Strategic analysis: Should Darden spin off its brands? (Part 24 of 25)
Potential return of 75% to 100%
Darden’s share price could rise 27% from the current price due to real estate valuation and tax efficiency gain, and another 50% to 80% gain from operating efficiency. In total, we’re looking at some potential 75% to 100% gain over the next one to three years if the spinoff is successful and the new management can work its magic. Sounds great, right? So how is this going to play out? Will share prices jump substantially right after the announcement of a spinoff?
Spinoffs tend to decline after the event
This is unlikely, because companies that spin off are generally known to decline for imbalances in market supply and demand. Those who want to own Darden’s REITs, including REIT ETFs and funds that specialize in real estate, will likely wait until the spinoff actually occurs before buying. The new high-growth and REIT companies could face selling pressure, as Darden is 80% held by institutions and brokers and is part of large ETFs like the iShares Select Dividend ETF (DVY), Consumer Discretionary Select Sector SPDR ETF (XLY), and WisdomTree Dividend ex-Financials ETF (DTN). When companies spin off a part of their business or businesses, they’ve often sold off historically at first, as Joel Greenblatt mentioned in his book (see Part 3), because they’re small or they’re non-core to the fund or ETF.
New REIT will likely be unattractive initially
But even after the spinoff, share prices could decline more or move sideways for a while. That’s because Darden would be the new REIT’s “only” customer. Risky. This concentration would likely deter investors if they see that Darden’s restaurants haven’t been performing well lately.
Further reasons why new companies may sell off
Poor performance at Olive Garden and Red Lobster will also negatively impact Darden’s new “mature” company. With new changes, internal and external pressures can lead to missed earnings. Uncertainties on the company’s future prospects and strategy outlook can cause selloffs. Managers may deliberately make new companies look unattractive, as their options’ strike price sometimes depends on the initial few days of trading. Yes, it’s possible.
Opportunity after the selloff
These options, of course, are given as an incentive for them to clean out garbage, align interests, and follow an incentive to add value. Besides, it isn’t like shares will jump right away after the company spins off, because investors would still want to see what the new management’s plan is and see it work before bidding share prices up. Generally, spinoff companies have performed well in the second year after the split occurs—subject to case.
Note the management change
This means investors should note who’ll be heading Darden’s new companies after the split. If the right kind of management is placed for each of the three businesses, then you have companies that will perform well. Otherwise, share prices may not rise as much. With Barington Capital Group LP proposing a split, though, it wouldn’t be surprising if the investment firm is already thinking about or searching for prospective candidates to be on the new companies’ management teams or boards.
If the new companies do perform well, valuation for the REIT should rise, as investors would be willing to pay more for a drop of cash flow that the REIT distributes. Even if the REIT doesn’t appreciate in value, a diversified REIT could buy Darden’s REIT out.
Investors looking for a more diversified spinoff opportunity can use the Guggenheim Spin-Off ETF (CSD).
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