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.
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.
