Please ensure Javascript is enabled for purposes of website accessibility

Activist Investors Have Had Enough of This Restaurant’s CEO and Board

By Mark Yagalla - Jul 22, 2014 at 4:46PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Starboard Value's latest letter to Darden Restaurants signals that the activist investor has had enough of management and the board of directors.

In April, I wrote an article titled "Activist Investors to Darden: Don't Throw Red Lobster Overboard." At the time, Darden Restaurants (DRI 3.64%) was thinking of spinning off Red Lobster. Activist investor Starboard Value objected to this idea because Starboard felt Red Lobster needed to be turned around in order for shareholders to get maximum value. Instead Darden decided to sell Red Lobster for $2.1 billion to private equity firm Golden Gate Capital. This Fool thinks that Red Lobster is a great catch for the private equity firm.

Source: Darden Restaurants

Starboard Value was quick to voice its displeasure with the deal. Starboard CEO Jeffrey Smith said that "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." Starboard Value was even asking for a special shareholder meeting to discuss Red Lobster. However, the board of Darden Restaurants rebuffed the offer and is selling Red Lobster without a shareholder vote.

Source: BJ's Restaurants

Darden Restaurants has chosen to fight Starboard Value every step of the way. For this Fool, this doesn't make much sense since Starboard owns over 7% of the company. Darden's approach is completely different from that of BJ's Restaurants (BJRI 3.40%). Earlier this year, PW Partners and Luxor Capital Partners were threatening BJ's Restaurants with a proxy fight and had five nominees for the company's board. In the end, BJ's Restaurants and the activists struck an agreement and nominated three new directors and approved a new $50 million share repurchase plan.

Why is Starboard Value so upset?
Well, for one, it's all about money. Since Darden agreed to sell Red Lobster, its stock has dropped 11%. For a hedge fund that owns 7% of it, that equates to a paper loss of about $70 million. The rest of Darden's shareholders have lost $930 million and they can't be too happy either. In the past five years, shares of Darden Restaurants have underperformed the S&P 500 by 66%. Compare Darden to other restaurant stocks and it does even worse. Shares of Darden Restaurants have trailed those of its closest direct peers by a whopping 296%.

The relationship does not look repairable
You know things are bad between Starboard Value and Darden Restaurants when Starboard Value started off its latest letter to the board by quoting Bill Darden, the founder of Darden Restaurants. The letter began with Bill Darden saying:

You just have to have good people if you are going to have a good operation, without them you are lost.

All this Fool can say is "ouch!" The letter didn't get any better from there. It went on to say that Darden Restaurants has drifted too far away from the founder's core principles. Starboard cited poor leadership and excessive corporate spending as Darden's problems. Starboard wants new leadership in place and has nominated its own slate of candidates for Darden's board.

Source: Darden Restaurants

Starboard sees current management and the board as hindering Darden's turnaround efforts. The hedge fund doesn't see how Darden's management can engineer a turnaround when they built Darden into what it is today. Clarence Otis started working for Darden in 1995 and became CEO in 2004 and Chairman in 2005.

Why didn't Darden go the route of BJ's Restaurants?
Why Darden has chosen to fight with Starboard Value puzzles this Fool. Shareholders and management should work together. Dialogue helps both sides and constructive criticism is great for a company, especially since there are so many stakeholders. That's why BJ's Restaurants chose to work with its activist shareholders and listen to them. After all, why wouldn't management listen to its largest shareholders? They are the ones that own the company and not management.

Source: wdpartners.com

BJ's Restaurants came to an agreement with its shareholders before the annual meeting, and things have been much better for all parties since then. Management has focused on running the business, and the results speak for themselves. First-quarter earnings per share beat expectations by $0.08 and revenue grew 9% year-over-year. BJ's also rolled out its new mobile app, which allows customers to place their orders in advance, pay without waiting for the check, view wait times, and make reservations.

Foolish final thoughts
The good news is that Starboard Value's fight with Darden's management will be decided in September at the annual meeting. Starboard Value has used the sell-off in Darden shares to increase its stake to 7.1%. If Starboard Value were to get its nominees elected, the hedge fund would likely split up Darden. One company would hold the real estate assets and Darden's Specialty Restaurant Group would become a separately traded company. Either way, I have to agree with what Starboard Value wrote toward the end of its letter.

We believe Darden is a valuable company worth improving and represents one of the most compelling investment opportunities currently available.

The upcoming annual meeting should make for great theater nonetheless. All this Fool can picture is the movie Wall Street and Gordon Gekko criticizing the management of Teldar Paper. In the end, it's up to the shareholders to decide what's best. Shareholders can either stick with management's turnaround plan or go with Starboard Value and see some big changes.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Darden Restaurants, Inc. Stock Quote
Darden Restaurants, Inc.
DRI
$118.51 (3.64%) $4.16
BJ's Restaurants, Inc. Stock Quote
BJ's Restaurants, Inc.
BJRI
$22.84 (3.40%) $0.75

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
316%
 
S&P 500 Returns
112%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/05/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.