Red Lobster Sale Is Small Fry for Darden Restaurants Investors

Source: Red Lobster.

Sorry, Charlie, but the decision by Darden Restaurants (NYSE: DRI  ) to sell its Red Lobster chain to private equity firm Golden Gate Capital for $2.1 billion doesn't let its board of directors off the hook.

Having snubbed efforts by two other private equity firms to have the restaurant operator take a more holistic approach to the troubles facing its casual-dining chains, the board may have ensured they find themselves filleted at the annual shareholders meeting.

Under the terms of the agreement with Golden Gate, Darden will receive net about $1.6 billion that some think represents a pretty steep tab for taxes. And with Golden Gate financing the deal with a separate sale-leaseback transaction for $1.5 billion -- meaning it's effectively paying around $600 million for Red Lobster's operations -- management is accused of selling the chain at "fire sale" prices.

Darden plans to use approximately $1 billion of the proceeds to retire outstanding debt and the remaining $600 million to buy back stock. Needless to say, Barington Capital, one of the hedge funds that was angling to have Darden do more than just shed the seafood chain, thinks the deal is "unconscionable" while Starboard Value said it "woefully undervalues" the restaurant's assets. Other analysts contend it's "giving the business away for free." 

The 5% drop in Darden's shares following the news shows investors don't think too much about the value it was able to land for the chain, either.

It was Barington that got the ball rolling last year with a presentation that said Darden should package both Red Lobster and its other ailing casual-dining chain Olive Garden into a separate entity that could be sold or spun off; the remaining growth-oriented concepts like Longhorn Steakhouse, The Capital Grille, and Yard House could be wrapped into another entity; and a real estate investment trust could be created that would house all the properties. 

From the beginning, Darden only paid lip service to the suggestions, responding with a plan to only sell or spin off the seafood chain. Management said the Italian restaurant concept Olive Garden was a growth opportunity just as much as the other chains it owned, and it thought little of the REIT idea because it says it would trade at lower valuations than similar REITs.

Starboard Value jumped into the fray by saying Darden really ought to slow down here. It's not that it completely endorsed Barington's ideas, but thought the troubles Darden was experiencing could be handled better than with a piecemeal approach. When it too was snubbed, it ended up saying it had lost confidence in Chairman and CEO Clarence Otis to lead the company and called for him to be ousted. It also called for a special meeting of shareholders to vote in a nonbinding referendum on the moves that management and the board were taking.

The friction between Darden and its investors was palpable, and it appeared the restaurant operator was trying to fast-forward a transaction before any investor plebiscite could be taken. Just this past week, it said it thought it could delay for up to four months holding such a meeting, by which time any vote would be moot since it expected to have some sort of deal completed by July at the latest, whether it was a sale or spinoff.

It's clear Darden knew it didn't have the support of outside shareholders, as Starboard had delivered to it petitions that amounted to about three-quarters of all the shares available for voting that weren't held by insiders, tied up in debt covenants, or out on loan. It may be why it was willing to dispose of Red Lobster for what Barington called "fire sale" prices.

Although the transaction could be seen as being valuable in that the surety of landing a deal now was less risky than trying to reel one in later, the disregard of shareholder wishes by Darden's board indicates they may pay the price for being so rash. It must now prove that it can turn Olive Garden around, a chain whose own performance has been seen as nearly inadequate as Red Lobster's. There's only a small window of opportunity for Darden Restaurants to get that concept to bloom -- or face the prospect that it will be gutted by investors.

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