Darden Restaurants has a significant amount of owned real estate (including buildings and Equipment) on its balance sheet ($3.0 billion) and have thought for years that equity investors do not assign the appropriate value to the Darden real estate holdings. As of May 28, 2008, Darden operated 1,702 restaurants (including 680 Red Lobster, 653 Olive Garden, 305 LongHorn Steakhouse, 32 Capital Grille, 23 and seven Seasons 52 restaurants). Of the company’s 1,427 restaurants open, 904 were located on owned sites and 798 were located on leased sites.

While owning a significant amount of real estate can provide a safety net to the company, removing the real estate can optimize Darden’s capital structure while improving investor perception and valuation on the core restaurant business. Traditionally, restaurant investor’s views real estate operations as a lower return proposition than the core restaurant business, thus creating an undervalued asset. Additionally, for the company to establish a permanent off-balance sheet capital financing vehicle for existing and future real estate capital needs would be extremely valuable for the entire enterprise.

  • In 1999, Darden formed two subsidiary corporations, each of which elected to be taxed as a Real Estate Investment Trust (REIT). Both corporations are currently holding certain restaurant real estate assets. Originally, the formation of the two REITs was designed primarily to assist the company in managing its real estate portfolio, reduce taxes, and provide a vehicle to access capital markets in the future. Upon a REIT spin-off, although we do not know if the tax implications would reverse, it is highly unlikely that the value of those tax implications would match the underlying value released as a result of the transaction.

  • In an attempt to determine the potential value of the stand-alone Darden REIT, it’s important to understand what the potential benefits and issues the company may face if it were to do a tax-free spin-off of its REIT. The Darden Real Estate Company would be an independent public company with its own Board of Directors and management team. A majority of the new company’s executives could be drawn internally from Darden, allowing the company to reduce its G&A costs. Further any additional property and leases would be negotiated on contributed property between Darden and the Darden REIT.

  • The following are some of the benefits that might accrue to the company if it were to spin-off its real estate business:

    Singular focus on the core restaurant business.

    Simplify balance sheet to include only core operations and a better valuation.

    Redeploy capital currently restricted by real estate in higher return restaurant business.
    Increase shareholder value with a significant share repurchase program.

    Reduce capital spending and significantly increase free cash flow.

    The Darden REIT will continue to aid Darden Restaurants in real estate solutions as new restaurants and concepts are added to the portfolio.

    Darden Restaurant will have Board level involvement at the Darden REIT.

    Darden Restaurant will be able to reduce depreciation expense

    Darden Restaurants will have the ability to transfer General and Administrative expenses to the Darden REIT.

  • The following are some of the disadvantages that we believe that Darden Restaurant might face:

    The company will incur lease expense on the currently owned properties.

    The Darden REIT will be organized with a master lease structure to allow for new properties to be added. Lease escalators are built in to future performance of the REIT.

    Darden Restaurants would lose flexibility associated with real estate ownership.

    Real estate is no longer available to pledge as collateral if needed.

Another French Revolution?

"Don't be complacent," writes Hedgeye Managing Director Neil Howe. "Tectonic shifts are underway in France. Is there the prospect of the new Sixth Republic? C'est vraiment possible."

read more

Cartoon of the Day: The Trend is Your Friend

"All of the key trending macro data suggests the U.S. economy is accelerating," Hedgeye CEO Keith McCullough says.

read more

A Sneak Peek At Hedgeye's 2017 GDP Estimates

Here's an inside look at our GDP estimates versus Wall Street consensus.

read more

Cartoon of the Day: Green Thumb

So far, 64 of 498 companies in the S&P 500 have reported aggregate sales and earnings growth of 6.1% and 16.8% respectively.

read more

Europe's Battles Against Apple, Google, Innovation & Jobs

"“I am very concerned the E.U. maintains a battle against the American giants while doing everything possible to sustain so-called national champions," writes economist Daniel Lacalle. "Attacking innovation doesn’t create jobs.”

read more

An Open Letter to Pandora Management...

"Please stop leaking information to the press," writes Hedgeye Internet & Media analyst Hesham Shaaban. "You are getting in your own way, and blowing up your shareholders in the process."

read more

A 'Toxic Cocktail' Brewing for A Best Idea Short

The first quarter earnings pre-announcement today is not the end of the story for Mednax (MD). Rising labor costs and slowing volume is a toxic cocktail...

read more

Energy Stocks: Time to Buy? Here's What You Need to Know

If you're heavily-invested in Energy stocks it's been a heck of a year. Energy is the worst-performing sector in the S&P 500 year-to-date and value investors are now hunting for bargains in the oil patch. Before you buy, here's what you need to know.

read more

McCullough: ‘My 1-Minute Summary of My Institutional Meetings in NYC Yesterday’

What are even some of the smartest investors in the world missing right now?

read more

Cartoon of the Day: Political Portfolio Positioning

Leave your politics out of your portfolio.

read more

Jim Rickards Answers the Hedgeye 21

Bestselling author Jim Rickards says if he could be any animal he’d be a T-Rex. He also loves bonds and hates equities. Check out all of his answers to the Hedgeye 21.

read more

Amazon's New 'Big Idea': Ignore It At Your Own Peril

"We all see another ‘big idea’ out of Amazon (or the press making one up) just about every day," writes Retail Sector Head Brian McGough. "But whatever you do, DON’T ignore this one!"

read more