Why Darden Is "Only" Dumping Red Lobster

Darden stock

Darden Restaurants is selling Red Lobster, and the market isn't happy. Source: Darden Restaurants.

Darden Restaurants  (NYSE: DRI  ) is officially selling Red Lobster, and shareholders aren't happy. But I think they should be.

To be sure, Darden stock fell more than 4% Friday after the company announced it will sell its Red Lobster business to Golden Gate Capital for $2.1 billion in cash. For perspective, that's nearly a third of Darden's current $6.4 billion market cap for a chain that comprised around 27% of last quarter's sales.

After taxes and transaction costs, Darden will take home roughly $1.6 billion, of which around $1 billion will be used to retire outstanding debt. The remaining $500 million to $600 million will be used to help fund a new share repurchase program of up to $700 million in fiscal 2015.

Golden Gate, for its part, scored arguably the country's best-known seafood chain for nine times trailing-12-month EBITDA, and Golden Gate Managing Director Josh Olshansky described it as "exactly the type of company in which we seek to invest given its great brand profile and strong management team." Furthermore, Olshansky insists, "We see significant opportunities for future growth by partnering with Kim Lopdrup and the management team to support the long-term success of Red Lobster."

And in case you're disappointed Red Lobster didn't fetch a higher price, keep in mind Darden told investors late last year it was mulling a number of alternatives, most notably including a tax-free spinoff of the chain and its respective real estate assets. However, Darden maintains it contacted a "broad universe" of potential buyers for the business, as well as a "significant number of real estate buyers to facilitate attractive sale-leaseback financing for the purchase." The end result -- with which I humbly approve, by the way -- was the board's unanimous agreement that selling to Golden Gate Capital represented the "superior value-creating alternative."

Why Darden is better off now
So why would Darden Restaurants want to get rid of its second-largest brand behind Olive Garden?

For one thing, keep in mind that Red Lobster has made a habit of consistently dragging down the superior performances of Darden's other chains -- that is, at least, in the broader context of the struggling casual-dining industry. Heck, that's why I argued last December such a sale would be the best thing for which shareholders could hope.

And Darden's most recent quarter ended February 23 was no different. Red Lobster's same-restaurant sales fell 8.8% year over year, compared to a 5.4% decline at Olive Garden, a 0.7% decline at Darden's Specialty Restaurant Group, and a 0.3% increase at LongHorn Steakhouse. Meanwhile, Red Lobster's Q3 sales fell 8.7% over the same period to $611 million. By contrast, Olive Garden's revenue dropped just 3.4% to $929 million, Longhorn increased 9.1% to $363 million, and Specialty Restaurant sales jumped 11.6% to $320 million.

Of course, Golden Gate might be able to turn Red Lobster around. And you know what? They'll deserve a solid golf clap if they can pull it off. But in the end, I think shareholders should be applauding -- not panning -- Darden's decision, which removes unneeded risk, improves its financial position, and allows it to focus more attention on further bolstering its strongest chains.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 18, 2014, at 11:58 AM, silverdragon8448 wrote:

    To make it successful need to provide a greater value. Not only lower prices but give it a more friendly atmosphere and greater customer service. It is the little things that will add up and increase the bottom line.

  • Report this Comment On May 19, 2014, at 9:51 AM, TommyD23 wrote:

    Don't you have to consider the fact that they really sold RL and land? The land was sold for $1.5 bil by Golden Gate. Using that valuation they really sold the operating unit for $600 million.

    Also, don't they have to retire the debt based on the fact that their credit rating is nosediving as they are losing stable cash flow in RL?

    Aren't they are initiating the share repurchase because they are having trouble maintaining their dividends?

    That doesn't sound like forward thinking decision to me.

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