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Darden exploring options for real estate

Darden exploring options for real estate

Franchising could also be in the future as Starboard takes control

Darden Restaurants Inc., has hired advisers to analyze its vast real estate portfolio as the company’s management starts fulfilling promises made by the activist investor Starboard Value during its summer-long proxy fight.

In addition, interim chief executive Gene Lee acknowledged on the company’s fiscal second quarter earnings call that Darden will evaluate other options, “including franchising and the composition of our brand portfolio.”

“The board and management team have the responsibility to make sure we’re maximizing every element of our business to drive shareholder value,” Lee said. “We want to be comprehensive and thoughtful in considering the options … while also maintaining the best structure for our ongoing business.”

Major changes at the brand have been expected since October, when shareholders voted in all 12 candidates backed by Starboard in a proxy vote. Jeffrey Smith, the CEO at Starboard, has since been named chairman of the board, and the company is actively looking for a permanent chief executive.

During the proxy fight in September, Starboard published a nearly 300-page plan to fix Darden that included a range of ideas, from salting pasta water to spinning off real estate in a real estate investment trust, or REIT.

This was the company’s first earnings call since that proxy vote — a fact not lost on Lee. “The new board has been engaged in the business from day one,” he said. “The management team and board are working well together to ensure we have the right strategy to drive long-term value creation for shareholders.”

Last month, the company announced cost cuts, including layoffs of 60 employees and the elimination of 25 open positions. Included in the cost cuts were the sale of the company’s corporate aircraft and the elimination of its aviation department. Darden also announced management changes, including the retirement of longtime CFO Brad Richmond, who will remain on the job through the end of March 2015.

Other cost cuts are forthcoming. Darden is working with Boston Consulting Group to pursue “significant, non-consumer-facing, cost-saving initiatives.” Those cuts, Lee said, could have “meaningful benefits” in the company’s 2016 fiscal year. Lee didn’t provide details, but said management is “encouraged by the opportunities identified.”

Real estate has been expected to be a major part of the new board’s strategy, and it is likely the first major change it makes at the Orlando-based

Orlando-based Darden -- owner of Olive Garden, LongHorn Steakhouse, Yard House, Bahama Breeze, Capital Grille, Seasons 52 and Eddie V’s -- owns more than 1,200 pieces of property. It owns the land and restaurants for 600 locations, and just the buildings on another 670, according to the Starboard report. The activist estimated at the time that this real estate was worth $2.5 billion to $3 billion.

Activists have long argued that the real estate would be more valuable to shareholders spun off or sold and then leased back to the company. Starboard estimated in its report that doing so would create $1 billion in shareholder value.

Starboard proposes franchising

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Darden has hired a trio of advisers to analyze its real estate, including J.P. Morgan, Moelis & Company and Skadden, Arps, Slate, Meagher & Flom.

Sara Senatore, analyst at Bernstein Research, said in a note that by owning its real estate, Darden is able to reinvest in its business because it is free from the burden of paying rent. If those restaurants suddenly have to start paying rent following a spinoff and sale-leaseback, Darden might have to cut more costs to make it work, she wrote.

“Given how thin [Darden] margins still are, we think further cost savings and increased topline will be needed to offset incremental rent expense,” Senatore wrote in a note Wednesday.

Franchising could be an even bigger change for the traditionally company-run Darden. Starboard proposed that Darden consider franchising its concepts in international markets in its September plan, and it also said the company should consider selling restaurants to franchisees in select domestic markets.

The franchising idea didn’t get as much attention as some other elements of the Starboard plan, such as its idea to separate Darden’s Specialty Restaurant Group from the rest of the company, and its complaints about the way Olive Garden distributes free breadsticks. However, Starboard said at the time that both Olive Garden and LongHorn could sell locations in low-profit markets where franchisees could theoretically operate more profitably.

Starboard called franchising “a proven method to improve operating performance and accelerate innovation” because franchisees “bring an ownership mentality to the restaurants.” Franchising restaurants also has higher profit margins than running store operations and is a favorite strategy of activist investors.

Miller Tabak + Co. Analyst Stephen Anderson said in a note today that if Darden ultimately decides to “monetize” its real estate portfolio, that “refranchising will be the most likely component of this strategy.”

In the meantime, Darden executives touted what some analysts call early evidence of a turnaround at the flagship concept Olive Garden. Same-store sales rose 0.5 percent in the company’s fiscal second quarter, which ended November 23. While that might not seem like much, Lee said it was the first quarterly increase in that chain’s comparable sales since the quarter ended May 2013. Also, Olive Garden has had four straight months of positive same-store sales, the first time that has happened since 2010.

“This has not been an ordinary year for Darden,” Lee said. “But despite all the noise and potential for distractions, our restaurant teams are as focused as I’ve ever seen them.”

Contact Jonathan Maze at [email protected].
Follow him on Twitter at @jonathanmaze

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