Wednesday, Sep 17, 2014 07:00 AM EDT
The real Olive Garden scandal: Why greedy hedge funders suddenly care
so much about breadsticks
that "hilarious" report last week ripping the chain eatery to pieces?
The back story will infuriate you
Last week, you may have noticed a kooky story about a hedge fund named
Garden for handing out too many unlimited breadsticks at a
time, and failing to salt its pasta water. The snarky 294-page
highlighted everything wrong with Olive Garden, along with
recommendations to fix it. And there was much laughter.
Business Insider’s Joe Weisenthal
presentation a masterpiece.
the New Yorker
debated its finer points. Business Insider even
on a field excursion to Olive Garden to check things out.
The story had all the proper elements for our Twitter-fueled “you
won’t believe what happened next” media age. Readers could mock that
silly chain restaurant they remember from their childhoods in the
suburbs, and the silly hedge fund that took the time to write the
world’s worst review.
Except Starboard Value does not spend its time crusading for better
mid-market Italian meals for no reason. It owns a bunch of shares in
Olive Garden’s parent company, Darden Restaurants, and wants to take
control of the company’s board. The scheme it’s concocted to increase
its share price has little to do with breadsticks and pasta water. It
really wants to steal Olive Garden’s real estate, and make a billion
dollars in the process.
Starboard Value doesn’t try to hide this. Right in the
it talks up Darden’s real estate holdings the way a starving man sizes
up a steak. Darden, owner of LongHorn Steakhouse, Capital Grille and
other chains, “has the largest real estate portfolio in the casual
dining industry, owning both the land and buildings on nearly 600
stores and the buildings on another 670,” Starboard Value writes. “We
believe that a real estate separation could create approximately $1
billion in shareholder value.”
This is a more common technique than you might realize. Private equity
firms often buy businesses with lots of real estate assets, like
nursing homes, restaurants or retail outlets. They then split the
company in two: one owns all the real estate, and one manages the rest
of the business. The operating company now has to lease back the real
estate from the property company, paying rent on what it used to own.
The private equity firm, meanwhile, can take profits from the lease
payments or by selling the entire real estate portfolio, making back
its initial investment. The more expensive the leases, the more the
private equity firm makes.
In this case, Starboard Value doesn’t have enough money to buy Darden
Restaurants outright. But it’s purchased enough shares to influence
Darden’s corporate strategy. Already it has forced the
replacement of the CEO
and the sell-off of parts of the business. And Starboard wants Darden
to undertake this sale-leaseback to increase the value of its shares:
It believes it can make anywhere between $6 and $10 a share off the
to Starboard Value’s presentation with
one of its own,
but never mentioned the sale-leaseback deal.)
A sale-leaseback arrangement may make sense for a company with lots of
real estate holdings, if it needs quick cash to make investments and
cannot access a loan. Think of it like a company making a reverse
mortgage. But Eileen Appelbaum of the Center for Economics and Policy
Research, co-author of a recent book called “Private
Equity at Work: When Wall Street Manages Main Street,”
explains the key difference. “If the company does this themselves,
they get to keep the money from the sale,” Appelbaum told Salon. “And
they get to spend it to make improvements. In this case and the
private equity case, the shareholders see the value.” Basically,
Starboard Value wants to strip Darden’s assets, the Wall Street
equivalent of pocketing the silverware.
Starboard Value has a history of asset-stripping. Earlier this year,
it forced Wausau Paper to
moving out of the century-old headquarters that gave the company its
name. Starboard Value demanded the company use some of those savings
from laying off workers to
pay Starboard a
In May, Starboard Value forced Darden to sell another of its chains,
to private equity fund Golden Gate Capital for $2.1 billion. The same
day, Golden Gate
sold the real estate
of 500 Red Lobster locations to a real estate investment trust (REIT)
for $1.5 billion. Darden used proceeds of the sale to
give dividend payments
to shareholders like Starboard Value. And Golden Gate made back most
of the investment in a blink with the real estate sale. But Red
Lobster now has to pay exorbitant rents on its restaurants. “The
sale-leaseback will cut their net earnings roughly in half,” Eileen
If Olive Garden has to cut its earnings in half to pay rent on
properties it previously owned, you can forget about upgrading the
menu or making any of the other improvements Starboard Value suggests.
The restaurants will barely be able to keep afloat. But Olive Garden’s
continued existence is of minimal importance to Starboard Value.
“These are shareholders, they don’t really care what happens once they
make their money,” said Eileen Appelbaum.
Take the example of Mervyn’s Department Stores, which in 2004 had
30,000 employees. A private equity consortium bought it that year, and
split off the company’s real estate holdings. Mervyn’s saw no money
from the sale, and had to lease back its stores from the property
company at high rents. The stores immediately cut 10-15 percent of
payroll, shedding thousands of jobs. When the recession hit, the
company suffered like its counterparts in retail, but its annual loss
in 2007 – $64 million – was less than the $80 million in rent it had
to pay. In 2008, the chain went into bankruptcy, eventually dissolving
all its remaining stores and putting the last 18,000 employees out of
The Mervyn’s case reveals the key problem with the sale-leaseback
scheme. “The reason these companies own their real estate is because
they’re a buffer in times of recession,” Eileen Appelbaum said.
Restaurants and retail stores are highly cyclical; new clothes and
nice dinners are the type of expenses that consumers immediately cut
during tough times. If these stores don’t have to pay rent, they can
better weather the downturns, which inevitably come with the business
cycle. “Strip them of the buffer and you put them at risk,” Appelbaum
Olive Garden and Red Lobster may not be destinations for hipster
Internet journalists, and they have seen
amid stagnant middle-class wages and
But they are still profitable businesses. Thousands of Americans work
there. Why should they be bled dry by predatory investors in the name
of “shareholder value”? What of the value of worker productivity
instead of the financial engineers?
Not salting your pasta water may be scandalous. But the real scandal
here is what this hedge fund wants to pull off, which can only be
called legalized theft.
David Dayen is a contributing writer for Salon. Follow him on
Copyright ©2014 Salon Media Group, Inc.