Red Lobster is Making a Mess of Things for These Companies

The Darden asset sale and associated American Realty Capital Properties Red Lobster property purchase have tossed business as usual out the window at this pair.

Jun 3, 2014 at 6:00AM

Darden (NYSE:DRI) is selling Red Lobster to a private equity shop that is, in turn, selling 500 of the restaurant's properties to American Realty Capital Properties (NYSE:VER). That's got investors up in arms about the prospects for both companies, and for good reason.

Push and push back
Darden is the owner of a collection restaurants including Olive Garden, Red Lobster, and LongHorn Steakhouse. It also owns smaller niche brands like Capital Grille. Although it is a leading player in the casual dining space, results have been middling at best over the last few years, particularly at Olive Garden, its biggest brand. That's led to activist investor calls for change.

(Source: I, Laslovarga, via Wikimedia Commons)

On that front, Darden came out swinging, with plans to sell its Red Lobster brand to Golden Gate Capital for $2.1 billion in cash. That isn't what the activists wanted, however, so they are still agitating for change. From Darden's perspective, Red Lobster was an odd fit because of its seafood focus that exposes the concept to often volatile seafood prices. Jettisoning the operation will help to smooth out Darden's costs and at the same time will allow it to focus on the rest of its brands.

The sale will reduce Darden's overall debt levels, allowing it to continue paying its current dividend. The yield has recently been in the mid 4% range. That should be enticing to most dividend investors, but the uncertainty surrounding this deal and continued calls for change from dissidents increases the risk profile. That said, Darden is an industry leader with great brands and those willing to take on moderate risks should consider the stock at these levels.

Closing the deal
Golden Gate is helping to pay for this deal by selling 500 of Red Lobster's properties to American Realty Capital for $1.5 billion. That leaves Golden Gate on the hook for just $600 million, but it means that American Realty has to come up with some cash. To do that, American Realty has decided to sell its multi-tenant portfolio to Blackstone (NYSE:BX) for $1.975 billion.

Recycling assets is a great trait in a real estate investment trust. However, in this case, American Realty had previously planed a spin off of these assets. Anyone hoping to get in on a fast-growing strip mall owner just lost that opportunity. Blackstone, meanwhile, got itself another portfolio of strip malls -- an asset class that's been out of favor but still has strong fundamentals. It's an area that Blackstone has been focusing on lately.

Despite the sale bringing in more than the purchase for American Realty, the acquisition of Red Lobster real estate doesn't do much to solve the big concerns surrounding the company. For starters, the company has expanded rapidly via acquisition over the last few years, and adding another 500 property portfolio does nothing to help ease the integration process.

Secondly, and perhaps more importantly, American Realty's buying spree has left it with a notable debt load. In fact, during the company's first quarter conference call President David Kay noted that, "Our debt levels are really the only stat that I can point to that isn't the same or better..." than competitors. American Realty's goal is to rectify that.

Too much of a good thing?
At the same time that American Realty announced the muti-tennant portfolio sale, it also announced it was selling 120,000,000 shares of stock at $12 a share. The proceeds are to be used to pay down debt. There are a couple of problems with this, however. For starters, it increases the number of shares outstanding by over 10%. That's notably diluting shareholders to pay down debt.

Dilution Concentration

(Source: FirstPrinciples, via Wikimedia Commons)

There's also the issue of cost. At $12 a share, American Realty Capital's $1 a share annual dividend equates to an 8.3% yield. At the end of the first quarter, however, CFO Brian Block said that, "...our weighted average interest rate was 3.7%..." Thus, issuing more shares is a pretty expensive proposition (a $120 million a year proposition, to be exact.)

The winners and losers
Blackstone will probably wind up the biggest winner in this complicated deal for Darden's Red Lobster. Meanwhile, American Realty Capital is now going through the exact types of growing pains that rapid acquisition led growth can lead to. That doesn't make it a bad investment, however, and jumping on the Red Lobster property was probably a good call. It does mean that you'll need to have a strong stomach if you want a piece of that 8% or so yield, though.

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Reuben Brewer 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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