SPLITTING THE CHECK:
AN IN-DEPTH LOOK AT DARDEN RESTAURANTS, INC. vs. BARINGTON CAPITAL GROUP LP

Table of Contents

Executive Summary 4
Position 5
Sense 6
Uncover 7
Solve 8
Build 9
Achieve 10
Bibliography 23

Executive Summary

This is the first paragraph of your executive summary. It should be indented, it should be double-spaced, and it should be in 12 pt Times New Roman font (as should the rest of the body of your term paper). An executive summary should be no longer than two pages (and preferably shorter), and should be written after your paper has been completed. It is a complete summary of your recommendations, and the reader should get a clear picture from this section alone. Assume that the reader reads nothing else.
Darden Restaurants, Inc., a multi-billion dollar full-service restaurant company, is facing – and will be facing many difficult challenges. In addition to billions in lost revenue from the economic downturn and a severe shortage in their most served menu item, they have recently been challenged by a new minority shareholder who is pressuring them to reorganize their corporate structure. This activist investor, Barington Capital Group, LP, is known for being particularly aggressive and frequently getting what they want.
Darden’s revenues are down significantly over the last couple of years in their two flagship – and typically most profitable restaurants, Red Lobster and Olive Garden. While they have consistently held the majority of the market share of the sector for quite some time, their top position is in peril – both because of poor performance, and an almost imminent battle with Barington.
They have recently acquired another chain to add to their “specialty” line of restaurants for $435 million – an amount some think was entirely too much. They also own a large majority of the land their restaurants reside on, which is a significant portion of their assets.
For all these reasons, Barington has requested that Darden split Red Lobster and Olive Garden from their otherwise profitable specialty restaurant group, as well as separate their land holdings from the rest of the company – or sell them off all together. They believe that Darden has been mishandled by management and that these steps will increase shareholder value in the long run.
Darden has two options in dealing with Barington: They can either give into their demands, or they can fight it with all their might. There appears to be no middle ground in Barington’s eyes.
Darden must first asses if the demands are viable. If so, are they also feasible? In the case they are neither, the recommendation is to strike first and employ one of the available tools that corporations have against takeovers. Most importantly, they must prepare themselves for what could be a long, drawn out court battle – which is sure to get ugly along the way.

Position
With over 2100 restaurants across the United States and Canada, Darden Restaurants, Inc. is the world’s largest full service restaurant company. While there are multiple Food and Service companies on the Fortune 500 list, Darden is the only one that offers both casual and fine dining. In an industry dominated by fast food chains, DRI has distinguished itself as a significant player within the sector.
Darden’s portfolio includes their two flagship restaurants, Red Lobster and The Olive Garden, along with Longhorn Steakhouse, and six restaurants in their “Specialty Restaurant Group,” which consists of Bahama Breeze, The Yardhouse, Seasons 52, The Capital Grill, Eddie V’s Prime Seafood, and Wildfish Seafood Grill. While Red Lobster and The Olive Garden are known for providing relatively inexpensive meals, the Specialty Restaurant Group consists of more upscale eateries that offer high-end amenities such as Kobe beef Steaks, extensive wine lists, and seasonally rotating artisan ingredients.
According to Darden’s website, their mission (stated as their “core purpose”) is to “Nourish and delight everyone we serve.” While this is obviously a reference to their customers, when reading their vision and values it is clear that their mission statement extends far beyond that initial impression to include all of their stakeholders – employees, suppliers, educational institutions, shareholders, and the communities they serve.
Chairman and CEO Clarence Otis, Jr. says "We're on a path to create what we believe is a truly great company; a vibrant organization that consistently produces competitively strong financial results and is a special place to work for employees. Our vision is to be a company that positively affects meaningfully more guests, employees, communities and business partners – a company that matters even more than we do today." Like other organizations, Darden’s values have developed and formed from those of their founder’s. When founder Bill Darden opened the doors of the first Red Lobster in 1968, he had a clear idea of how he wanted to conduct business, and Darden’s values – like many organizations, are based on those of their founder’s.
• Integrity and Fairness – It all starts with integrity and fairness. We trust in the integrity and fairness of each other to always do the right thing, to be open, honest and forthright with ourselves and others, to demonstrate courage, to solve without blame and to follow through on all our commitments.
• Respect and Caring – We reach out with respect and caring. We have a genuine interest in the well-being of others. We know the importance of listening, the power of understanding and the immeasurable value of support.
• Diversity - Even though we have a common vision, we embrace and celebrate our individual differences. We are strengthened by a diversity of cultures, perspectives, attitudes, and ideas. We honor each other's heritage and uniqueness. Our power of diversity makes a world of difference.
• Always Learning, Always Teaching - We learn from others as they learn from us. We learn. We teach. We grow.
• Being of Service – Being of service is our pleasure. We treat people as special and appreciated by giving of ourselves, doing more than expected, anticipating needs, and making a difference.
• Teamwork – Teamwork works. By trusting one another, we bring together the best in all of us and go beyond the boundaries of ordinary success.
• Excellence - We have a passion to set and to pursue, with innovation, courage and humility, ever higher standards.

Any restaurant has many stakeholders, but that number nears exponential numbers with a company has as many restaurants with such a wide variety of menu options – all in varied parts of North America. In prioritizing Darden’s stakeholders is difficult because of this. When attempting to prioritize stakeholders, one should consider the impact that stake has. That is to say: if this relationship ceased to exist, how deeply would it affect each party? For example – one would assume that because Darden’s Seasons 52 restaurant specializes in seasonal, artisan foods they are not purchasing much of their food from huge suppliers like Sysco, Corp. – but rather from artisanal bakeries, fresh seafood markets, and family farms. While a worldwide food distributer would no doubt feel the effects of the loss of a client such as Darden, it would not leave them in ruin. Local suppliers, however, would be affected significantly by any change in the mutual relationship. That being said, this paper will generalize stakeholders and assume that the type of relationship has no bearing on the order of importance in order to stay within the required boundaries set forth.
Darden, like any other company in a customer service or hospitality industry has to accept the fact that customers are their number one stakeholder. This is undeniable and absolute. While consumers would get along just fine without Darden, their restaurants would cease to exist without customers. However, Darden would say that their employees come in a close second.
It is clear that Darden recognizes the value of quality employees, and it shows in the way they treat them. In fact, they are the only full service restaurant company that has ever been ranked on Fortune magazine’s “100 Best Companies to Work For” list. They debuted on the list in 2011 at number 99, and made a significant jump in 2012 – coming in at number 65. They offer their employees many opportunities and benefits rare in the industry, such as health insurance available on day one of employment, anniversary/vacation pay, and strong upward mobility (more than 500 of Darden's 1,900 general managers – over 25%, rose from an hourly position). Add to that a flexible work schedule and company stock options, and it is easy to see why Darden is a desirable place to work.
In addition to a strong commitment to their employees, Darden also holds great value in being actively involved in the communities they serve. The Darden Foundation has three main programs that have the goal of enriching and preserving our environment. “Recipe for Success” provides the tools and resources for low-income students to graduate college. Through this program Darden makes regular contributions to Boys & Girls Clubs of America, City Year, College Summit, Hispanic Scholarship Fund, National Restaurant Association Educational Foundation and United Negro College Fund. Their “Preservation of Natural Resources” program partners include The New England Aquarium, The Everglades Foundation and National Recreation and Parks Association, among others, and focuses on conserving and restoring water ecosystems, creating and maintaining community gardens that promote food security, and protecting and preserving open spaces. Darden realizes that their company’s success depends upon available, affordable, high-quality natural resources, and are taking steps to assure these resources are available for future generations. Finally, through partnerships with Feeding America food banks, The American Red Cross, Habitat for Humanity International, Second Harvest Food Bank of Central Florida and the Coalition for the Homeless of Central Florida, the “Good Neighbor” program provides services of hunger relief, disaster relief, and shelter not only in their hometown of Central Florida, but across the country as a whole.
As any financier can tell you, the number one goal of any corporation is to maximize shareholder’s value. So on the surface it may seem strange to see owners (stockholders) near the bottom of the list – that is until one realizes that by taking care of all of those previously mentioned, that is exactly what Darden is doing. Construct a Customer Value Proposition…increasing value. Keep your employees happy and they respond in kind to the customers… increasing value. Let the communities you serve know that they are important to you and your company… you are creating value. Not one owner of one share in the world would blink an eye at being the low man on the stakeholder totem pole if they understood that taking care of others first is positively correlated to the price of their stock.
Darden’s financials (relative to the rest of the industry sector), are fairly stable. They have posted profits of roughly $1.8 billion for three straight years, and have consistently outperformed analyst’s expectations. They did, however, get hit relatively hard by the recession. It is a fairly understandable, if not predictable outcome though. In periods of economic downturn people tend to stay in to eat as opposed to going out – or even worse for Darden, they find more budget-friendly alternatives. For the most part, it seem as though they have weathered that storm, providing cash flow through other means, and are experiencing a resurgence of late. Compared to other companies in the same industry, Darden has a comparable debt/assets ratio, a lower that average cash flow from operations/total debt ratio, and a significantly lower current assets/current liabilities ratio. Having said that, their debt/EBITDA ratio is much higher than the industry average, coming in at a 2.57 average versus 1.57 industry wide. This implies that Darden is skilled at accounting practices, writing off much of their interest, depreciation, and amortization in order to reduce their taxes. They seem to be a relatively lucrative firm if looking through the eyes of an investor. They have posted an average earnings per share of $2.87 over the last five years – a decent return in any industry over the same period.
On the whole, the restaurant industry is beginning to show signs of improvement and give hope to companies like Darden that the worst is over – for now. The housing market has begun to emerge from the hole that the crash created, and according to Bloomberg Financial, consumer spending is up more than expected. It will just be a matter of time until the masses forget about the worries of yesterday and return in full force to instigate a two and a half hour wait at your local Olive Garden.
Sense
There are always threats and risks that a food service company must deal with. Fluctuating food prices are a big part of this, as food costs account for (according to Restaurant.com) approximately 40% of the cost of goods sold. Darden Restaurants were recently hit particularly hard by a steep increase in the price of shrimp. This is mainly in part to a string of outbreaks of the disease Early Mortality Syndrome, or EMS, in Thailand – the world’s largest shrimp exporter. This outbreak has created the one of the largest shrimp shortages in recent memory, and is only three years removed from the same disease ravaging Vietnam in 2010, and China the year before that. Because EMS attacks shrimp long before reaching sexual maturity, populations have not had the ability to recover in subsequent generations. India and Ecuador have tried to pick up the slack, but they have fallen far short of being able match Thailand’s share of almost one-third of the world’s shrimp supply. As a result, prices have more than doubled since February 2013, as seen in the following chart provided by IndexMundi.com. It is estimated that (according to Darden’s Chief Financial Officer) shrimp accounts for over 35% of the cost of food across Darden’s chains. However, Red Lobster, who is famous for their “Never-Ending Shrimp” promotion, has been hit particularly hard. Their sales are down 6% and costs are up 19% compared to the same time last year. The disease is not the only thing pushing shrimp prices higher either. The Commerce Department ruled in August that India, China, Malaysia, Ecuador, and Vietnam have all been taking advantage of the shortage by unfairly subsidizing shrimp that's exported to the United States. The United States Government is currently in the process of implementing a duty on all shrimp imported form many of these countries – which will ultimately cause prices to rise yet again.
Along with the unpredictable volatility and availability of food commodities like shrimp, all restaurants have to deal with the threat of food-borne illnesses – and the resulting fallout. In Darden’s 10-K Annual Report filed 7/20/2102 (Appendix A), they provide a summary of the acknowledged “Risk Factors” (not including the risks and uncertainties associated with conducting normal business operations) that are the biggest threats to their bottom line. The first and foremost on this list is: “Food safety and food-borne illness concerns throughout the supply chain,” followed by: “Unfavorable publicity, or a failure to respond effectively to adverse publicity.” The importance they place on the danger of food-borne illness and the recognized fallout from handling it improperly after the fact is shown in their placement on the list. While Darden has not faced anything of this sort that was news worthy or earth shattering, that fact that the fallout can be so severe should be noted.
Of the companies listed on the Fortune 500, Darden does not face much in the way of legitimate competitors in terms of overall net worth. There are many restaurant companies on the list, but none that offer full service that are the size of Darden. However, even though none of them possess as fat of an assets column on their balance sheet, there are many that are large enough and well known enough to be considered legitimate competitors. Besides Darden, three others represent the majority market share of the sector. These include: DineEquity, Inc. (IHOP, Applebee’s); Brinker International [NYSE: EAT] (Chili’s Bar and Grill, Maggiano’s Little Italy); and – probably Darden’s most relevant competitor, Bloomin’ Brands, Inc. (Outback Steakhouse, Carrabba’s Italian Grill, Bonefish Grill, and others). As of November, 2013, SeekingAlpha.com estimates the casual dining sector to be worth approximately $75 billion, of which revenue and net income for of the sector leaders are shown in the following chart.

While these numbers appear to be all-telling, they do not represent the whole story. For example, DineEquity, Inc. implemented a 99% franchisee plan for their Applebee’s brand, in which they only kept 1% of their restaurants as test markets for new products. This, according to their CFO, is an attempt to become a company whose number one goal to increase value for their shareholders. In doing so, their revenue has plummeted, but they have reduced their debt by $500 million and repurchased over 100 million shares of stock since the plan launched. On the surface, it looks like they have an insignificant share of the market, but they are in fact expanding at an exponential rate – increasing their numbers almost 29% over since the plan went into effect, to reach 3600 restaurants located in 17 different countries as of August 2013. Even franchising out 99% of their restaurants, DineEquity still had a net income 2.6 times greater that Bloomin’ Brands – who posted almost 5 times the revenue of DineEquity in 2012.
Not only does Darden face competition from larger companies, but also privately owned “Mom and Pop” restaurants, who have the ability to take a lion’s share of the market on a location-to-location basis. That means that, unlike companies like Microsoft or Coca-Cola, Darden’s competitors are numbered not by the handful – but in the tens of millions. According to Restaurant.Org, seven out of ten restaurants in the United States are still one-unit eateries. That means that of the 980,000 restaurants in the U.S., there are 686,000 that are considered “local.” Many of these restaurants have strong followers and command a sense of loyalty that large chains just cannot compete with. It is easy to see why this is so significant when one considers that we spend $1.8 billion (according to the National Restaurant Association) eating out on a daily basis.
2013 has seen sales drop significantly in Darden’s two largest restaurants. Their biggest chain, Olive Garden, saw same-restaurant sales drop 4% in the first quarter, along with a 5.2% drop at Red Lobster in the same period. Compound that with a drop in sales in 2012 of 2.5% and 5.3%, respectively, and one can understand why there may be cause for concern. There are many factors contributing to this decline in sales – most notably being economic weakness, or consumers shifting to lower priced options. Sales at Darden’s high end chains, however, have been more robust as well-off consumers continue to dine at upscale restaurants, resulting in a sales increase of 0.5% in the first quarter. This is following a breakout year in 2012, in which their high-end restaurants realized a 19% increase in sales.
Facing food shortages, the threat of illness, intense competition from restaurants of all sizes, and significant revenue loss is still not the biggest portion on Darden’s “problem plate”. The most pressing obstacle Darden is facing involves a recent minority stake (2.8%) stock purchase by the activist investment group, Barington Investments. Based on Darden’s current market value of $6.47 billion, (as of October 9th, 2013), their stake is worth approximately $181 million. They are pushing Darden to split their holdings into two separate companies – one solely for Red Lobster and The Olive Garden, and the other consisting of their specialty restaurants. Barington believes this move will better serve Darden’s shareholders because it would separate the poor performing flagship restaurants from the profit-posting upscale locations. Other recommendations by Barington include an aggressive reduction in spending, and completely separating Darden’s Real Estate holdings from the rest of their portfolio.
They contest that Darden’s management is doing shareholders a disservice by continuing their current corporate structure. Based on same-restaurant sales in recent years it is hard to argue against Barington’s claims.
Darden is yet to react to the recommendations, but one can be sure they are not taking this lightly. Barington is known for getting what they want, or consequences are soon to follow. Earlier this year the hedge fund built up a stake in Jones Group, Inc., urging the clothing retailer to reduce costs and sell portions of its portfolio. Jones failed to respond in a way that satisfied Barrington Group, and are now, according to Dana Mattioli of the Wall Street Journal, in the late stages of an auction of the entire company. This makes any “recommendations” that Barington makes (if that is what it is called when the corporate equivalent of a tornado asks you to do something to your company) and the road you decide to make all the more slippery.
There is a frequent talk about the motives and morality – even the legality of the actions of so called “activist investors” such as Barington Capital. According to Investopedia.com, an activist investor is defined as:
“An individual or group that purchases large numbers of a public company's shares and/or tries to obtain seats on the company's board with the goal of effecting a major change in the company. A company can become a target for activist investors if it is mismanaged, has excessive costs, could be run more profitably as a private company or has another problem that the activist investor believes it can fix to make the company more valuable.”
Activist investors are an offshoot of minority stake investors who operate under a different set of rules and guidelines. Much of what an activist investor initiates when they take stake in a company falls under the “gray area” of the law. They are criticized that their only concern is the immediate future – with no thought of the future value of a firms stock. They are known to get in, shake things up (or break up the company), and get out with their bounty to let the remaining shareholders worry about the future. An article in The Economist describes them as: “… the descendants of the corporate raiders and asset-strippers who helped enliven the 1980s. Like their forebears, they target companies with sleepy managers, too much idle cash or ill-fitting divisions that might be lucratively spun off.” Based on this colorful description it is now time to find which of these categories the managers of Darden Restaurants fall under… But first, the core problem must be identified.
Based on all of the information gathered, defining the problem was a relatively simple conclusion. The gap is obvious, and the symptoms are all evident and explainable causes of the problem.
• The Gap: The desired state – to have all restaurants profitable. The present state – Darden’s top two restaurants are losing money – a combined average of 4.6% in the last two years alone.
• The Symptoms: Economic downturn, food shortage of one of their primary menu items, and intense competition from others within the sector are causing this gap.
• The Problem: Darden is facing an overall decline in revenues over the last several years because of poor performance by Red Lobster and Olive Garden.
In pinpointing the problem definition a fishbone diagram was used to establish criteria for the symptoms and the problem definition, (see Appendix B). But because of the looming issues Darden is facing further analysis was needed, therefore a problem/urgency table was used to identify what was mission critical. URGENT NOT URGENT BARINGTON'S DEMANDS POOR FLAGSHIP PERFORMANCE SHRIMP SHORTAGE WEAK ECONOMY
MISSION CRITICAL

COMPETITION PROBLEMS
NOT MISSION CRITICAL

As the table shows, almost everything is “mission critical”, but Barington was the only one put under “urgent” as well because of the time frame Darden is most likely facing to act on the issue. Poor performance can be weathered through revenues – though depleted, but still coming in. The shrimp shortage and weak economy are put under “not urgent” because they are both out of anyone’s control. And competition was put in “at your discretion” because there is always going to be competition. It should be a firm’s goal to constantly be seeking differentiation and the upper hand with their competitors.
Poor performance and the resulting loss of revenue is very bad for any firm, however, this case is rather unique in that there is a symptom that is more critical than the actual problem. Were it not for underperforming, Barington would most likely not be in the picture. However, billion dollar corporations can live for a relatively long time operating in the red, but the actions of activist investors can cause the walls to come crashing down much faster. Now we will uncover possible solutions to deal with Barington and their demands.
Uncover
Based on the problem described in the previous section, develop a number of potential solutions and describe them in as much detail as possible given the constraints of the paper. This might be a good place to use some of the tools described in class, such as mental maps, brainstorming and fishbone diagrams (if you haven’t thoroughly determined the cause).
So, is the recent poor performance by Darden’s flagship restaurants the reason that Barington has come into the picture, or is there something else afoot? Does Barington truly have the shareholders in mind, or are they planning on pulling the corporate version of a “dine and dash?”
In this case study, there are really only two ways this can be dealt with. Either acquiesce (at least to some extent) or prepare for a brutal battle. Because of the levity of the situation, different alternatives are really not an option. Some may think that this is too cut and dry. Others may think it is lazy (including a certain professor who may see this as a student attempting to get away with cutting a section short), but if observed in the right light it is apparent there are only two options. So what would be the best road to take? Well that depends on where management thinks the company is going and where they want it to be. So let’s weigh out the possible options.
Solve
Based on the information presented, it appears that the managers of Darden may fall into more than one of The Economist’s categories. They have what seems like a plethora of land assets that could be liquidated or leased back, which sounds like it fits perfectly into “ill-fitting divisions that might be lucratively spun off.” There has also been what some to see as a fair amount mismanagement in regards to overextending the cash they have on hand. Many, according to the Wall Street Journal, consider the $435 million that Darden spent in 2012 to acquire the Yardhouse Grill far too much to for a chain so early in its life and with an apparent ceiling on possible revenues.
On the other hand, maybe Barington is benign in their endeavor. Perhaps their only goal is to maximize shareholder value. This is something that will need to be addressed as events unfold and not an assumption that should be made at this time. After all, takeover attempts aren’t all bad, are they? Companies that have split their holdings in an effort to separate poor performing assets from the rest of their portfolio in the past have shown that this is an effective way to increase a firm’s value. In September of 2011, activist investor Sardar Biglari openly challenged the management of Cracker Barrel over performance issues. This eventually led to a proxy battle between management and Mr. Biglari, in which (years later) management ultimately won by hiring a new CEO, issuing a double dividend, and most importantly, posting better financials. Since Sadar Biglari began to challenge Cracker Barrel’s management they have seen a 54% gain in their stock price – nearly double the average of peers DineEquity, Brinker International, Denny’s Corp., as well as Darden.

This is mentioned to point out that there are times when being challenged by an activist investor can be a good thing. That is not to say that this will always be the case, but in this case it made the management of Cracker Barrel re-assess their firms place, and resulted in increased earnings and a dramatic rise in their stock price. Even if a company decides to fight the takeover, it does not always mean that the results will be negative.
Build
Putting this plan through an ethical screen is perhaps the most difficult part of the process. This is because of the defenses that should be employed against an open all-out attack on the company. Management knows that Barington will employ every single weapon in their arsenal in order to achieve their goals, and Darden’s managers need to figure out how far they are willing to go in order to realize their own aspirations.
There are many options for Darden if they decide to fight Barington – many of them considered slimy at the least.
1. There is a “freeze out,” which is a statistical measure to eliminate unwanted minority shareholders. This is where a company will merge with a start-up (or sometimes a shell), with the intention of transferring the minority shareholders over to the new company. This leaves them with none of the benefits of ownership, but all of the liabilities held by the parent company. This means they can no longer have any say in any decisions made by management. Because the minority shareholder is no longer a shareholder of the parent company, they will no longer have access to that company's information, or have any future relationship with the company.
2. Reverse stock splits are an option as well. This is where, instead of issuing a 2 for one split, they merge two shares back in to one. This can be a useful tool because, depending on the number of shares a minority holder owns, it can also remove their ability to have any say in boardroom decisions based on the company charter.
3. The third option, and the most dangerous of them all in terms of lawsuits, it to change the corporate charter. The company can change the number of shares required to make decisions, make all shares except a select few non-voting shares, or – even worse for everyone involved, approve a ridiculous amount of new stock offerings that would dilute the current shares to a level that would be incapable of holding any sway.
A cost/benefit analysis is not really applicable to this case study. Because of the unthinkable number of possible variables involved, it would not benefit to run one. As in the Cracker Barrel case, there was no way of knowing either the outcome of the legal battle, the ensuing corporate changes, nor their resulting windfall. Litigation can never happen or it can be drug out for many years, so trying to put any tangible costs or benefits on this would be futile. As far as intangibles, they would also only be realized as things progress.
Achieve
A timeline is extremely difficult to set down in Darden’s situation. As mentioned in the previous section, litigations can last for many years, and you never know how your challenger will react.

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