Red Lobster, it seems, is about to be somebody else's problem.
Though it's not yet a done deal, Darden Restaurants (DRI), the owner of the seafood chain, set plans to sell it to private equity firm Golden Gate Capital in a $2.1 billion agreement. This sale had been contemplated for some time, as Red Lobster has been a drag on its parent company. Like many casual dining restaurants, including DineEquity's (DIN) Applebee's and Brinker International's (EAT) Chili's, customer counts largely have been weak for months as competition has intensified and "fast casual" chains such as Chipotle (CMG) have become more popular.
Darden says it's determined to make a go of fixing Olive Garden, another restaurant it owns that customers have turned against of late. In eight of the past nine months, guest traffic has been lower than the year-ago period. To try and address this, Darden has taken steps such as adding a burger, reworking the menu in general and even changing Olive Garden's logo, though the latter of these can create only so much buzz.
The company said it would "increase our focus on the Olive Garden brand renaissance program" and make an effort to "regain momentum" at the Italian chain. Not having to worry about two large, aging brands in need of repair will certainly be a benefit, although the road here will be long whether it succeeds or not.
It's highly likely some of the existing Red Lobster locations — 706 of them as of Feb. 23 — will be shutting down as a result of the sale. Golden Gate isn't going to be interested in holding on to a slow-growth shop customers are abandoning, and one with only modest ability to raise prices.
Ultimately, Golden Gate wants a positive return, and it isn't a stretch to expect downsizing to be part of that. Maybe Red Lobster eventually goes public as its own entity a few years from now, but regardless, the key is that this is about a financial restructuring. Red Lobster restaurants are what they are. That's not to say the menus can't be altered to a degree, that the stores can't be improved, that some customers can't be enticed back. It's only that Golden Gate isn't doing this because they're big fans of scallop and shrimp recipes.
In this acquisition, Golden Gate, whose previous investments include California Pizza Kitchen and Eddie Bauer, simultaneously arranged to sell the real estate for around 500 of the Red Lobster properties to American Realty Capital Properties (ARCP) and then lease the locations back. Those stores are logically viewed as the most viable for a chain that's been woeful at attracting diners. During the past 28 months, year-over-year guest traffic has been negative 21 times at Red Lobster, including nine in a row.
Plans in question
Total sales in fiscal year 2013 were $2.62 billion, though that was a 1.7% decline from the prior year. On a per-restaurant basis, the average store had sales of $3.7 million, down from $3.8 million in 2012. With trends being what they are, lowering Red Lobster's costs will be a top priority, because currently, revenue expansion isn't there.
Relatively speaking, Red Lobster is a cheap asset compared with similar operators, and that's a reflection of sluggish demand for its fare. One measure demonstrates this. The sale price that's been agreed upon is equal to about nine times the amount of Red Lobster's earnings before interest, taxes, depreciation and amortization, whereas competitors such as Ruby Tuesday (RT), Ignite Restaurant Group (IRG) — the owner of Romano's Macaroni Grill — and DineEqity have an average of nearer to 13. In other words, Wall Street puts a higher value on others, and that's telling considering the poor data for the group overall.
Meanwhile, Darden still has ample work ahead to solve some of its marketplace problems, as well as fending off activist shareholders who want the company to go in a different direction, not take a disappointing price. At the moment, it's stirred up the ire of a set of investors who fought against this very plan with Red Lobster. In March, Barington Capital Group said it was so unhappy with Darden that it wanted the board of directors to seriously consider firing CEO Clarence Otis.
Instead of parting with Red Lobster, Barington proposed that, among other things, Darden should separate Olive Garden and Red Lobster into one company and put its Capital Grille, LongHorn Steakhouse and other smaller chains into their own business. Another investor group, Starboard Value, similarly has opposed Darden's plans, and in published reports Friday expressed bafflement at the Golden Gate undertaking.
Darden says it will get cash proceeds of about $1.6 billion through the sale, around $1 billion of which will go to pay debt. The rest will be used to buy back shares. It hopes to complete the agreement in a few months.
On the whole, investors weren't impressed with any of this, as Darden's stock traded down 3.1% to $49.10. And it's difficult to imagine Darden's opponents have given up yet.