Thursday, October 10, 2013

Darden Restaurants Pressured to Break Up

Activist investor Barington Capital is pushing for the breakup of Darden Restaurants, according to today's Wall Street Journal.   Darden operates the following restaurant chains: Red Lobster, Olive Garden, LongHorn Steakhouse, Bahama Breeze, Seasons 52, The Capital Grille, Eddie V's, and Yard House.  The newspaper reports that, "The investor group argues that Darden should create one company with its Olive Garden and Red Lobster restaurants, and another with its higher-growth chains, which include Capital Grille."   

One could argue for a breakup of the firm, but this particular rationale does not make sense.   Why should Darden own multiple restaurant chains?  Presumably, they believe that significant economies of scope (i.e. synergies) exist among the chains.   If you believe that the company should be broken up, then you must believe that these synergies are relatively small.  

The article suggests, though, that the activist investor wants to split the high growth businesses from the low growth ones.  Why will this increase shareholder value?   Do they think that the P/E ratio of the firm is too low because it's being dragged down by the lower growth businesses in the portfolio.  If so, that's faulty logic.   The investors can see that some chains are higher growth than others, and they understand how to value the parts.   You can't create a pop in valuation just by putting the high growth chains in a different firm and looking for a high P/E ratio.  Why?  Well, investors will offset that high P/E with a very low one in the firm that remains holding the low growth businesses.  You have not magically created value just by segregating units with different expectations of future growth.   The only reason why it could make sense would be if you believed that the higher growth businesses somehow are fundamentally different, and that they share synergies with each other, but not with the lower growth units.  I don't see how that is the case, but that would have to be the rationale to pursue this particular breakup strategy. 

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