Podcast Summary
Retirement Plans, Red Lobster: Debate continues over universal retirement coverage and employer-based plan readiness. Red Lobster's 'endless shrimp' promotion reportedly cost $11M and may have contributed to bankruptcy, with supplier manipulation allegations still under investigation
The discussion revolved around two main topics: universal coverage for retirement plans and the bankruptcy of Red Lobster. Regarding retirement plans, there's ongoing debate about implementing federal or state mandates for enrollment in some type of plan, such as IRA-type plans. Employer-based retirement plans and their current state of readiness can be explored further in PGIM's The Out Thinking Investor podcast. As for Red Lobster's bankruptcy, the "endless shrimp" promotion, which allowed customers to eat as much shrimp as they wanted, reportedly cost the company $11 million. Additionally, there were allegations of the largest shrimp supplier, Thai Union, manipulating the supply chain to benefit financially, but the details are still in dispute. The endless shrimp promotion, while not the sole cause, did contribute to the financial strain of Red Lobster.
Darden Restaurants Proxy Fight: The Darden Restaurants proxy fight with Starboard Value led to suggestions for operational and financial improvements, including the controversial addition of salt to pasta water at Olive Garden, which influenced Red Lobster's future as a subsidiary and now independent company.
The current struggles of Red Lobster can be traced back to its time as part of the Darden Restaurants conglomerate, which is best known for Olive Garden and their famous unlimited breadsticks. Around a decade ago, there was a high-profile proxy fight between Darden's management and board, and the activist hedge fund Starboard Value. Starboard suggested numerous operational and financial improvements, including spinning off subsidiaries and restructuring kitchen processes at Olive Garden. One of their most notable suggestions was to add salt to the pasta water, which sparked controversy due to its simplicity yet significant impact on the taste. The incident became a significant moment in Wall Street history, and although Red Lobster is now an independent company, its past as part of Darden continues to influence its story.
Darden's cost-cutting measures: Activist investor Starboard Value Capital replaced Darden's entire board due to cost-cutting measures, including using inferior salt for pasta, and the inadequate sale of Red Lobster to a private equity firm without shareholder input.
The cost-cutting measures taken by Darden, including using inferior salt for pasta, led to public backlash and a historic proxy fight. Starboard Value Capital, an activist investor, replaced the entire 12-person board due to their outrage over the company's management, including the sale of Red Lobster to a private equity firm for a price deemed inadequate. This moment marked a significant shift in investor activism and left Darden's legal, financial, and communications teams humiliated. The sale of Red Lobster, a valuable asset, without shareholder input further fueled the tension.
Red Lobster real estate opportunity: Starboard identified the potential to increase the value of Red Lobster and Olive Garden by monetizing their real estate through REITs, potentially leading to higher valuations
During the sale of Red Lobster by Golden Gate, it was revealed that the business was only worth approximately $600 million, with the brand holding minimal value. However, Olive Garden and Red Lobster both owned most of their real estate, which Starboard saw as an untapped opportunity. Starboard believed that by monetizing this real estate, they could increase the valuation of the companies if they were split into two. This belief was reinforced by the US tax code, which allows Real Estate Investment Trusts (REITs) to avoid federal income tax by collecting rents and paying out more than 90% of it as dividends. Essentially, this tax structure allows for the rearrangement of cash flows, potentially leading to a higher valuation. It's important to note that this is a complex financial strategy, and the actual outcome would depend on various factors.
Company Real Estate Separation: Separating a company's operating business from its real estate holdings can create significant value through the sale of real estate and the creation of a REIT, allowing each entity to focus on its core competencies and maximize worth.
Separating a company's operating business from its real estate holdings can create additional value. This concept was demonstrated through the Darden Restaurants case study, where the company split into two entities: Old Darden, which managed the restaurants, and Red Lobster, which was sold and its real estate was turned into a REIT. The sale of Red Lobster's real estate brought in significant funds for the buyer, while Darden created its own REIT, increasing shareholder value. This separation allowed each entity to focus on its core competencies and maximize their individual worth. The success of this strategy is evident in the post-2014 and 2015 period, where both companies thrived despite facing different financial situations.
Casual Dining Sector Challenges: The casual dining sector has faced intense competition, heavy promotional discounting, and struggled to adapt to the pandemic, with companies like Red Lobster facing large rent obligations and significant challenges in offering takeout, online ordering, and delivery
Darden Restaurants, which includes Olive Garden and LongHorn Steakhouse, has outperformed the struggling casual dining sector, including companies like Chili's and Red Lobster. The sector has faced intense competition and heavy promotional discounting, making it difficult for companies to differentiate and thrive. The pandemic further crippled the industry, with restaurants shutting down and a significant decrease in traffic, making it particularly challenging for companies like Red Lobster that were not well-equipped for takeout, online ordering, and delivery. Additionally, Red Lobster's large rent obligations, which totaled $190 million, added a heavy burden to the company, making any operating slip-ups particularly detrimental. Overall, the casual dining sector has faced significant challenges, and companies that have been able to adapt and execute well, like Darden, have seen success.
Red Lobster sale: Golden Gate's sale of Red Lobster to Thai Union generated substantial returns for the private equity firm due to heavy borrowing, but the debate continues on if private equity involvement led to value depletion or if Thai Union could manage it better.
The private equity firm, Golden Gate, bought Red Lobster for $2.1 billion in 2014, sold 49% of it for almost the same amount in 2016, and ultimately exited in 2020, leaving Thai Union, a publicly traded Thai seafood company, as the new owner. Golden Gate's investment returned substantial amounts due to the large amount of borrowed capital used. However, the question remains whether private equity's involvement led to the depletion of Red Lobster's value or if Thai Union, as an operating company, could have managed it better. The pandemic added challenges, but there have been significant management changes since Thai Union's acquisition. Notably, Realty Income, Red Lobster's landlord, expressed confidence in the company's ability to recover despite its onerous leases. The debate continues on the role private equity plays in corporate value creation or destruction.
Red Lobster revival: Red Lobster, despite challenges, has potential for revival through bankruptcy process and new ownership, offering investors an opportunity to turn things around
Red Lobster, despite facing mismanagement and underperformance, is an iconic brand with potential for revival. With $2 trillion in sales and a decent business structure, the company could benefit from a bankruptcy process to clean up its balance sheet and leases. The new owners, led by Fortress Investment Group, have an opportunity to turn things around for Red Lobster. Meanwhile, in the world of food chains, Suji and the podcast hosts share their personal preferences, with Suji expressing a strong affinity for Chili's and its large portions, while acknowledging that the food quality is subjective. In the investment world, they also discuss their investment choices, with Suji going long on Chili's and expressing a preference for its food over Applebee's and TGI Fridays. Additionally, they express excitement about their long position on Caravaggio.
Caravaggio's popularity: Caravaggio's paintings are highly favored by many, resulting in an overwhelming response when asked to name top 5 painters, potentially making investing in his works a wise decision
The unexpected enthusiasm and passion people have for the painter Caravaggio. This was evident when I asked my readers to name their top 5 painters, and the response I received was overwhelming, with more responses than any finance question I've ever asked before. Caravaggio stood out as a clear favorite, surpassing the likes of Van Gogh, Michelangelo, Titian, El Goyas, and Velasquez. It seems that there is a lot of love for this painter, and investing in his works could potentially be a wise decision. I want to thank Sujit for joining the show and sharing his insights. Unhedged is produced by Jake Harper and edited by Bryant Erstat, with additional help from various team members. For more content, premium subscribers can get the unhedged newsletter for free, and a 30-day free trial is available to everyone else. I'm Rob Armstrong, and thank you for listening.