4 Reasons Darden Is Selling Red Lobster

Darden Restaurants finally unloads Red Lobster in a $2.1 billion deal. It didn't have much of a choice.

May 17, 2014 at 8:37AM

We finally have someone willing to part with some serious bread to get its hands on those Cheddar Bay biscuits. Darden Restaurants (NYSE:DRI) announced on Friday that it's selling Red Lobster to Golden Gate Capital in a $2.1 billion transaction.

The market didn't care for the deal, sending shares of Red Lobster 4% lower on the news. There are too many activist investors out there believing that Darden could've held out for more, but after reviewing the reasons why Red Lobster was on the block to begin with it's a welcome surprise that a suitable buyout offer was made at all. Let's go over the reasons why Darden wanted to cut bait on Red Lobster. 

1. Red Lobster's popularity is fading fast
It's been a rough few quarters for Red Lobster, and things have only gotten worse since Darden announced that it would be unloading the casual dining seafood chain late last year. 

U.S. same-restaurant sales plunged 8.8% in its most recent quarter, and that's including slight menu price increases along the way. The actual traffic at Red Lobster has been even scarier with guest counts for the months of December, January, and February falling by an average of 12.3%, 18.7%, and 11.9%, respectively.

This wasn't a fluke. Comps had clocked in 4.5% lower a quarter earlier and were off by 5.2% the quarter before that. There are plenty of chains posting uninspiring same-restaurant sales these days, but Red Lobster has been a disaster that only appears to be getting worse.

2. Darden can use the money
Selling a chain that's still generating healthy cash flows may seem like a bad idea, but Darden will be compensated handsomely for the handoff. It stands to clear $1.6 billion in after-tax proceeds from the sale, and it will put it to good use.

Darden will use $1 billion to retire old debt, and the balance will go to a share buyback. This may not be as popular as declaring a monster dividend or acquiring faster growing concepts, but it will help sustain the current dividend by decreasing the number of shares outstanding and trimming its debt interest. 

3. Darden can use the focus
Red Lobster accounted for $611 million or 27% of Darden's $2.23 billion in revenue in its latest quarter. The larger Olive Garden accounted for $929 million or 42% of the mix. That leaves a handful of Darden's other concepts accounting for just 31% of the revenue mix. That's a shame because nearly every chain at Darden is doing better than Olive Garden or Red Lobster. 

Moving on from Red Lobster will boost sales contributions from the smaller chains from 31% to 43% of the mix. Darden can then focus on growing those concepts as it deals with turning around one struggling and mature concept than two unwieldy behemoths. 

4. Red Lobster could be worth less over time
Selling now at $2.1 billion eliminates the need to sell for less in the future. Darden tried to fix Red Lobster. It tweaked prices. It beefed up the menu with more landlubber choices. Nothing that Darden has done has helped.

Seafood isn't necessarily less popular now than it was a couple of years ago. The problem here is that folks are getting their fill at sushi places and more stylish casual dining seafood eateries including Bloomin' Brands' (NASDAQ:BLMN) Bonefish Grill. Darden operates on a different fiscal calendar than Bloomin' but we've seen comps at Bonefish Grill check in up 0.9% for the three months through December and off by just 1.5% during the weather-challenged quarter ending in March. 

Red Lobster will require a lot of money for a makeover and the marketing of the reshaped chain if it wants to bounce back. It's better off going through that process away from the quarterly scrutiny of a publicly traded operator.

By the same token, Red Lobster would be a deteriorating asset in Darden's hands. A turnaround would seem unlikely, and the offers will continue to shrink with every passing quarter. Investors upset that Darden couldn't drum up a larger offer can't ignore that the chain's been on the bidding block for five months. It's not a secret. If someone had a better offer Darden would've taken a better offer.

Darden's moving on. Accept it.

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Rick Munarriz 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.

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