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Source: Financial Times Lex, December 10, 2013 commentary



Darden Restaurants: Food fight

Whether activist investors can cook is not the point. Only serve them hors d’oeuvres and they will storm the kitchen, whatever their culinary talents. So Darden Restaurants is learning. The parent company of the languishing Red Lobster and Olive Garden restaurant chains has offered some nibbles, such as $50m in cost cuts, to agitator Barington Capital. While appetising, they fall short of the heaping platter of spin-offs Barington craves – and which, if enacted, could lead to indigestion.

Traffic at the major “casual dining” (cheapish, waiter service) chains fell nearly a fifth between 2006 and 2012, JPMorgan says. The troubles are not just about the weak US consumer or the rise of “fast casual” (cheaper, counter service) chains such as Chipotle. Darden has not adapted. Operating expenses ate up 10 per cent of revenue in the 2013 financial year, twice the level of rival Brinker (the parent of Chili’s). Its capital expenditure to revenue ratio of 8 per cent also looks high. As such, Darden’s hefty dividend takes up much of its $300m in free cash flow.

Barington’s most daring demand is that Darden break itself up. Its smaller chains would be put into a new company, which could trade at a higher valuation given that – unlike Olive Garden and Red Lobster – they have positive same-store sales growth. Yet this new company could take some of the $150m in cost cuts Barington also wants away with it.

A spicier idea is a flotation of Darden’s sizeable property portfolio. Property companies tend to trade on higher multiples than restaurant companies, and Morgan Stanley estimates that floating the division could boost total shareholder value by 25 per cent. Risk lurks, though. The move requires Darden to become a debtor to the property company, since it must lease space and leverage would spike.

Barington’s spin-off ideas are not necessarily unwise, but they are trickier than presented. And the menu of fixes still lacks a plan to grow sales again at the flagship chains.

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Copyright The Financial Times Limited 2013.



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