Red Lobster Spinoff Caught in Trap of Its Own Making

Having barged ahead with its Red Lobster spinoff and shrugged off the counsel of shareholders who sought to have Darden Restaurants (NYSE: DRI  )  undergo a more complete overhaul, the restaurant operator finds itself in hot water with those who can influence votes. Two widely respected proxy services blasted Darden last week for creating an opaque environment that reflects poorly on its corporate governance practices.

Institutional Shareholder Services says the bylaws change Darden enacted in response to investor efforts to call for a special shareholder meeting to discuss the spinoff "inherently lacks transparency, results in answers whose credibility relies on the credibility of the very board whose judgment is being challenged, and may never reach a moment of denouement." And because of how the restaurant chain has marginalized company critics in the past, Darden's public claim that it's an open organization for investors "rings somewhat hollow" for Glass Lewis.

Last year, hedge fund operator Barington Capital made the case that Darden could halt its decline if it undertook a variety of measures, including spinning off the Red Lobster and Olive Garden chains into a separate company; packaging the remaining growth-oriented concepts like Longhorn Steakhouse, The Capital Grille, and Yard House into another entity; and creating a real estate investment trust. 

Perhaps thinking it would mollify the investor, Darden announced it would only shed the seafood chain, causing acrimony to ensue and Barington to say it had lost confidence in management. It's joined in the call for change by fellow hedge fund operator Starboard Capital, which called for a special shareholder meeting to allow investors a chance to voice their concerns and vote in a non-binding referendum to have the spinoff stopped.

Darden, though, says a meeting isn't necessary as its door is always open to investors. However, in case shareholders persisted, Darden enacted changes to its bylaws that give the board discretion on delaying the annual shareholder meeting while requiring shareholders who submit proposals or nominate directors to disclose more information about their plans and their relationship with nominees, to complete a questionnaire about their nominee's qualifications, and reveal discussions they may have had with other shareholders.

Now both proxy services endorsed Starboard's call for a special meeting of shareholders, with the ISS concluding, "the value of a shareholder meeting is precisely that it provides a definitive, authentic, and unassailable answer to the question of what shareholders want."

I'm not sure I disagree with Darden's view that spinning off Red Lobster is rightly in the purview of management discretion, that it has the responsibility of operating the business, and that having to hold a special meeting of investors every time someone disagrees with what it does is a costly distraction. Yet its ham-handed approach to dealing with dissension puts the restaurant operator in a negative light, making it looking like it's trying to quash all those who disagree with its plans. 

There is some merit to Barington's recommendations, though the exact details could always be different, and Starboard is simply seeking to have Darden slow down and seek out a more holistic approach. Instead, Darden Restaurants has brought the situation to a boiling point, putting it at odds with investor advocates, and positioning itself in a net from which it will find difficultly disentangling itself.

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