restaurant chain.

Starboard feels that Red Lobster should be turned around first. The firm is also unhappy with management's plan to turn the chain around. Its argument is that Red Lobster does not need to be a separate company for change to occur. Matter of fact, changes need to be happening now.

Plenty of value in the real estate
Starboard Value considers the real estate that Darden is sitting on highly valuable. It values the real estate at as much as $4 billion. Starboard thinks the real estate should be spun off. Doing so would create a restaurant operating company and a REIT.

If Darden goes ahead and spins off Red Lobster, a good portion of that real estate value would disappear too. This is because a good portion of Darden's real estate value comes from Red Lobster. Starboard's opinion is that Red Lobster's poor operational performance would lower the value of the real estate if Red Lobster were to be spun off.

How is the competition doing?
Some of Darden's competitors have fared much better over the past few years. Two companies with multiple concepts in their portfolios include Brinker International (NYSE: EAT  ) and Bloomin Brands (NASDAQ: BLMN  ) . Both companies have seen their shares rise more than 30% in the past year.

In Brinker International's latest quarter, its Chili's brand saw comparable sales increase 0.3% in the U.S. and 1.4% internationally. Brinker's Maggiano's Little Italy, which competes with Olive Garden, saw comparable sales rise 0.9%.

Bloomin Brands' latest quarter saw comparable sales for company-owned restaurants in the U.S. rise 1.4%. Total revenue increased 5.2% to $1.1 billion. The company continues to expand; it opened 15 new restaurants and renovated 36 locations in the period.

How do shares compare? 

  Market cap Forward P/E Price/Sales Dividend Yield
Darden Restaurants $6.52B 17.65 0.78 4.3%
Bloomin Brands $2.83B 15.52 0.71 N/A
Brinker International $3.40B 16.18 1.26 1.9%

Source: Yahoo! Finance

Foolish assessment

I have to agree with many of the points made by Starboard Value. Now does not look like the time to spin off Red Lobster. However, there is something to be said that if a spin-off were to occur, then management at Red Lobster would not be dealing with other aspects of Darden's organization. Management would be focused solely on turning around Red Lobster.

Overall, I see great value that can be unlocked for shareholders in Darden's brands and real estate. Hopefully, Darden management and Starboard Value can come to an agreement that increases shareholder value and benefits the company and its shareholders.

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