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Strategic analysis: Should Darden spin off its brands?

Part 25
Strategic analysis: Should Darden spin off its brands? (Part 25 of 25)

Darden analysis: Why is Darden’s present situation so special?

An attractive opportunity awaits

This must have been a long story, so we’re summarizing the important information in this last page. Because Barington Capital Group LP is involved in the event, there’s a high probability of a spinoff. However, investing in Darden Restaurants Inc. (DRI) now may not be the best idea since Darden’s fundamentals are falling and we’ve yet to see whether a spinoff will take place—despite encouraging dialogs. Although share prices have risen 10% from the announcement of Barington’s stake, this is normal because the market often perceives spinoffs as positive.

Performance of ETFs and Darden 2013-10-29Enlarge Graph

Post-spinoff selloff still likely

Disposal of shares by institutions, as well as Darden’s still uncertain future, will likely lead to selloffs post-spinoff. But there’re reasons to be optimistic, as Barington Capital Group may already have candidates in mind for Darden’s new businesses’ management teams, and Darden’s brands are still well known throughout the United States.

Core problems at Olive Garden and Red Lobster

Darden’s core problem lies in its higher average check per guest and slower guest turnover, as fast-casual chains like Chipotle, Panera, Potbelly, and Noodles Co are cheaper and more suited to today’s average US citizen. As the labor market remains weak, consumers are trading down towards cheaper alternatives, healthier and lighter dishes, and quicker meals. We must see smaller meal portions, quicker turnover, smaller dishes, lower average checks, increased operating efficiencies, and more efficient advertising expenditure in order for Olive Garden and Red Lobster to become more competitive against other firms that compete for the mass market.

A split will strengthen Darden as a business

Since the company’s organizational structure and culture lean more towards premium checks (higher-pricing menu items) and alcohol sales, it’s probably best to split the company into at least two, as Barington has recommended, so that cultures and strategies align with what’s needed for each brand’s success. While LongHorn Steakhouse isn’t as high-priced, it’s more expensive compared to Texas Roadhouse (TXRH), with an average check that’s closer to Outback Steakhouse, held by Bloomin’ Brands Inc. (BLMN). However, with lower guest traffic per square foot compared to Outback Steakhouse, further operating efficiency could be achieved at LongHorn Steakhouse as well.

Spinoffs generally outperform

Lastly, spinoffs generally outperform the S&P 500 by 10% every year. This still holds true today if we compare the performance of the SPDR S&P 500 ETF (SPY) and the Guggenheim Spin-Off ETF (CSD) over the past three years, even though CSD hasn’t outperformed Consumer Discretionary Select Sector SPDR ETF (XLY) since 2007. CSD’s performance this year has been remarkable, outperforming the SPY by 20%.

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