Darden, under pressure, to spin off or sell Red Lobster

By Lisa Baertlein and Aditi Shrivastava

(Reuters) - Darden Restaurants Inc (DRI) said it would spin off or sell its floundering Red Lobster chain, bowing to pressure from hedge fund Barington Capital Group, and warned that earnings would fall more than expected this year due to weak demand.

Barington, which represents shareholders who own more than 2 percent of Darden, and some Wall Street analysts contended that Darden's move was not aggressive enough.

"While today's announcement is a first step toward improving focus and operating execution at Red Lobster and Olive Garden, we view the plan Darden announced today as incomplete and inadequate," James Mitarotonda, chairman and chief executive of Barington, said in a statement.

New York-based Barington says Darden has become too large and complex to compete with direct rivals such as Cheesecake Factory (CAKE) and Brinker International's (EAT) Chili's Grill & Bar. The company also is under pressure from popular limited-service chains like Chipotle Mexican Grill (CMG), which have been stealing customers.

Barington has been pushing the company for months to split in two: one company to operate its mature Olive Garden and Red Lobster chains, and another for growing brands such as LongHorn Steakhouse, Seasons 52, Capital Grille and three others.

The hedge fund also has urged Darden, the largest U.S. full-service restaurant operator, to explore creating a publicly traded real estate investment trust (REIT) to "unlock the value" of its property holdings.

Barington said those actions could push Darden's stock to between $71 and $80. The shares were down 4.9 percent to $50.34 in midday trading on the New York Stock Exchange.

Asked on a conference call with investment analysts why the company was keeping Olive Garden, Darden Chief Executive Clarence Otis said the chain contributes strong cash flow and is a significant part of the company. Olive Garden has historically contributed about half of Darden's total revenue but of late has struggled to grow sales at established restaurants.

Otis said Darden had reviewed the potential for a REIT and determined that substantial costs and other factors did not make this a viable option.

"That is not something that we think makes sense going forward. We think the plan that we've outlined is a plan that best creates shareholder value," he said.

Janney Capital Markets analyst Mark Kalinowski gave the plan a mixed review.

"While we to some degree applaud this unexpected move ... we are somewhat puzzled that what will be left behind is still a seven-brand company in an industry in which succeeding over the long term with one brand can prove challenging," he said.

LATER, LOBSTER

Orlando-based Darden forecast a year-over-year drop in earnings per share of 15 to 20 percent for its fiscal year ending May 2014, due in part to a significant deterioration in Red Lobster's business in the latest quarter. It previously called for a decline of 3 to 5 percent.

Darden expects to close a tax-free spinoff of Red Lobster in early fiscal 2015 but said it also would consider a sale of the seafood chain, which accounts for an estimated 30 percent of company revenue.

A sale of Red Lobster could bring in $2.0 billion to $2.5 billion, Miller Tabak & Co analyst Stephen Anderson told Reuters.

Same-restaurant sales at Red Lobster declined a steeper-than-expected 4.5 percent in the second quarter that ended November 24 and have fallen in four of the last five quarters.

Many U.S. restaurant chains are fighting to increase sales and traffic amid intense competition that has taught budget-conscious diners to shop around for deals.

"Red Lobster has almost (been) forgotten as a place to eat by U.S. families as they perceive the brand as not offering the most value per plate," said Brian Sozzi, chief executive of Belus Capital Advisors.

While Darden has attracted younger and higher-income diners to Olive Garden, LongHorn Steakhouse and its other chains, the company has not replicated that success at Red Lobster.

"The spinoff will transform Darden into two independent public companies that can each focus on their different opportunities," Otis said.

Restaurant operators ranging from Darden direct rival Brinker to McDonald's Corp (MCD) have used that same strategy in recent years to focus on their core operations and improve results.

Darden's announcement on Thursday also outlined fewer new restaurant openings and other cost savings, proposed changes to executive compensation and plans to revive Olive Garden.

Some analysts cheered Darden's vow to put a halt to acquisitions after a multi-year buying spree that most recently added Eddie V's and Yard House to its holdings.

"It's about time," Kalinowski said.

Darden said its proposed cost-savings plans are expected to save $60 million annually. The company said it plans to use the freed-up cash to support dividends, share buybacks and to strengthen its credit profile.

Darden, whose market value is $6.9 billion, also said second-quarter net income fell 41 percent to $19.8 million, or 15 cents per share.

Goldman Sachs & Co is financial adviser to Darden, while Latham & Watkins will be its legal counsel. Wachtell, Lipton, Rosen & Katz is the legal adviser to Darden's board. (Reporting by Lisa Baertlein in Los Angeles and Aditi Shrivastava in Bangalore; Editing by Kirti Pandey, Saumyadeb Chakrabarty, John Wallace and Cynthia Osterman)