By Julie Jargon And David Benoit
The owner of the Olive Garden and LongHorn Steakhouse
restaurants hopes to spice up profits by jettisoning much of its
real estate, a move that could set a precedent in an industry
increasingly shifting to an "asset-light" model of ownership.
Darden Restaurants Inc. said on Tuesday it would transfer about
430 of its more than 1,500 restaurants to a publicly traded
real-estate investment trust and lease them back, the first major
restaurant chain to take such a step after prodding by activist
investor Starboard Value LP.
The Orlando, Fla., chain's action is the boldest in a string of
moves by restaurant operators to juice returns by removing assets
from their balance sheets. McDonald's Corp. and a host of other
companies have been selling more of their restaurants to
franchisees in an effort to reduce financial risk and establish
more-consistent revenue streams. The retooling comes at a time when
the retailers face higher costs associated with wages, health care
and food.
Transferring outlets to REITs enables restaurant and retail
chains to collect an upfront sum that can be used to pay down debt
and to improve return on invested capital, a metric investors use
to evaluate companies.
Bob Evans Farms Inc., which operates nearly 600 restaurants,
last week said it is considering selling and leasing back between
30% and 60% of its properties, or transferring them to a REIT.
Doing so would allow it to separate its packaged-meat and
restaurant businesses, which investor Sandell Asset Management
Corp. has been urging.
Darden, which doesn't franchise its restaurants in the U.S.,
mostly will be transferring Olive Garden stores into the planned
REIT. Darden also has listed 75 restaurant properties for
individual sale lease-back deals and said more than 30 have been
sold or are under contract.
Analysts say McDonald's, with its vast real estate holdings,
could separate its properties in the U.S. as part of its turnaround
effort. McDonald's Chief Administrative Officer Peter Bensen told
investors last month that the company is "looking at all
opportunities to further enhance value for all shareholders. We
have looked at the REIT over the years. We continue to look at
it."
Years ago, it was in vogue for restaurants to buy real estate.
In the 1960s, '70s and '80s, chains including McDonald's and
Cracker Barrel Old Country Store Inc., and to a lesser extent,
Burger King and Wendy's, began snapping up real estate because it
was inexpensive.
But "in the 1990s, commercial real estate became really
expensive and the own-your-own real estate model didn't become as
important to the Chipotles of the world," said John Gordon, founder
of restaurant consulting firm Pacific Management Consulting
Group.
REITs pay little or no tax on their earnings as long as they
distribute the bulk of their profits to investors through
dividends, which is why they are attractive to investors.
But the move carries risk.
"The restaurant business is site-specific," Mr. Gordon said.
"Let's say you have an Olive Garden that's doing OK now and can
support the rent payment, but what if the neighborhood turns bad
and sales go down?"
Restaurants that own their properties have the flexibility to
close underperforming restaurants or rebuild and remodel without
needing approval from a landlord. But if they sign a 20-year lease,
which is customary in commercial real estate, they're locked into
paying rent regardless of what happens to the business.
KeyBanc Capital Markets analyst Christopher O'Cull said it is
unlikely that any of Darden's restaurants would have trouble paying
rent, especially now that sales are on the upswing.
Darden said it would pay market rate for rent, which varies
depending on the city. Mr. O'Cull said rent is likely to be between
6% and 7% of sales, with an increase of 1% or 2% a year.
"That's manageable," he said. "If Olive Garden were to have
negative sales for a prolonged period of time, it would be a
problem. But Olive Garden is a fairly healthy brand."
Darden's real estate was among the more heated points of debate
during its losing proxy fight with activist hedge fund Starboard.
The former board at Darden had argued that a real estate split
would add leverage and deprive it of control over store
remodels.
Darden on Tuesday said it would use $1 billion in proceeds from
the REIT deal to pay down its current debt.
During the proxy fight, Starboard said rent wouldn't be a
problem if Darden strengthened results at Olive Garden and the
other chains. It felt the company could support about $171 million
a year in rent. Tuesday, Darden said it now expects to pay about
$135 million a year in additional rent.
"The benefits to Darden include an improved capital structure
with no funded debt maturities for 20 years, improved capital
allocation that strengthens our return on invested capital and a
strong, conservative financial position that offers solid coverage
for market rents," said Darden Chief Executive Gene Lee. Operations
and guest experience would "remain the same."
Darden's quarterly earnings were $105.3 million, or 82 cents a
share, up from $86.5 million, or 65 cents a share, a year earlier,
on a 14% revenue gain to $1.88 billion.
The stock was up a penny to $69.39 on Tuesday.
Write to Julie Jargon at julie.jargon@wsj.com and David Benoit
at david.benoit@wsj.com
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