"Clearly today's announcement is a thumb in the eye of activist investors." -- Janney Capital Markets analyst Mark Kalinowski, from his note: Who knew lobsters had middle fingers?
Darden Restaurants Inc's (NYSE: DRI ) announced sale of Red Lobster to Golden Gate Capital has resulted in American Realty Capital Properties (NASDAQ: ARCP ) acquiring 500 Red Lobster sites in a sale-leaseback transaction with Golden Gate.
Is this deal kosher, or just a shell game? That is the question being hotly debated by analysts, shareholders, and the media.
However, there's nothing fishy about this Red Lobster transaction. In fact, when you take a deeper dive, this Red Lobster deal seems to benefit all parties.
Darden is able to unload its biggest drag on same store growth and earnings. The proceeds of this transaction are earmarked to reduce $1 billion of Darden debt, fund ~$600 million in share buy-backs, and maintain Darden's current $0.55 dividend paid to shareholders.
American Realty Capital continues on its path of rapid accretive growth while at the same time forging a relationship with private equity wheeler-dealer Golden Gate Capital.
The decision to sell
Darden Restaurants has been under pressure from two activist hedge funds to wait for a special shareholder meeting to discuss alternatives for Red Lobster prior to pulling the trigger on any type of deal.
The majority of analysts quoted in a recent National Restaurant News article actually seem to be positive or neutral regarding the Darden decision to sell its 706 unit Red Lobster restaurant chain to private equity firm Golden Gate Capital. This deal was structured as a $2.1 billion cash transaction, with the majority being allocated to former Darden real estate.
The buyer with a large appetite
American Realty Capital Properties CEO Nick Schorsch has recently revealed an almost insatiable appetite for megadeals accretive to earnings. The chance to bolt-on 500 Red Lobster properties with a single $1.5 billion sale lease-back transaction with Golden Gate appears to have been just too tasty to pass up.
Golden Gate Capital has demonstrated a successful track record when it comes to scooping up and resuscitating casual dining chains. They currently operate California Pizza Kitchen, and On The Border Mexican restaurants. In February 2013, Golden Gate sold its 200 plus unit Romano's Macaroni Grill chain to Ignite Restaurant Group.
The alchemy of turning real estate into gold
American Capital, or ARCP, has quickly become the big dog in the single-tenant triple-net lease REIT space. ARCP brings a $10.2 billion market cap to the table, comprised of: 3,731 properties that are 99% leased, containing ~90 million square feet, with a weighted average remaining term of not quite 11 years.
ARCP was happy to fork over $1.5 billion because the terms of the deal are consistent with its recently announced guidance to acquire at 8% cap rates or better. The upside for ARCP includes:
1. The deal comes in at a GAAP cap rate of close to 10%, with a cash cap rate of ~8%.
2. Over 93% of the properties will be leased for an initial 25 year term, with the balance of the sites being leasehold assets with an 18.5 year average term.
3. The leases are structured with a 2% annual rent increases
Why couldn't Darden pull off the same deal?
Frankly, Darden management has had many years to try and turn around the Red Lobster chain with little or no success.
If it would have made sense to repurpose a significant chunk of the Red Lobsters into Olive Gardens --or any of the smaller specialty Darden chains such as LongHorn Steakhouse, Bahama Breeze, or Yard House -- that would have already happened.
In theory, Darden could have attempted to structure a large Red Lobster anchored restaurant REIT. However, an equity REIT comprised of 700 ailing Red Lobster casual dining restaurants would likely have been met with a tepid reception on Wall Street. Darden shareholders should be glad management selected a more conservative course of action.
Golden Gate and ARCP: synergies beyond Red Lobster
Golden Gate owns many other consumer/retail chains beyond its restaurant group, including: Eddie Bauer, J. Jill, Zales Corporation with over 1,890 locations, and Payless ShoeSource -- the largest family footwear retailer in the America's. They also own companies in five other vertical markets: Financial Services, Industrials and Energy; IT and Business Services; Software, as well as Technical Hardware, Telecom, and Semiconductors. Golden Gate is constantly buying and selling companies which have significant real estate footprints.
Real estate is the sole core business focus of American Realty Capital. It would seem logical that this huge Red Lobster sale-leaseback deal could be the beginning of a mutually beneficial relationship for both companies.