It's been said that no conglomerate can fire on every cylinder. That's certainly the case for Ignite Restaurant Group (NASDAQ:IRG) and Darden Restaurants (NYSE:DRI) While some of their more recognized brands are struggling, Brick House Tavern and Tap (Ignite) and Longhorn Steakhouse (Darden) are knocking it out of the park. Could some new spin-off's help Darden and Ignite realize their potential?
Running in different directions
Darden Restaurants is certainly no stranger to spin-offs. In fact, the company just sold its Red Lobster franchise for $2.1 billion, and I think this makes it even more likely that further spin-offs could happen. They received so much money for a struggling chain that they should be open to offers and Olive Garden is still moving in a different direction than their other franchises.
In it's most recent quarter Olive Garden had negative same-store sales growth (5.4%) while Longhorn steakhouse had essentially flat comps but top-line growth of 9.1%. Further, Olive Garden's comparable sales actually went slightly lower in February than January, but Longhorn's improved. When you take into account that in the previous quarter Longhorn had same-store sales growth (yoy) of 5%, it seems likely that growth will be strong again in the back half of 2014.
At the same time, Ignite Restaurant Group has brands that are running in opposite directions as well. Comparable restaurant sales increased 10% at its "man cave" themed Brick House Tavern + Tap, but they sank 6% at Joe's Crab Shack and sank 4.1% at Macaroni Grill.
So we know that these these restaurant groups have brands that are moving apart, but does it matter?
Why spin-offs make sense for Longhorn and Brick House
The track record of performance for spin-offs tends to beat the market. This interesting article from Forbes explains some of the merits of spin-off investments in detail, and it shows a 178% edge (vs. the market) that a spin-off ETF recently turned in. More importantly it highlights the top reason that Brick House and Longhorn should be spun off--the opportunity for a distinct investment identity.
Investments are typically lumped into one of two categories: high-growth or value. Having a clear investment identity is so important to restaurants, because restaurant growth requires an enormous reinvestment of capital. If customers love your food, eventually, you'll need to build new restaurants to capitalize on that growth. A restaurant growth stock that acts like a value stock, say by paying a dividend, is making a huge mistake. Since Darden and Ignite have a few struggling brands, they can't fully engage in either a growth or a value strategy, which hurts their cause.
If Longhorn were spun off (perhaps with another Darden high performer, like Capital Grille), it could free itself of the burden of Darden's dividend program. With a new management team focused solely on the growth of this business, the growth strategy at Longhorn (or Brick House) could be fully realized. By bringing either spin-off to the public markets, Longhorn or Brick House could raise capital that would be used for growing their store count. At the moment, growth is hindered because cash must be funneled into the under-performing brands of both Darden and Ignite.
Finally, if Darden wanted to go a different route, they may even consider selling Olive Garden to private investors (ala Red Lobster). Such a move would allow Olive Garden to escape the quarterly Wall Street "expectations game," and focus on improving its business. This would also have a positive impact on Longhorn and other Darden brands, simply because it would remove a burden and allow Darden to focus one-hundred percent on growth.
Foolish conclusion: spin them off!
In many cases, conglomerates tend to hold really strong businesses back. It's just not possible for management to give the proper attention to a high-performer when it's focused on saving other struggling brands. That seems to be the case for both Brick House and Longhorn.
I feel a spin-off would help these restaurants unlock their full potential, and it would benefit both restaurants and shareholders of Darden and Ignite.
Adem Tahiri 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.