This is the way rumors start -- and end -- and start again.
LA Weekly ran a blog post about the trials and tribulations at Red Lobster. Parent company Darden Restaurants (NYSE:DRI) has been struggling to draw guests and shake negative comps at the country's largest seafood restaurant, and it announced plans to either sell of spin off the concept by the middle of next year.
Unfortunately for LA Weekly's Squid Ink blog column, the entry describing the news originally had an unfortunate headline suggesting that Red Lobster was closing. In this world of social media, it was too easy for folks to take the headline without reading the contents of an article and begin spreading it virally. Before you know it, "Red Lobster closing" started trending. LA Weekly eventually edited its headline for accuracy, but the damage was done. Darden even took to Twitter to clear its own name.
That's nice, but what if LA Weekly's post wasn't wrong as much as it was just early? How sure can we be that Red Lobster will be able to find a buyer or be financially feasible as a spinoff? For starters, Darden has closed chains before. It shuttered the 51-unit China Coast chain in 1995. Red Lobster is much larger at 705 restaurants, but what happens if Darden can't turn around the chain's waning popularity?
Things are pretty bad at Red Lobster. Comps have fallen 4.5% and 5.2% in the past two quarters. Red Lobster has been increasing prices over the past year, so its actual popularity is declining even faster. Store traffic declined 7.3% last month, and there was a 9.9% plunge in October. Red Lobster revamped its menu 14 months ago -- adding new non-seafood dishes to appeal to landlubbers -- but it didn't work.
Darden's been able to use even a meandering Red Lobster as a cash cow, taking its cash flow and throwing it at smaller and more promising concepts. However, that naturally ends if Red Lobster is sold or spun off. In other words, Red Lobster has outlived its usefulness to Darden. Why else would Darden be dropping it as bait in the water to reel in a suitor? Why would it spin off a chain that is no longer a growth vehicle -- there's one less restaurant now than there was a year ago -- to investors beyond making the remaining assets look better?
Red Lobster's dwindling bottom-line performance is a big reason profitability is plunging at Darden. Why would someone else want to buy it? Private equity firms don't have a problem taking chances, but we've seen what happens to concepts once they start to fade. As big as Steak and Ale, Bennigan's, or Howard Johnson's were, good luck finding one today.
Red Lobster is still alive, but it's not well. Anyone thinking there will be 705 or more Red Lobsters across North America in three to five years hasn't learned enough from history -- or from Darden.
Longtime Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.