Red Lobster Split Seen as Wrong Recipe to Boost Darden: Real M&A

Shareholders aren’t happy with Darden Restaurants Inc.’s plan to sell or spin off Red Lobster, which doesn’t solve the biggest problem: finding more customers.

Darden, also the owner of Olive Garden and LongHorn Steakhouse, slid 3.5 percent last week after announcing it will separate the Red Lobster seafood chain. Raymond James Financial Inc. says a breakup won’t create much value for Darden, which is trading at a discount to most of its competitors. The plan falls short of activist investor Barington Capital Group LP’s proposals for a bigger shakeup, including ways to profit from its real estate. Starboard Value LP, which disclosed a stake in the company today, also said Darden’s proposal is inadequate.

With Red Lobster’s same-store sales declining, Darden instead should focus on luring diners to boost returns over the long haul, according to Albert Fried & Co. Some private-equity firms may see an opportunity to buy the chain and bring it back to health, Miller Tabak & Co. said. Acquirers in the U.S. restaurant industry typically pay about the equivalent of the target’s revenue, implying $2.6 billion for Red Lobster, according to data compiled by Bloomberg. As a standalone company though, it would trade at a discount to other chains, S&P Capital IQ said.

“The market is disappointed and saying, ‘OK, this is just a concession,’” Sachin Shah, a special situations and merger arbitrage strategist at New York-based Albert Fried, said in a phone interview. “Step one really should be fixing the business. Right now, Darden needs to be aggressive in innovating and investing in the business and changing the mentality that Red Lobster is a mature, stagnant brand. That’s how you create long-term value.”

Planning Strategy

Rich Jeffers, a spokesman for Orlando, Florida-based Darden, said the company is beginning work on a strategic plan for Red Lobster and picked Kim Lopdrup from its specialty restaurant group to lead the effort as chief executive officer of the chain.

Darden said the separation will allow Red Lobster’s marketing and operating strategies to be more tailored to the chain of 705 restaurants. Darden hasn’t yet decided whether it will sell Red Lobster or spin it off as a publicly traded company. It expects to close on any deal by the early part of fiscal 2015, which begins in late May.

While Darden is taking steps in the right direction, they’re not transformative and “could result in only modest changes in performance,” Sara Senatore, an analyst at Sanford C. Bernstein & Co., wrote in a Dec. 19 report. “Specifically, the value of a Red Lobster remains an open question.”

Not Enough?

Darden’s plans for Red Lobster may not be enough on their own, David Tarantino, an analyst at Robert W. Baird & Co., wrote in a Dec. 20 report. The key to creating value for shareholders rests with Darden’s ability to boost its operations, “and visibility to such improvement remains low.”

The restaurant operator is trailing some of its rivals amid competition for customers who are eating out less. Since the U.S. recession ended in June 2009, the Bloomberg Industries index of North American casual restaurants has climbed 164 percent, versus only a 55 percent gain at Darden.

Darden’s same-store sales fell in the past six months, and growth at Olive Garden -- its largest chain, accounting for more than 40 percent of revenue -- has slowed. While its smaller brands such as The Capital Grille and Eddie V’s are seeing a pickup in revenue at restaurants open for more than a year, Red Lobster’s same-store sales tumbled 4.6 percent in the quarter that ended in November after a 2.2 percent dip in the year that ended in May, according to data compiled by Bloomberg.

“This quarter was very bad” for Red Lobster, Bryan Elliott, an Atlanta-based analyst at Raymond James, said in a phone interview. “Its customer base is slowly dissipating.”

Activist Push

Shareholder Barington Capital, which has been pressing for changes at the $6.7 billion company, outlined its proposals last week before the restaurant operator announced its own plan. The New York-based hedge fund suggested splitting Darden in two because having more narrowly focused companies would lead to better operational performance. It would involve breaking apart Olive Garden and Red Lobster into one company and the smaller, faster-growing chains into another.

Barington, which owns more than 2 percent of Darden shares, also said that creating a publicly traded real estate investment trust would unlock the value of the company’s properties, which it pegs at about $4 billion.

Darden’s plan “fails to address significant opportunities to enhance long-term shareholder value,” Barington CEO James Mitarotonda wrote in an e-mail Dec. 19 to Bloomberg News.

‘Significant Opportunities’

Today, Starboard disclosed a 5.6 percent stake in Darden and said the company’s plan for Red Lobster falls short of what’s needed to boost its value. It said it may seek talks with management and other shareholders.

There is “significant opportunity” to improve Darden’s operating performance and potential to generate value from the company’s real estate holdings, Starboard, a New York-based hedge fund, said in a filing.

Darden shares gained 6.4 percent today to $54.35.

There may be private-equity firms that are willing to stomach the turnaround Red Lobster needs and also see value in its real estate, according to Stephen Anderson, a New York-based analyst at Miller Tabak. While Darden is probably too large for a buyout, Red Lobster is about the size financial buyers typically seek, he said.

Deal Comparisons

Similar-sized U.S. restaurants have sold for 0.5 to 1.5 times trailing 12-month revenue, before accounting for any cash or debt, data compiled by Bloomberg show. Using the median multiple of 1, Red Lobster would command about $2.6 billion in a sale.

“Private equity might come in to make some changes to the brand, look for increased efficiencies and close some unprofitable locations,” Anderson said in a phone interview.

If Darden doesn’t receive any offers for Red Lobster and opts instead to take it public, it will probably fetch a lower valuation than peers as sales remain weak and customers continue to shy away from the rising cost of seafood, according to S&P Capital IQ’s Jim Yin. A deal won’t have much of an effect on Darden’s valuation either, the New York-based analyst said.

Darden’s enterprise value last week of $9.5 billion was equal to 7.4 times its trailing 12-month earnings before interest, taxes, depreciation and amortization. That’s already lower than 86 percent of North American casual restaurants, data compiled by Bloomberg show.

Splitting off Red Lobster “will probably be neutral at best,” Yin said in a phone interview. “The benefit of the potentially slightly higher valuation of this newer Darden I don’t think will compensate for the decreased valuation that will be put on Red Lobster.”