Mr. Market did not take too kindly to the news that Darden Restaurants (DRI +2.13%) is selling Red Lobster for $2.1 billion. Hedge fund Starboard Value came out and said that the deal undervalues Red Lobster by as much as $800 million. Further complicating matters is the fact the Golden Gate Capital is the buyer. Golden Gate Capital is known for spotting a good deal when it sees one.
The questions on everyone's minds are: Who's getting the better deal, Darden or Golden Gate Capital? And what does this mean for Darden shareholders?
Source: Red Lobster
You no longer need to go to Red Lobster for cheddar bay biscuits
One of the best things about going to Red Lobster has always been the cheddar bay biscuits. But now, you don't have to go to Red Lobster for them. Just search and you come up with recipes like this one from the Brown Eyed Baker. Then you can make them yourself.
Source: Brown Eyed Baker
It's problems like this that have led to Red Lobster's sales declines. Red Lobster is the weakest brand in Darden's portfolio, so it makes sense for management to sell it. In Darden's most recent quarter, comparable sales at Red Lobster declined 8.8%. The only bright spot was that Red Lobster benefited from an increase in prices and menu mix, but it still wasn't enough to offset the double-digit decline in foot traffic.
|
Red Lobster |
December |
January |
February |
|
Same-Restaurant Sales |
-10.2% |
-12.2% |
-4.5% |
|
Same-Restaurant Traffic |
-12.3% |
-18.7% |
-11.9% |
|
Pricing |
1.7% |
1.8% |
1.7% |
|
Menu Mix |
0.4% |
4.7% |
5.8% |
Source: Darden Restaurants
A formula for success
What's making matters difficult for Darden investors is that Red Lobster's buyer is Golden Gate Capital. Golden Gate Capital is following a pattern that it used on past restaurant deals. One of its last deals was the purchase of Romano's Macaroni Grill from Brinker International (EAT +0.19%) in 2008 for $88 million. Golden Gate then immediately turned around and sold 39 of the locations to Cardinal Capital Partners, which provided Golden Gate Capital with the majority of the capital it needed for the purchase.
Last year, Golden Gate Capital cashed out of its investment in Romano's Macaroni Grill by selling the chain to Ignite Restaurant Group (NASDAQ: IRG) for $55 million. It is estimated that Golden Gate Capital made 2.5 times its investment in Macaroni Grill.
Source: Romano's Macaroni Grill
Golden Gate Capital appears to be following the same formula with Red Lobster. The purchase price is $2.1 billion. However, Golden Gate has already entered into a deal with American Realty Capital Partners for a sale-leaseback transaction valued at $1.5 billion. Thus, Golden Gate Capital only has to come up with about $600 million to get the Red Lobster brand and ownership of the remaining 205 restaurants.
Golden Gate Capital looks to be happy with the deal. According to Josh Olshansky, a managing director at Golden Gate:
Red Lobster is an exceptionally strong brand with an unparalleled market position in seafood casual dining. Red Lobster is exactly the type of company in which we seek to invest given its great brand profile and strong management team. We see significant opportunities for future growth by partnering with Kim Lopdrup and the management team to support the long-term success of Red Lobster.
Joe's Crab Shack continues to outperform Red Lobster
Darden Restaurants cannot blame Red Lobster's poor performance on the fact that it is a seafood restaurant. I first highlighted Red Lobster's struggles with competitor Joe's Crab Shack in November with "Joe's Crab Shack Is Eating Red Lobster's Lunch." Joe's Crab Shack has delivered six straight years of annual comparable sales growth for its parent Ignite Restaurant Group.
The latest quarter, however, was more of a struggle for Joe's Crab Shack, as comparable sales decreased 6% due to the winter weather. With plenty of outdoor seating, it's easy to see why comparable sales fell at Joe's. The results were still 2.8% better than Red Lobster's.
Source: Joe's Crab Shack
What's next for Darden Restaurants?
Starboard Value, which owns 5.5% of Darden Restaurants, voiced its displeasure with the deal. Starboard CEO Jeffrey Smith said:
The announced sale woefully undervalues Red Lobster and its real estate assets. It appears that Darden has instead sold Red Lobster in a rushed transaction at a severe discount.
Darden Restaurants said it concluded that the Golden Gate Capital deal was the best option for the company. Darden expects to receive $1.6 billion from the transaction and will use $1 billion to retire outstanding debt; the balance will go toward share repurchases.
Source: Darden Restaurants
Foolish final thoughts
I do think Golden Gate Capital is getting a good deal with its purchase of Red Lobster. The firm will likely make plenty of money off the deal, just like it did with Romano's Macaroni Grill. And while some may question why Darden Restaurants did not do a deal directly with American Capital Realty Partners, I think the company just wanted to get rid of Red Lobster.
I think Red Lobster had become too much of a distraction for management; it took the company's focus away from turning around Olive Garden and growing its other concepts. If the company can achieve those goals and continue rewarding shareholders with share buybacks and dividends, I think the long-term future just got a little brighter for Darden shareholders.
