Yesterday was a big day – DRI rose 3.5% on 2x the average daily volume. As we’ve said before, the theme here is consistent: The stock rises on days change is in the air and falls when management publicly digs their heels in.
The title of this note derives from the French saying: “L’heure entre chien et loup.” It refers to the moments following sunset, when the sky darkens and vision becomes unclear, making it difficult to distinguish between dogs and wolves.
We’re using this expression to create a metaphor for the uncomfortable situation that is unfolding at Darden, following the news that Starboard Value has won shareholder consent to call a Special Meeting. With yesterday’s victory, the sun is beginning to set in Orlando and it’s becoming increasingly difficult for management to distinguish between dog and wolf.
From where we sit, there is enough light to see the animal in front of them is a dog. Unfortunately, management appears predisposed to a certain view. As a result, they see a wolf and, by extension, feel trapped. It didn’t have to be this way. The truth is, there is a way out of this situation that would leave all constituents feeling safe and shareholders feeling happy. For some reason, this has been so unclear to the powers that be in Orlando.
Part of the haze may be stemming from the notion that Starboard only got 55% of shareholders to consent. On the surface, this might appear like a slim margin of victory. However, the turnover since the record date, shares short and the retail component are all factors that suggest this is a convincing margin of victory. We hope Darden’s advisors will give the Board and management a straight story, so that they can see the situation more clearly. If they wait until nightfall, however, we suspect that dog could soon become a wolf.
This French saying also highlights the stark contrast between the “familiar and comfortable” and the “unknown and dangerous.” Ever since activists began pushing for change at Darden, management has retreated and found solace in the confines of Orlando, where they have lived a comfortable life for many years. Between the lifestyle they are fighting to protect and the considerable financial resources at their disposal, they have been unwilling to face the harsh reality of the situation. In its 18 years as a public company, Darden has never found itself in a similar situation. Knowing how to properly respond, therefore, can be a daunting task.
Under significant pressure, CEO Clarence Otis has been unwilling to hold himself accountable for his decisions. For example, Mr. Otis failed to stress test his plans to create shareholder value with critical Wall Street analysts, opting, instead, to conduct one-on-one meetings with shareholders. Alas, the moat he has built around his castle is not serving him well. As a result, the Board and management now find themselves in the center of a very uncomfortable situation in which they are losing control of the company.
Yesterday, Jeffrey C. Smith, Managing Member, Chief Executive Officer and Chief Investment Officer of Starboard Value LP, went on CNBC to discuss Darden’s proposed separation of Red Lobster. Reading between the lines, Mr. Smith is very clear about what needs to happen at Darden:
“There clearly have been operational issues and clearly there are strategic issues now and that all starts at the top. I mean, so as a shareholder, our power, our control is with the Board. Our power is, in theory, at some point to be able to nominate directors and potentially replace the Board if they’re not doing a great job in overseeing management and how the business is being run. The biggest decision for a board is in choosing the CEO and continuing to choose the CEO and I think there are some strategic issues here and operational issues. So, is Mr. Otis in a hot seat? I think he is in a hot seat.”
The shareholders of Darden have spoken – it is time for significant change.
One wild card, and a current “unknown” to outsiders, is the financial performance of Darden to-date in 4QF14. With nearly two-thirds of the quarter in the books, management knows precisely how the period is shaping up. The leverage they might have with shareholders is to prove their recent operational initiatives are gaining traction. However, given the current data we are seeing on sales trends, we highly doubt there will be much good news to talk about when they report earnings. In fact, considering the lack of momentum in the business, we expect to hear disappointing guidance for FY15. Even after two disastrous years of -10% and approximately -25% EPS growth, it’s unlikely they will be able to hit the current consensus estimate of 12% EPS growth in FY15.
Change is in the air.
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Editor's Note: This note was originally sent to subscribers on April 23, 2014 at 8:16 a.m EST by Hedgeye Restaurants sector head Howard Penney. Follow Howard on Twitter @HedgeyeHWP.