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. 

Breaking Up Nokia?

Bloomberg BusinessWeek has conducted an interesting sum-of-the-parts analysis of Nokia.  The magazine argues that Nokia is worth more apart than it is together. Specifically, Bloomberg attempted to value the three major units of Nokia:  mobile phones, mapping systems, and infrastructure equipment.  It chose one comparable firm for each unit, and then valued the units based on the revenue multiples of the comparables.  The conclusion: Nokia's sum-of-the-parts may be worth 52% more than the whole! 

What should we make of this analysis?   I think it's certainly advisable for investors and executives to be looking at whether Nokia might be worth more in a break-up.  However, I have some concerns with concluding that the sum of the parts exceed the value of the current whole based on this methodology.   First, I would like to have seen some other valuation methods besides revenue multiples.  One wonders how much the numbers shift based on different valuation techniques.  Revenue multiples seem particularly troublesome here since the mobile phone unit seems in serious distress, with market share plummeting over the past few years as the smartphone business has been dominated by rivals such as Android and Apple. 

Second, the methodology only chooses one comparable for each Nokia business unit.  I would much rather see a set of comparables for each unit, with an average taken of the revenue or earnings multiples for those rivals. 

Third, sum-of-the-parts analyses can be a bit dangerous if significant synergies exist among the units, and if those synergies might be lost during a break-up.  I don't know enough about the intricacies of Nokia's business to determine the extent of synergies; the article at BusinessWeek.com does not mention synergies at all.  

Finally, the rapid significant decline in the mobile phone business at Nokia really does make valuation a challenge.  Projecting forward based on history can be difficult based on the deterioration happening in the business.  As one expert noted in the article, "“It’s hard to do a sum-of-the-parts analysis when the floor is falling out and you don’t know where the bottom is.” (Michael Liss, fund manager at American Century)