Olive Garden's Parent Needs a Fix, but Would a Company Split Help?

Darden Restaurants has long frustrated investors. Its flagship brand, Olive Garden, has seen traffic dip as all-you-can-eat salad and breadsticks no longer entice budget diners as they once did, and widespread discounting has pummeled profits. Even worse for Darden management, those discounts have largely failed to boost sales.

Is there a fix? Barington Capital Group, a hedge fund that owns about 2.8 percent of Darden’s shares, is pushing for a split of the company into three units: the mature chains, Red Lobster and Olive Garden; a growth unit that consists of the LongHorn Steakhouse, Bahama Breeze, Yard House, Capital Grille, Seasons 52, and Eddie V’s brands; and a publicly traded investment trust with Darden’s extensive real estate holdings. The Orlando-based company owns more real estate than most of its restaurant competitors; Barington estimates that Darden’s land and property holdings are worth more than $4 billion.

Barington argues that Darden’s portfolio has become too complex to compete in the industry, as it added five of its eight restaurant brands since 2007. “As a result of these acquisitions, Darden has become a complex business, managing eight restaurant brands that target different customer segments, have different marketing needs, serve vastly different menus with different price points and require different culinary and customer experience innovations,” Barington said in a presentation (PDF) it released today, ahead of the company’s Dec. 19 quarterly earnings call.

In an e-mailed statement, Darden said its board “will take the time necessary to thoroughly evaluate Barington’s suggestions, just as the company does for any of its shareholders.” Olive Garden and Red Lobster accounted for almost three-quarters of the company’s $8.7 billion in revenue over the past year. The company has more than 2,100 restaurants total.

Barington contends that its plan would send Darden shares as high as $80. At its current price of around $52, the stock has gained 16 percent this year—including 13 percent since Barington revealed its breakup plans in October—trailing rivals such as Brinker International (47 percent), Cheesecake Factory (46 percent), Del Frisco’s Restaurant Group (35 percent), and DineEquity (24 percent), the parent of the Applebee’s and IHOP chains.

Wall Street analysts aren’t persuaded, for the most part, that splitting Darden would help all that much. Analysts have generally been more keen on a broad $50 million cost-cutting plan the chain introduced this fall. Darden spends significantly more than rivals on advertising, primarily for its two flagship chains, and it’s far from clear that those ubiquitous TV ads are helping the company much. For Darden, the “biggest value enhancer” would be a turnaround at Olive Garden, Oppenheimer analyst Brian Bittner wrote in a client note today, although he’s not optimistic that will begin in the current quarter. In October, Telsey Advisory Group analyst Peter Saleh predicted that Darden directors would not split the company but begin focusing on free cash flow and less on expansion.

Barington said its recommendations had been subject to an independent review by Houlihan Lokey, an investment bank the hedge fund hired to assess the plan. “Their work not only confirms the opportunities we identified to improve long-term shareholder value at Darden, it also adds practical strategies to execute our recommendations and mitigate implementation costs,” Barington’s founder and chief executive, James Mitarotonda, said in a statement.

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