Not unlike the crustacean for which it is named, Red Lobster is caught in a trap with no clear way out.
At issue is the seafood restaurant chain’s sale last month to Golden Gate Capital for $2.1 billion. Parent company Darden Restaurants, which also owns casual dining chains like Olive Garden, Bahama Breeze, and LongHorn Steakhouse, among others, says the sale is both strategically sound and fully priced. But shareholders, most notably activist hedge funds Starboard Value and Barington Capital, say that not only was the price paid for Red Lobster low, but also that the sale itself was a scorched earth tactic meant to save the jobs of Darden’s board members and executives.
Darden and the activist hedge funds have been fighting since late 2013 over the company’s strategic direction, and the battle is now set to come to a boil at its annual meeting scheduled for later this year, where Starboard and Barington are seeking to replace the entire Darden board as a result of the Red Lobster deal.
The announcement of the Red Lobster sale on May 16 marked the culmination of more than six months of increasingly antagonistic back-and-forth between Darden and the activist hedge funds over its strategic direction that included a proposal to spin off both Red Lobster and Olive Garden and a major rebranding of Olive Garden, among other moves. During that time, Darden’s stock price has swung wildly from more than $54 per share to as low as $47 per share.
Both Starboard and Barington have been trying to stop the Red Lobster sale for months, and Starboard even called for a special meeting that had the support of a majority of Darden shareholders to vote on what to do with the Red Lobster brand.
But Darden pulled the trigger on a Red Lobster sale before that meeting could happen, setting off a litany of columns everywhere from the New York Times to stock blogs and tiny activist trade publications that claimed the deal exhibited deplorable corporate governance and seemed designed to beat back the hedge funds at the expense of its own shareholders.
“It does certainly seem to be an ill-advised deal or a move of desperation,” said Mark Chen, professor of finance and corporate governance at Georgia State University. “How much value can they actually unlock by selling off this division and holding on to Olive Garden? The move to sell Red Lobster blatantly disregards the wishes of shareholders. For management to come out shortly after shareholders voted for a special meeting and do a sale that doesn’t require shareholder approval is definitely in blatant defiance of the earlier vote.”
Chen also takes issue with the steps that Darden took to reach the deal, which also included changing some of its bylaws.
“It cancelled an analyst conference; they also made it more difficult for shareholders to nominate new directors; they changed the bylaws; and it’s much more onerous in terms of getting through the stage of nominating a director,” Chen said. “Short of calling off the sale, it’s interesting to see what management will do in order to stave off a proxy contest.”
A representative for Darden told BuzzFeed that the company held numerous discussions with shareholders prior to the Red Lobster sale and that it has been listening to their concerns at every turn.
“We have spent, and continue to spend, an extensive amount of time talking directly with shareholders and the financial community,” read a statement Darden provided to BuzzFeed that also cited its “many investor relations awards.”
“Over the past year, members of Darden’s Board and management have met with shareholders representing over 60% of Darden’s shares, including numerous meetings and conversations with Starboard and Barington to understand their views and over 25 sell-side analysts. Many of these conversations were held multiple times. We believe the agreement for Red Lobster addresses key issues that our shareholders have raised, including the need to preserve the Company’s dividend and regain momentum at Olive Garden.”
Starboard founder Jeff Smith and James Mitarotonda, CEO of Barington Capital, have a different view of the deal, however. They have described it as an “unconscionable” move and a “fire sale” that “woefully undervalues” the Red Lobster brand.
Smith contends that the $1.6 billion in after-tax proceeds from the Red Lobster sale will net the company a mere $100 million — half of the brand’s trailing 12-month cash flow — more than the value of its real estate. Put another way, according to Smith, whose analysis has been supported by financial blogs, the sale values Red Lobster’s real estate at $1.5 billion, but the restaurant at just $100 million. Red Lobster, according to filings, had negative 2.8% growth in average same-store sales last year across its nearly 700 locations. To draw an analogy to the tech world, it is similar to how Yahoo investors value the core company as next to nothing and view most of its worth as stemming from its stake in Chinese e-commerce giant Alibaba.
Darden argues that Smith’s analysis is “incorrect and unrealistic” because it assumes that the real estate sale could be conducted tax-free, adding that the terms of the deal reached with Golden Gate Capital came after extensive meetings with potential buyers and analysis on the final price.
That Darden selected Golden Gate as the acquirer for Red Lobster is itself intriguing given that, as one private equity executive who declined to be named because he does business with the firm said, they are often used as leverage in scorched earth campaigns. Indeed, Golden Gate surfaced in the long-running Men’s Wearhouse-JoS A Bank takeover battle when the latter tried to buy Eddie Bauer from Golden Gate in an effort to stave off selling to the former.
Everything that Darden has done up to this point is legally above board, since the Red Lobster deal does not require shareholder approval.
“The sale of Red Lobster does not require approval of shareholders, thereby making it difficult for any party dissenting to stop the transaction,” said Ron Geffner, partner at Sadis & Goldberg. “It’s a cost-benefit analysis for everybody involved. There may be times when the management of a company believes they are not in a position to pacify opposing shareholders and that by granting them an audience, if not required by law, will delay the closing of a transaction or increase costs or introduce additional risks.”
Still, Starboard and Barington and perhaps other Darden investors will still be seeking justice at the company’s annual meeting later this summer or early fall. And in the meantime, Red Lobster is left to just tread water.