Rocked By Red Lobster, Darden Stock Down 4%

Bloomberg News

Red Lobster has weighed like a rock in Darden Restaurants' portfolio, but plans to jettison the business are proving a weight on the stock.

Darden Restaurants (DRI) said Friday it will sell the struggling Red Lobster business to Golden Gate Capital for $2.1 billion in cash. Darden shares were down 3.6% to $48.82 in late afternoon trading following the news, which has some activist investors quite steamed.

Hedge fund Starboard Value pushed Darden for a special meeting and vote on the separation of Red Lobster, announced in December. But the agreement announced Friday doesn't require shareholder approval, fueling consternation among those who agitated for a bigger transaction — the sale of all real estate and reorganization of Red Lobster, Olive Garden, LongHorn Steakhouse and other restaurant businesses.

After taxes and transaction costs, Darden will be left with $1.6 billion in deal proceeds. It plans to use $1 billion to pay down debt and another $500 to $600 million for share repurchases. Red Lobster real estate alone is worth $1.5 billion, according to Howard Penney, an analyst with Hedgeye Risk Management.

"They're giving the [Red Lobster] business away for free," Penney says.

Starboard said in a statement Friday that the Red Lobster deal "woefully undervalues" Red Lobster's real estate, brand and $2.5 billion in revenue. Starboard criticized Darden's board for "the audacity to negotiate a transaction that does not require shareholder approval when a significant majority of Darden's shareholders have formally demanded a special meeting on this very topic."

Barington Capital Group called the transaction price a "fire sale."

Sale-and-lease arrangements for remaining Darden real estate could be in the offing. Darden CEO Clarence Otis Jr. told the Wall Street Journal that in this "very, very robust, very favorable real-estate market," Darden will "assess what that means for our other properties."

One of the Street's ardent Darden bulls, analyst Mark Kalinowski at Janney Montgomery Scott, admitted Friday that "business trends remain lousy, and the ability of activists to generate meaningful change appears to have taken a hit." (See Barron's, "Darden Could Jump 40% On Hedge Fund Plan," Dec. 13, 2013, subscription required and Stocks To Watch: “Darden Restaurants: Breakup Battle Heats Up,” March 26.)

The big question now is if Darden can finally turn things around at Olive Garden. There, Darden has struggled to produce positive same-store sales gains in a competitive and difficult environment: meat, grain, fuel and labor costs have been on the rise, and pasta-and-steak menus are not staples of a healthy daily diet.

The stock, down 4% over the past 12 months, has woefully underperformed the broader market and bakes in skepticism about management's ability to improve sales. Still, the shares aren't exactly on sale at 20 times estimated earnings of $2.46 per share for the fiscal year that ends this month, especially in light of negative sales trends and tepid earnings growth projections.

Kalinowski maintains his Buy rating and $54 price target on Darden. And for patient investors, Darden's 4.4% dividend yield is attractive.