In 2014, Darden Restaurants was beset by activist investors pushing changes at the owner of Olive Garden, Red Lobster and several other casual dining chains. It responded with a plan to sell Red Lobster. Shareholders revolted and called for a special meeting in opposition to that strategy.
Rather than listen to shareholders, Darden went ahead and sold the seafood chain, anyway, to Golden Gate Capital for $2.1 billion. The result was one of the all-time great Wall Street analyst quotes, from Mark Kalinowski: “Who knew lobsters had middle fingers?”
Generally, it’s a bad idea when a management team so blatantly opposes shareholders’ wishes and, within months, every member of Darden’s board was ousted in a proxy vote led by the activist investor that led the drive for a shareholder vote, Starboard Value.
Darden has done just fine in the years since then. Red Lobster? That’s a good question.
Last week, as our Joe Guszkowski reported, the company acknowledged that it was closing restaurants as it focuses on a “turnaround.” Shortly thereafter, Bloomberg reported that Red Lobster was working with lenders to renegotiate its rents.
The issues reported last week are not necessarily the direct result of the 2014 sale and, in fact, one could argue that Darden saved its shareholders from the inevitable downfall of its casual dining seafood brand. If Darden kept Red Lobster, there was a decent chance that activists would one day push hard for its spinoff.
Darden’s mistake in 2014 was more about not listening to shareholders than it was about getting rid of Red Lobster, specifically.
But it’s also worth looking at Red Lobster in the post-deal environment. The Red Lobster purchase was a huge win for Golden Gate. The private equity firm sold most of Red Lobster’s real estate holdings for $1.5 billion before the ink was even dry on its purchase agreement. It took a $575 million investment from Thai Union in 2016 and then sold the rest of the chain to the seafood company in 2020.
Between 2016 and 2021, system sales shrunk 7%, as did average unit volumes, according to Restaurant Business sister company Technomic. We can assume based on last week’s reporting that both numbers didn’t improve all that much in 2022.
By comparison, system sales at Olive Garden, Red Lobster’s estranged sister concept, rose 9% over that same period and average unit volumes rose 5%.
And Red Lobster is now looking to renegotiate rents, which puts that 2014 real estate sale into question.
Red Lobster is hardly alone in selling off real estate. Sale-leasebacks are common financing strategies and, as any real estate professional will point out, a reasonable source of financing. Darden spun off some of its real estate shortly after its board was overhauled, but it was a much smaller amount.
But it’s one thing to use sale-leasebacks to invest back in the business and generate growth. It’s another thing altogether to use such sale-leasebacks to help an investment firm buy the chain in the first place, which is what Golden Gate did with Red Lobster.
The deal was symbolic of the sort of get-rid-of-every-asset strategy too many private equity firms take, particularly with standalone casual dining chains at a time when consumers were shifting more spending to takeout.
By unloading so much real estate, Red Lobster put more pressure on its assets to generate profitability, erasing some margin for error. The past few decades are littered with declining casual dining chains whose private equity owners stripped of any monetizable assets.
While Red Lobster likely got a break during the pandemic, the post-pandemic environment hasn’t been great on companies with thin margins. And then, with labor and food costs both up at near-historical rates, those leases signed nine years ago start looking awfully cumbersome.