U.S. Markets closed

Darden keeping Olive Garden hurts investors but helps Red Lobster

Xun Yao Chen

Despite displeased investors, Darden may have made the best decision (Part 8 of 10)

(Continued from Part 7)

Olive Garden

For existing investors, the decision not to spin off Olive Garden may limit share price appreciation growth. Despite the plans and hopes for existing management to turn around Olive Garden (see a previous article), whether it will work or not is something for investors to see by venturing into the restaurant from time to time in 2014.

Furthermore, Olive Garden’s business still looks far different from the rest of Darden’s brands. Average check per guest at Olive Garden is only about $15 to $16, while alcohol sales only account for 7.5% of total sales.

In contrast, Darden’s more premium brands have average check per guest above $25 and alcohol sales above 25% of total sales. Unless Darden can figure out a new business model that would disrupt the way restaurants have operated in the past, it’s quite an unusual mix.

LongHorn Steakhouse

Investors may ask why LongHorn Steakhouse hasn’t spun off. There are varying views among analysts and hedge funds on this. Just a few days ago, Starboard hedge fund pushed for spinning off Red Lobster, Olive Garden, and LongHorn Steakhouse as a whole, while Barington Capital Group recommends grouping Red Lobster and Olive Garden together.

Based on average check per guest, LongHorn Steakhouse does fall close to Red Lobster and Olive Garden. But people perceive steak to be a separate category and it’s still a growing market compared to casual seafood and Italian. (As our in-depth analysis shows, steak brands have performed well recently: Darden Analysis: Why lower average checks are outperforming.) Even if pressure is on to separate LongHorn Steakhouse, it’s the most unlikely because management wouldn’t let go of it.

Red Lobster spinoff

Regardless, investors should be cheering management’s decision to only separate Red Lobster, because Red Lobster has experienced underperformance in same-store sales growth over the past few years and its financials are expected to look poor.

This means opportunity. By separating just Red Lobster, the new management can focus on rebuilding every single part of Red Lobster’s brand—from the menu to the kitchen to operations to management. While the overall Darden value may be higher if management also decided to remove Olive Garden and Red Lobster together, it could have hampered recovery.

Continue to Part 9

Browse this series on Market Realist: