Overview: Starboard Value's activist position at Darden (Part 2 of 7)
Darden sells Red Lobster business
Activist investor Starboard Value has launched a proxy fight to gain control over the board of Darden Restaurants (DRI), after opposing the sale of Darden’s Red Lobster seafood chain to private equity company Golden Gate Capital. The fund said the sale of Red Lobster was “a value-destructive transaction” and that it “woefully undervalues” the brand and its real estate.
In a July letter, Starboard said that in the two months since the sale was announced Darden’s stock price has declined by ~11% and underperformed its peers by 16%. The stock price is currently down 11% year-to-date (or YTD). Another activist fund and shareholder Barington Capital also noted in a release that the Red Lobster transaction was made at a “fire sale” price. Darden saw a lawsuit from Starboard last month over disclosure of the records of the Red Lobster sale as the fund claimed “Darden shouldn’t be allowed to hide information regarding a deal of this magnitude which has had such negative consequences for its shareholders.”
The Red Lobster business was sold for $2.1 billion last month. Darden said in a release that it expects to receive net cash proceeds, after tax and transaction costs, of a~$1.6 billion, of which ~$1 billion was to be used to retire outstanding debt. The remaining net proceeds of ~$500–$600 million will be deployed for a new share repurchase program of up to $700 million in fiscal 2015. Darden said the purchase price was approximately nine times Red Lobster’s earnings before interest, taxes, depreciation, and amortization (or EBITDA) for the 12 months ending April 27, 2014. Golden Gate Capital also separately executed a $1.5 billion sale-leaseback agreement with American Realty Capital Properties (ARCP). Darden said “the Red Lobster sale allowed it to monetize a declining asset at an optimal price with proceeds used for buybacks and debt retirement which benefits shareholders more than carrying the risk and volatility associated with owning Red Lobster.”
Starboard and Barington believe sale of Red Lobster destroyed value
Starboard has called the sale the “most egregious violations of shareholder trust we have ever seen,” and added that the decision resulted in a loss of more than $1 billion in shareholder value. The fund said that Red Lobster generated $2.5 billion in sales and $108 million in EBITDA and that Darden’s actual net proceeds from the deal for the operating business “approximate zero” given the debt breakage costs and transaction fees.
A March presentation by the hedge fund noted that Red Lobster’s operating business and real estate assets were estimated to be worth ~$2.4 billion. Starboard believes Darden destroyed $800 million in shareholder value with the sale, and added that “given the readily apparent opportunity for improvement in Red Lobster’s earnings, the value destruction relative to the true value of Red Lobster inside of Darden was likely well over $1 billion.” It further said this was approximately in line with the $1 billion in market value that Darden’s stock has lost relative to peers that include Cheesecake Factory (CAKE), Texas Roadhouse (TXRH), Brinker International Inc. (EAT) and Bloomin’ Brands (BLMN). Starboard said that the board needs to be accountable because the “negative reaction to the Red Lobster sale isn’t an isolated incident—it follows a period during which Darden’s stock had already underperformed peers by ~300%.”
The fund claimed that the nine times EBITDA transaction multiple claimed by Darden was a “gross distortion of the facts.” Golden Gate agreed to sell Red Lobster’s real estate to American Realty Capital Properties for $1.5 billion, so the actual purchase price for the Red Lobster operating business is just $600 million. Starboard said “due to the tax-inefficient manner in which the transaction was structured, the net proceeds to Darden of $1.6 billion, less the $1.5 billion of real estate value that could have been realized by Darden tax-free, meant that the value of Red Lobster’s operating business was a paltry $100 million, or less than one times EBITDA.”
Both Starboard and Barington believe that Darden’s management failed to explore options such as the retention of Red Lobster’s real estate and the creation of a real estate investment trust (or REIT) to enhance future shareholder value. Last year they proposed Darden’s break up into three separate companies comprising real estate assets spun off as an REIT; one consisting of flagship brands Olive Garden and Red Lobster; and a third one with higher growth brands such as Longhorn Steakhouse, and the Specialty Restaurant Group with Bahama Breeze, Eddie V’s Steakhouse, The Capital Grille, Seasons 52, and Yard House brands.
Darden says Red Lobster REIT wasn’t a viable option
In response, Darden said that the “$2.1 billion purchase price represents a premium multiple compared to comparable restaurant deals and exceeded industry analysts’ expected valuation ranges for the Red Lobster business, particularly taking into account Red Lobster’s deteriorating performance.” Also, Starboard’s suggested tax free and other tax efficient alternatives “were explored in depth by the Board and advisers, but weren’t viable, value creating options,” Darden noted in a release. It added that its board believes that a Red Lobster REIT wasn’t a viable tax efficient alternative. Given its exposure to a single property type and single tenant, a Red Lobster REIT would likely trade at a meaningful discount to publicly-traded triple net REITs, the company said. It added that Starboard incorrectly assumed that a $1.5 billion valuation of Red Lobster’s real estate, which was achieved through a highly competitive bidding process, could have been achieved in a stand-alone REIT.
Browse this series on Market Realist: