Red Lobster has brought out the seafood lover in San Francisco-based private equity investment firm Golden Gate Capital. The firm, which controls over $12 billion in capital and has a history of acquiring or investing in big consumer names, is purchasing the Red Lobster chain from parent Darden Restaurants (NYSE:DRI). You might recall three years ago when Golden Gate acquired California Pizza Kitchen. Golden Gate has big plans in store for Red Lobster, but Darden Restaurants has even bigger plans for the cash. Is this a good move or a sign of a managerial problem?
Trading Red Lobster for some green
The deal that was announced on Friday is for $2.1 billion in cash in exchange for its Red Lobster business and "certain other related assets and assumed liabilities." After all the lawyers and middlemen get their share, Darden Restaurants expects to net $1.6 billion. $1 billion of this is earmarked for a much-needed debt pay down. As of February of this year, Darden Restaurants had liabilities to the tune of $5.1 billion.
Darden Restaurants anticipates that the debt pay down will strengthen its credit metrics and allow it to continue to pay its quarterly dividend of $0.55 per share. This dividend currently costs the company nearly $300 million a year in cash. Finally, Darden Restaurants plans to execute new stock buybacks up to $700 million. Based on the current market cap, this should retire enough shares to boost earnings per share by around 10% while also reducing the cash needs for the dividend by 10%.
Maximizing shareholder value
Darden Restaurants reminds everybody that in the last five years alone, it has returned over $2 billion to shareholders in the form of dividends and share buybacks. It wants you to know, based on that history, that it has a shareholder-first mentality. With that in mind, Golden Gate Capital was selected from a "broad universe of potential financial and strategic buyers." According to Darden Restaurants, the company considered a myriad of value-creating options, and it decided this one was simply the best for shareholders.
Clarence Otis, Chairman and CEO of Darden Restaurants, stated, "Our Board and management team are highly focused on enhancing shareholder value, and we believe this transaction is consistent with the efforts under way to deliver on this responsibility." Darden Restaurants also owns the Olive Garden and Longhorn Steakhouse chains. The sale of Red Lobster will allow Darden Restaurants to focus its attention on these two strong brands. Last quarter, for instance, Red Lobster saw a revenue decline of 8.7% while Olive Garden saw a decline of only 3.4% and Longhorn Steakhouse sales soared by 9.1%. Traffic at Red Lobster declined by double-digit percentages each month of the quarter.
Foolish final thoughts
Back in March during Darden's earnings conference call, COO Eugene Lee stated, "We thought that [a Red Lobster] promotion that we ran in December was going to be more effective than what it was. It tested very well and we were focusing on superior sea food. It really resonated with the consumers in test and then when we put it in market it did not perform at the level we thought it was going to perform at."
It sounds like the problem with Red Lobster, at least in part, is something wrong with their testing and being able to figure out how to make the customer happy in the real world. Is Red Lobster really that much of a distraction or was it a merely a symptom of another larger underlying problem in the organization that happened to hit Red Lobster harder? We will know the answer if Darden is truly successful at engineering a turnaround at Olive Garden.
Was red lobster sold too cheaply knowing how transaction expenses are gaining efficiency?
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Nickey Friedman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.