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Here's Why Red Lobster's Demise Could Happen Sooner Than You Think

Red Lobster's days are numbered. While it was struggling to stay relevant under former owner Darden Restaurants (NYSE: DRI  ) , it now faces a dismal future at the hands of private equity firm Golden Gate Capital.

The reason for this is simple. Despite efforts to characterize things differently, the private equity industry isn't interested in investing in a failing restaurant franchise in a last-ditch attempt to revitalize the brand -- click here to learn more about the history of private equity companies. Golden Gate will instead extract as much cash out of the business as possible in an effort to maximize its own return on investment.

In fact, Golden Gate has already begun doing so. "On the same morning that Darden announced the sale of Red Lobster, Golden Gate Capital announced that it had sold the real estate assets of 500 Red Lobster properties in a sale-leaseback deal with American Realty Capital for $1.5 billion," a recent Fortune article explained.

As a result, "Golden Gate, which stripped Red Lobster's real estate assets and sold them off, arranged to recoup 71% of the total investment before it even took control of the restaurants."

As Motley Fool contributor John Maxfield explains in the video below, the result is that Red Lobster, which has already been struggling with declining same-store sales and profitability, now faces a higher expense base. Needless to say, this probably won't end well for the chain.

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Read/Post Comments (8) | Recommend This Article (36)

Comments from our Foolish Readers

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  • Report this Comment On July 02, 2014, at 8:13 PM, thatlldopig wrote:

    Mr. Maxfield: I believed that Darden should have held onto Red Lobster by pursuing a sale-leaseback strategy to allow for reinvestment in the brand. Other than your belief that Golden Gate Capital is trying to funnel cash to itself, do you have any evidence or argument that Golden Gate will not use the capital it received to revitalize the brand as it stated or as I feel Darden should have done?

  • Report this Comment On July 02, 2014, at 9:01 PM, Wayners999 wrote:

    I have a question. Did Golden Gate buy all the outstanding shares? They can't just steal from other investors and sell assets, collect and collect a dividend for themselves and screw all other shareholders. This article is very misleading. Golden Gate saw an asset play. Good for them. Wall Street missed the Real Estate value under Darden. Screw them too.

  • Report this Comment On July 02, 2014, at 10:09 PM, angelady7 wrote:

    Red Lobster used to be one of the best places to eat. When they first opened people would wait up to 45 minutes to get in just for " lunch". Their menu was fantastic and the food was very good. However, over the years, the menu kept changing and not for the better. This is why many restaurants are having problems. When I go out to eat it is for a particular item on the menu. Applebbee's, along with several other restaurants kept taking certain dishes off the menu. Once they took what I went there for, there was not any sense in going to them again and we have not. I think if Red Lobster would go back to their original menu, better quality food again and lower the prices business would be booming again.

  • Report this Comment On July 02, 2014, at 10:16 PM, foodwatcher wrote:

    thatlldopig - this is an easy one. Look at what Golden Gate did to Macaroni Grill, On The Border, and California Pizza Kitchen. The story is identical with each of those. Negative sales became more negative, portion sizes got smaller, ingredients became inferior, facilities became dilapidated, and staff sizes got much smaller. For further evidence, look at Ignite's earning's call comments after purchasing Macaroni Grill from GG - "...staffing levels were unsustainably low...", "...turnaround will be much worse condition than originally thought...".

  • Report this Comment On July 03, 2014, at 12:04 AM, hefman99 wrote:

    Totally disagree with Mr. Maxfield's analysis. What Golden Gate understands is that Red Lobster is in the restaurant business and not the real estate business. They divested the real estate to generate a quick cash return, but also because they no longer have to support a team a real estate managers. As well, if rent is higher in some cases than otherwise it will help Red Lobster management have a better understanding of the true costs of running each unit. In my opinion Darden should have, if they didn't, been burdening each restaurant with a fair market rent expense so that they could have understood this issue. Next Golden Gate will likely evaluate which restaurants generate positive cash flow, which are neutral (low profit to very low loss), and which generate cash losses. The losers will be closed, the neutrals will be evaluated for potential turn around or closure and the positives will continue to operate. Then there will likely be strategic initiatives to try to grow same store sales in those remaining stores (new menu items, new promotions, pricing review, marketing campaigns, etc.). If they can determine how to increase same store sales and profits they may decide to open some new locations to prove out the concepts. If those new locations work they will look to exit and reap a nice return either through a sale or public offering. One initiative I would try is to set up a food truck in the parking lot of each Red Lobster that sells high quality Lobster Rolls at lunch to compete with the fast casual dining experiences at Chipotle and Panera. In short though Mr. Maxfield businesses should choose one industry for their focus; not two. Getting out from under the real estate is a smart move in the attempt to turn around Red Lobster.

  • Report this Comment On July 03, 2014, at 8:51 AM, cynic37 wrote:

    Sadly, this is just the way things go. There was never any hope of rescuing the Red Lobster brand so the real estate play was the only one that made any sense. It had to be done before the chain went bankrupt or their would be no leverage in the sale of the properties. I would imagine that under a Darwinian model, the strongest of the stores will remain. A reorganization bankruptcy filing will occur. Taking the 71% already recaptured, voiding the bad leases, and running the profitable ones makes sense for all involved except the ones losing their jobs.

  • Report this Comment On July 03, 2014, at 3:27 PM, Tommylee2 wrote:

    This is sad to read as Red Lobster has always been one of my favorite seafood restaurants and i really had hoped it would survive. Business is business, and greed is greed and some businesses don't know the difference. This corporation cares nothing about the thousands of employees it is going to be putting in the streets and the thousands of suppliers who are going to be hurt by the loss of this contract or the millions of diners who loved to eat there. Bottom line profit is all they care about.

    A comment herein says there was never any hope of saving them but he is wrong because they were worth saving and someone who really cared would have gotten them back in the black again and back on top where they belong.

    Unfortunately when they are gone a lot of people will never know what real seafood is, they'll just think Captain D's or Long John Silver's is seafood.

    I think I'll go eat there tonight just in case they close tomorrow.

  • Report this Comment On July 06, 2014, at 9:58 AM, TomMariner wrote:

    Angelady has it right! Once the folks with a vision have built a company, then cashed out (or be driven out by raider tricks) it becomes an "organization".

    Organizations employ acres of ambitious people turning cranks so they can get recognized and promoted to turn even bigger cranks. The quickest way to success in that environment is not to innovate and grow, it is through the "Power of NO". Printed pages of PowerPoints that promised dramatic 10 digit instant dollars to the bottom line bottom line by stopping doing something would reach the moon.

    "If we cut down the number of menu items in a Red Lobster menu, our supply chain gets lean and we save gazillions worldwide". The VP of Sales' pleas that will drop his same store sales will meet with laughter because that is NEXT quarter, and a drop in revenues will only drain the bottom line by the profit percentage.

    And the MBA making the PowerPoint gets to be VP Logistics and the VP Sales gets canned because sales are dropping. And, inevitably, everyone is gone -- hopefully to a firm where everyone is excited about making customers happy with great products. Where managers who value PowerPoints above employees and customers can repeat the cycle.

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John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

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