Darden Restaurants Inc. is the latest publicly traded restaurant company to field calls from shareholders to spin off or sell major parts of its business —just days after reporting a “surprisingly weak” first quarter and announcing layoffs and cost-cutting initiatives.
The Orlando, Fla.-based parent of Red Lobster, Olive Garden, LongHorn Steakhouse and a “specialty” group of high-growth casual-dining brands recently held meetings with hedge fund Barington Capital Group LP, a firm that has suggested publicly that Darden split itself into two companies.
Barington, which reportedly owns a 2.8-percent stake in Darden, was quoted in the Wall Street Journal calling for the company to spin off its flagship Olive Garden and Red Lobster chains, which have performed erratically over the past year, into a separate company. The remaining entity would consist of the better-performing LongHorn Steakhouse and the five chains in Darden’s Specialty Restaurant Group: Bahama Breeze, Eddie V’s Steakhouse, The Capital Grille, Seasons 52 and Yard House.
Darden’s director of communications, Rich Jeffers, wrote in an email that Darden welcomed Barington’s input about how the company could enhance shareholder value. “The board [of directors] will take the time necessary to thoroughly evaluate Barington’s suggestions, just as the company does for any of its shareholders,” he wrote.
Before Barington’s proposals were reported this past week, Darden announced that it would eliminate 85 jobs at its corporate headquarters and implement other cost-cutting initiatives. The company aims to save $50 million per year in annual general and administrative expenses beginning fiscal 2015. At the same time, president and chief operating officer Drew Madsen announced his retirement, which will take effect at the end of Darden’s second quarter in November.
Darden also reported that fiscal first quarter same-store sales fell 4 percent at Olive Garden and 5.2 percent at Red Lobster. LongHorn’s same-store sales rose 3.2 percent in the first quarter, while the Specialty Restaurant Group’s collective comparable sales rose 0.5 percent.
Of all of Darden’s brands, its two largest concepts, Olive Garden and Red Lobster, have had the most erratic performance in the past year. While same-store sales had risen slightly to 1.1 percent at Olive Garden and 3.2 percent at Red Lobster in the fourth quarter of fiscal 2013, annual same-store sales at those chains decreased 1.1 percent and 2.2 percent for the full year.
Darden leaders said those two brands’ heavy focus on value advertising would be the norm going forward, in an effort to increase restaurant traffic, even at the risk of profit margins.
In the first quarter following that disclosure, Olive Garden achieved its sales targets with the three-course Italian dinner for $12.95 promotion in June and the Never Ending Pasta Bowl in August, but the brand’s “two Italian dinners for $25” offer fell below expectations for traffic, officials said. Similarly at Red Lobster, the Endless Shrimp promotion in August met expectations, but the June and July offers of Seaside Mix & Match and the Four Course Seafood Feast, respectively, did not.
Parts and parcels
Activist shareholders have made public demands of several other public restaurant companies this year.
Last month, for example, Bob Evans Farms Inc. fended off a call from Sandell Asset Management, which has a more than 5-percent stake in the Columbus, Ohio-based company, to split its restaurant and packaged-foods businesses and perform a giant sale-leaseback transaction of its owned real estate.
In August, the board of directors at Cracker Barrel Old Country Store Inc. rebuffed shareholder Sardar Biglari’s nomination to the board for the third time in three years. Among other proposals, Biglari had called for Cracker Barrel to slow the pace of its new-unit openings and for the removal of several directors from the board.
In light of the news that Barington had taken an activist stakeholder position with Darden this week, securities analyst Sara Senatore with Bernstein Research republished a research note from earlier this year that explored how Darden might unlock shareholder value in the absence of a sales turnaround at Red Lobster and Olive Garden.
Her note found that a “sum-of-the-parts” analysis commonly used by investors looking to break up an underperforming company likely would not find Darden to be significantly undervalued.
“We believe investors assessing Darden may also be considering nonfundamental drivers [of value creation],” Senatore wrote in April, “such as a potential spinoff of either the high-growth Specialty Restaurant Group at a presumably premium multiple, or the low-growth ‘cash cow’ of Red Lobster to a financial acquirer. A sum-of-the-parts analysis using comparable publicly traded companies does not suggest Darden’s assets are substantially underappreciated.”
Darden’s real estate holdings could be worth as much as $30 per share if they were part of a sale-leaseback transaction, she noted, but Darden likely would not pursue such a deal because operating cash flow would decrease significantly if the company had to pay much higher rent to a new landlord.
John Gordon, principal of San Diego-based Pacific Management Consulting Group, speculated that Darden would fight calls to divest the Specialty Restaurant Group because of what Darden officials call “internal synergies,” which the company would be unwilling to give up.
Darden wants to keep the high-growth potential of Capital Grille and its other assets in the specialty group, Gordon said, and it needs the significant cash flow from Olive Garden and Red Lobster to fund it.
“When you ramp up development of a Capital Grille or a Seasons 52 or LongHorn, the first year is expensive and a little slow,” he said. “Darden has said that the Specialty Restaurant Group concepts can stand on their own, but is that always true? I suspect that’s what they’re talking about when they talk about internal synergies.”
He added that Darden — as well as Bob Evans, for that matter — likely would have no interest in exploring a sale-leaseback transaction for its real estate.
“The reason why the investors want to do it is because they just want to make some money in the next year, but the restaurant brands are there forever,” Gordon said. “It’s the tale of the U.S. economy: short-term gratification versus longer-term thinking. But once you hold your real estate, your P&L looks better and you can own your destiny more, rather than some landlord owning it.”
Darden operates 704 Red Lobster units, 832 Olive Garden restaurants, 438 LongHorn Steakhouse units and 175 locations in the Specialty Restaurant Group.