Thankfully, this could be the last note I write about one of the worst managed companies I've followed in my 20-year history as a restaurant analyst.  My criticism of Darden has been very harsh at times, but given the state of the company it’s been more than justified.  Personally, I’m tired of being negative.  I’m also tired of witnessing the biggest destruction of shareholder value in the history of casual dining.


It’s hard to believe, but I’ve been vocal about the need for significant change at Darden for precisely 746 days now.  It was back in July 2012, when I first introduced my “unthinkable short” case on Darden in which I harped on the severe mismanagement of the company. 


The value destruction we’ve been speaking of since then can be seen in the consensus FY15 EPS estimate of $2.26 (Hedgeye is at $2.00).  As a point of reference, the consensus FY15 EPS estimate was $5.30 back in FY13.   The ironic part of all of this is that the CEO and the Board want you to leave what is left of the company in their hands.  Brinker International, one of Darden’s largest competitors in the casual dining space, has seen its consensus FY15 EPS estimate go from $2.80 to $3.10. 


Given the success of Brinker over the past 746 days, Darden management cannot blame a difficult casual dining environment for their troubles.  Instead, the trouble lies in their inability to recognize, manage and allocate capital appropriately in this difficult consumer environment.


For the sake of shareholders, Starboard must get control of the Board on September 30th.  Without a change of this magnitude, they can expect more of the same: dismal returns, value destructive initiatives, and a complete disregard for shareholder concerns.


This week, Starboard reiterated its commitment to fixing the issues that have consistently plagued Darden.  In addition, they increased their ownership in the company to 7.1%.  While this is good news, we believe any upside potential in the stock has been negated by the continual blunders of management and the Board.


I once used the phrase “a generational opportunity” to describe the upside potential for Darden shareholders.  Alas, that phrase is no longer applicable – the sale of Red Lobster changed everything.  It’s now much more difficult to create significant value. 


I applaud Starboard’s continual effort to push for significant change at Darden, but the fact of the matter is they’re facing an uphill battle.  The issues the company faces are similar to those back in July 2012 when we first began calling for change at the company – unrealistic guidance, poor capital allocation and constant cash burn.  Without new management in the next 12-months, the current team will either need to cut its plans for new unit development or cut the dividend.


In short, management’s current business plan doesn’t produce enough cash to execute the Brand Renaissance plan at Olive Garden.  As seen on page 19 of the most recent company presentation, management suggests there are only 300 restaurants in need of a remodel.



Source: Company Presentation 


However, if management wants the chain to have a consistent look and feel, and accomplish its goal of “bring[ing] the Brand Renaissance to life in every guest touchpoint,” it will need to remodel all 837 restaurants.  We estimate this will cost the company approximately $550 to $600 million in capital investment.


According to current guidance, the company will generate $87 million in FCF in FY15 – but we know the company’s ability to provide accurate guidance is highly suspect.  This guidance implies that it will take between 5-6 years to complete the Brand Renaissance remodels.  Obviously, this plan is a non-starter and should be unacceptable to any shareholder.


As we have modeled, the company needs to spend significantly more to fix Olive Garden in a timely manner.  Spending $200 million a year would allow Darden to complete the remodel program in 3 years, but it would put the company in a negative FCF position. 


Why does management consistently put the company in a box, where it has no choice but to lower capex or cut the dividend?





Call with questions.


Howard Penney

Managing Director


Fred Masotta



CARTOON OF THE DAY: GRILLIN’ AND CHILLIN’ - chillin  cartoon 07.18.2014


US economic growth isn’t heating up this summer.

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Retail Callouts (7/18): VFC, TGT

Takeaway: VFC - 2 callouts from print, 1) International, 2) SIGMA. TGT - still feeling the heat from the data breach



VFC - 2Q14 Earnings


Takeaway: Two key callouts from the print this morning. 1) International growth rate continues to accelerate sequentially on both the one and two year trend line. European constant currency growth rate up 900bps YY. 2) SIGMA - gross margin came in 80bps below expectations, but inventories look much cleaner heading out of 2Q compared to 1Q. A much better set up for VFC heading into the balance of the year.


Retail Callouts (7/18): VFC, TGT - chart1 7 18



TGT, AMZN - Amazon Has the Best Consumer Perception of Any Brand Mid-year, rankings show Target hit hard by data breach



  • "The retailer last year was the No. 7 best-perceived brand among consumers, but not only did it fall off the top 10 list, it plummeted all the way down to No. 21."


Takeaway: This survey ask respondents whether they've heard anything about the brand in the past 2 weeks, and if so was it positive or negative. TGT has been no stranger to headlines over the past 8 months, and the data breach continues to affect shopper perception of the brand. The reality is that when a customer has a great experience in retail, they tell a friend. When a customer has a customer has a bad experience, they tell 20. Just ask JCP or LULU. Some of these 'fire your customer' events are worse than others, but there's one commonality - they take a very long time to recover.



Alibaba IPO Seen Possible in Sept.



  • "Alibaba Group Holding Ltd. is now said to be envisioning an initial public offering in September."
  • "The company on Friday, in a regulatory filing with the Securities and Exchange Commission, valued itself at $130 billion, up from the $117 billion valuation in late June."


APP - American Apparel Shareholders Seek Resignation of Board Members



  • "On the eve of the company’s naming five new directors to its board — the confirmation is expected as early as next week, according to sources — a hedge fund has demanded the resignation of the firm’s two co-chairman, David Danziger and Allan Mayer."


Back-to-school/college spending shows slight year-over-year improvement



  • "Families this summer will spend slightly more on back-to-school items than they did in 2013. According to NRF’s 2014 Back-to-School Survey conducted by Prosper Insights & Analytics, the average family with children in grades K-12 will spend $669.28 on apparel, shoes, supplies and electronics, up 5% from $634.78 in 2013."
  • "Total spending on back to school will drop slightly to $26.5 billion as the survey found there are slightly fewer students in households this summer."


House votes to expand tax break for store remodels



  • "The House has passed legislation broadening a federal tax law that makes it cheaper for retailers to remodel their stores, the National Retail Federation said."
  • "Lawmakers voted 258-160 today to make 'bonus depreciation' permanent, and granted NRF’s request that it be expanded to include stores that are owned rather than just those that are leased. The measure now heads to the Senate."

Keith's Macro Notebook 7/18: VIX RUSSELL 2000 UST 10YR

LEISURE LETTER (07/18/2014)

Tickers: LVS, H, PEB, WYN, MTN


  • July 23:  TRIP 2Q call (430pm)
  • July 24:  
    • WYN 2Q call (830am)
    • PNK 2Q call (9am)
    • LHO 2Q call (930am)
    • PENN 2Q call (10am)
    • HOT 2Q call (1030am)
  • July 25:
    • PEB 2Q call (9am)


LVS & 1928:HK (Jornal Tribunal de Macau) The Macau government's Land, Public Works and Transport Bureau halted construction on Sands China Ltd’s Parisian casino-resort in Cotai. Construction ceased because the developer has permission only to undertake earthworks on the site. However, the contractor has already built a structure 10 or more floors in height.

Takeaway: As highlighted during the LVS 2Q earnings call, the reason for the the construction halt is now known. LVS emphasized that Parisian remains on target to open in late 2015.  However, our sources are skeptical that the property will be up and running in 2015.


H – the Company and Playa Hotels & Resorts B.V. announced plans to introduce the Hyatt Ziva brand to Cancun. Formerly Dreams Cancun, the resort’s multi-million dollar renovation began June 1, and it is expected to reopen in late 2015 as Hyatt Ziva Cancun. The resort will be managed by Playa Resorts Management, the operational component of Playa Hotels & Resorts. 


In addition to Hyatt Ziva Cancun in Mexico, Playa is scheduled to open Hyatt Ziva Puerto Vallarta in late 2014. In the Caribbean, Hyatt Zilara Rose Hall and Hyatt Ziva Rose Hall in Montego Bay are scheduled to open in late 2014. The two new resorts will be co-located on Jamaica’s most romantic beach, formerly home to The Ritz-Carlton. Hyatt Zilara Rose Hall will offer an adults-only all inclusive experience that will be separate, but connected to, Hyatt Ziva Rose Hall, which will cater to guests of all ages.

Takeaway: Building the new brands, one asset at a time.


PEB – announced the acquisition of 331-room luxury, The Nines hotel in Portland, OR for $127.0 million. PEB noted (during the next 12 months), the company currently forecasts that the hotel will generate EBITDA of $12.0 to $12.6 million and NOI of $10.4 to $11.0 million.  As well as, in conjunction with the acquisition, the company is assuming three secured, non-recourse loans totaling $50.7M, which are subject to a weighted average interest rate of 7.4%.

Takeaway: We highlighted this yet-to-be-announced acquisition in our May 12 Leisure Letter based on a May 7th application by a Pebblebrook Hotel Trust subsidiary to take over the liquor license of the hotel and its restaurants.


WYN – announced it completed a term securitization transaction involving the issuance of $350 million of asset-backed notes. Sierra Timeshare 2014-2 Receivables Funding LLC issued $277 million of A rated notes and $73 million of BBB rated notes.  The notes were backed by vacation ownership loans and had coupons of 2.05% and 2.40%, respectively, for an overall weighted average coupon of 2.12%. The advance rate for this transaction was 91%

Takeaway: Very good terms for a consumer receivable securitization.


MTN – Air Canada recently informed Eagle county airport officials that it would need a $115,000 revenue guarantee to continue even scaled-back service to the valley. Without the guarantee, the flights wouldn’t be scheduled for the coming ski season. Eagle County Director of Aviation Greg Phillips took that news to the Eagle County commissioners, who quickly approved reserving the entire amount in order to keep the flight. EGE Air Alliance, a local group dedicated to bringing more service into the airport, is focused on two main projects: maintaining the guarantees for a summer flight from Houston — which requires about $450,000 in guarantees — and work on a probable 2015 ballot issue to provide a still-undecided form of tax funding for future flights.  The Vail Town Council voted unanimously to approve — a contribution of $25,000, with another $14,000, if it’s matched dollar for dollar by Vail Resorts as well as the Beaver Creek Resort Company.

Takeaway: The truth about airline lift subsidies into EGE airport are now becoming public information. Such subsidies are not discussed by MTN management. 


Macau Junkets Capital Infusion (GGR Asia) Hong Kong-listed China Star Entertainment Ltd is to loan HKD200 million (US$25.8 million) to an unnamed Macau junket promoter, only identified as ‘Junket Company 3′. The loan is via a China Star Entertainment subsidiary registered in the British Virgin Islands called Classic Champion Holdings Ltd and is spread across 24 months at an annual interest rate of 10%. The filing said the junket firm concerned currently promotes 46 tables at an unnamed casino in Macau. China Star, which runs Casino Lan Kwai Fong in the Macau Peninsula under the gaming licence of SJM Holdings Ltd, added that the junket promoter had generated rolling chip turnover of approximately HKD357.38 billion for the 18 months to June 30. China Star reported in its 2013 annual results to December 31 that Casino Lan Kwai Fong operated a total of 84 gaming tables, targeting VIPs and mass-market customers, and 128 slot machines. China Star said in late June there was a delay in its move to buy an equity interest in the profit stream from another junket promoter at the casino hotel called Eight Elements Entertainment Ltd

Takeaway: More liquidity can't be bad.


Macau Junket Acquistion (GGR Asia) International Entertainment Corp (IEC), a Hong Kong-listed company that in January announced it was interested in buying a 70% economic interest in Macau junket investor Suncity International Holdings Ltd, says in its annual report that the deal has not yet been concluded.  International Entertainment describes its current main activities as “hotel operations, and leasing of properties for casino and ancillary leisure and entertainment operations”. On January 9, IEC it said it had entered into a term sheet with Suncity International – the potential vendor – and Alvin Chau Cheok Wa, the sole beneficial owner of the vendor – about acquiring a 70% economic interest in the business. It was to be effected via purchase of a 70% equity interest in Suncity International, which in turn International Entertainment said was entitled to all the net profit from gaming promotion operations by Sun City Gaming Promotions Co Ltd. In January the deal was described as worth HK$7.35 billion (US$948 million), to be settled in cash and through the issue of new shares at HK$5 each, representing up to 29 percent of the enlarged share capital of International Entertainment.

Takeaway: Could the recent VIP challenges result in "recast" transaction terms?


South Korea Gaming Expansion (GGR Asia) The provincial government of South Gyeongsang in South Korea on Wednesday signed a deal with an international consortium to develop a movie-themed park based on 20th Century Fox’s films. The project, to be part of a larger entertainment complex featuring a casino, will be located near the city of Busan, in the south of the country. The partners in the movie-themed park project include Fox Consumer Products Inc, the marketing and licensing arm of 20th Century Fox group, and Village Roadshow Theme Parks Ltd, one of Australia’s largest theme park operators, with interests in China and the United States. The site is forecast to open by the second half of 2018. The entertainment complex will be built in a 2.8-million-square-metre (30.1 million sq feet) site in Changwon, according to media reports. The entertainment complex will also include a six-star hotel, a water park, a cinema, retail areas and a golf course. The theme park will be its centrepiece, featuring more than 25 rides and attractions with characters and story lines from 20th Century Fox’s movies.


The reports gave no details about the casino component. Local authorities expect the entertainment complex to attract around 10 million foreign and local tourists a year. They believe it will benefit from the fact there are more than 60 cities with a population in excess of one million within three-hours’ flying time of Busan’s international airport.

Takeaway: More casinos coming in S Korea


Slot System Failure ( Lumière Place technology officials worked Thursday to determine what caused a slot machine failure that forced a temporary casino shutdown. State gaming regulators ordered the casino closed at 11:45 p.m. Wednesday, about four hours after the problem surfaced. The casino reopened about 6:30 a.m. Thursday, said spokeswomen for Lumière Place and the Missouri Gaming Commission.  Lumière Place officials said in a statement that “a system failure” of the slot machines began just before 8 p.m. The casino began manually paying customers their slots winnings as workers tried to fix the problem.  

Takeaway: Technical glitch at Lumiere won't have an impact.  


Hard Rock Hotel Planned for Lake Tahoe – Officials for the Las Vegas-based Warner Hospitality and the Tahoe-based Park family that owns the former Horizon Casino Resort at Stateline say the $60 million renovation and reprogramming will convert the former Horizon property to the Hard Rock Hotel & Casino Lake Tahoe and will include more than 500 hotel rooms and a 25,000-square-foot casino.

Takeaway: Could be a handful of new slots for this property.  


China Real Estate – The average prices of new homes in 70 major cities fell 0.5% in June from the previous month, accelerating from May’s 0.2% monthly drop based on data issued by the National Bureau of Statistics.  Prices in Shanghai and the southern city of Guangzhou fell 0.6% each from May, the biggest drop since January 2011.


Hedgeye remains negative on consumer spending and believes in more inflation.  Following  a great call on rising housing prices, the Hedgeye

Macro/Financials team is turning decidedly less positive. 

Takeaway:  We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.

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