Darden Should 86 Spinoff Plans

 | Mar 04, 2014 | 2:24 PM EST  | Comments
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pnra

I am a big believer in the idea of shrinking to grow. I like companies that spin off divisions that aren't doing as well as the main part of a company or have lots of cyclicality and are, therefore, holding back an enterprise that has secular growth, meaning it doesn't need the economy to roar to make the numbers. We have seen corporate divorces create value after value in industries as diverse as tobacco with Altria (MO), to mismatched conglomerates Tyco International (TYC) and Fortune Brands Home & Security (FBHS), and PPG Industries (PPG) and DuPont (DD), which have spun off and are spinning off commodity businesses to bring out the value of their parent.

But just like in real life, not every divorce is a good one. Some, in fact, are ruinous and potentially disastrous, and I fear such is the case with management's decision at Darden Restaurants (DRI) to spin off or sell Red Lobster, leaving Olive Garden, LongHorn Steakhouse and a specialty group of restaurants to remain as the New Darden.

This plan -- which is in part a reaction to two activists calling for the company to bring out value -- would create a viable but slow-growing mishmash of restaurants and another company that, if not sold to someone with a lot of hope, would barely be able to stay afloat. If New Darden were to load up the Red Lobster spinoff with debt, as some think might happen, in order to fund Olive Garden, I think the possibility of this spinoff just plain failing might be the most likely scenario.

Darden used to be one of the great growth performers in the restaurant business. Its combination of the fast-growing Olive Garden and Red Lobster, along with steak joints like the basic LongHorn and the high-priced Capital Grille, as well as the flotsam and jetsam of Bahama Breeze and Seasons 52, had terrific appeal because of its consistency, its bountiful buyback and its outsized dividend.

But somewhere along the way the whole chain, yes, the whole chain, lost its way. Yesterday, the company fleshed out its recovery plan but at the same time preannounced hideous numbers -- but more important, it revealed horrendous same-store sales numbers, including a 5.4% decline for Olive Garden and an 8.8% dip for Red Lobster. Wow, that's just phenomenally bad. Management's new spinoff plan is just a terrible admission that it has no idea what to do with Red Lobster, no ability to turn it around (it has tried mightily over the years) and, instead, just wants to offload it onto what no doubt will be an unsuspecting public.

Plus, it isn't as if Olive Garden is burning up the joint with terrific numbers. It only looks good by comparison to the heinous performance of the place that clearly no longer inspires the seafood lovers in us.

It's no wonder that the activists are furious. One of them, James Mitarotonda, chairman and CEO of Barrington Capital, announced that he has "lost all confidence" in the ability of Darden CEO Clarence Otis to run the company.

To me, it is a wonder that the company's board doesn't feel the same way. Yes, performance was good for a while under Otis, but now the company seems hopelessly left behind by outfits like Chipotle (CMG) and Panera (PNRA) that offer more natural and organic menus, or even by a relatively similar outfit, Brinker International (EAT), the owner of Chilis and Maggianos, which is putting up decent comparable-store numbers.

The plans we saw yesterday to turn around Olive Garden hardly inspired anyone -- no reason to think it will happen. To me, the activists are dead right. It's time for a new guard to try to fix these places, not just to throw away one and attempt to turn the others. Why not give someone new a chance, before taking such drastic action? This isn't addition by subtraction, it's just plain old subtraction -- and bad math, at that.

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