SALON
Wednesday, Sep 17, 2014 04:45 PM EDT
Remember that "hilarious" report last week
ripping the chain eatery to pieces? The back story will infuriate you
David Dayen
Topics:
Olive Garden,
Labor,
Workers,
hedge fund,
investors,
greed,
Editor's Picks,
Media Criticism,
breadsticks,
Pasta,
Water,
Red Lobster,
Business News,
Politics News
Last week, you may have noticed a kooky story about a hedge fund named Starboard Value
chastising Olive Garden for handing out too many unlimited breadsticks at a time, and failing to salt its pasta water. The snarky 294-page
presentation highlighted everything wrong with Olive Garden, along with recommendations to fix it. And there was much laughter.
Business Insider’s Joe Weisenthal
called the presentation a masterpiece.
Vox and
Mother Jones and
Slate and
the New Yorker debated its finer points. Business Insider even
sent reporters on a field excursion to Olive Garden to check things out.
The story had all the proper elements for our Twitter-fueled “you
won’t believe what happened next” media age. Readers could mock that
silly chain restaurant they remember from their childhoods in the
suburbs, and the silly hedge fund that took the time to write the
world’s worst review.
Except Starboard Value does not spend its
time crusading for better mid-market Italian meals for no reason. It
owns a bunch of shares in Olive Garden’s parent company, Darden
Restaurants, and wants to take control of the company’s board. The
scheme it’s concocted to increase its share price has little to do with
breadsticks and pasta water. It really wants to steal Olive Garden’s
real estate, and make a billion dollars in the process.
Starboard Value doesn’t try to hide this. Right in the
executive summary,
it talks up Darden’s real estate holdings the way a starving man sizes
up a steak. Darden, owner of LongHorn Steakhouse, Capital Grille and
other chains, “has the largest real estate portfolio in the casual
dining industry, owning both the land and buildings on nearly 600 stores
and the buildings on another 670,” Starboard Value writes. “We believe
that a real estate separation could create approximately $1 billion in
shareholder value.” Here’s the actual slide:
This is a more common technique than you might realize. Private
equity firms often buy businesses with lots of real estate assets, like
nursing homes, restaurants or retail outlets. They then split the
company in two: one owns all the real estate, and one manages the rest
of the business. The operating company now has to lease back the real
estate from the property company, paying rent on what it used to own.
The private equity firm, meanwhile, can take profits from the lease
payments or by selling the entire real estate portfolio, making back its
initial investment. The more expensive the leases, the more the private
equity firm makes.
In this case, Starboard Value doesn’t have
enough money to buy Darden Restaurants outright. But it’s purchased
enough shares to influence Darden’s corporate strategy. Already it has
forced the
replacement of the CEO
and the sell-off of parts of the business. And Starboard wants Darden
to undertake this sale-leaseback to increase the value of its shares: It
believes it can make anywhere between $6 and $10 a share off the deal.
(Darden
responded to Starboard Value’s presentation with
one of its own, but never mentioned the sale-leaseback deal.)
A
sale-leaseback arrangement may make sense for a company with lots of
real estate holdings, if it needs quick cash to make investments and
cannot access a loan. Think of it like a company making a reverse
mortgage. But Eileen Appelbaum of the Center for Economics and Policy
Research, co-author of a recent book called “
Private Equity at Work: When Wall Street Manages Main Street,”
explains the key difference. “If the company does this themselves, they
get to keep the money from the sale,” Appelbaum told Salon. “And they
get to spend it to make improvements. In this case and the private
equity case, the shareholders see the value.” Basically, Starboard Value
wants to strip Darden’s assets, the Wall Street equivalent of pocketing
the silverware.
Starboard Value has a history of asset-stripping. Earlier this year, it forced Wausau Paper to
change CEOs and
consolidate mills,
moving out of the century-old headquarters that gave the company its
name. Starboard Value demanded the company use some of those savings
from laying off workers to
pay Starboard a dividend.
In May, Starboard Value forced Darden to sell another of its chains,
Red Lobster, to private equity fund Golden Gate Capital for $2.1 billion. The same day, Golden Gate
sold the real estate of 500 Red Lobster locations to a real estate investment trust (REIT) for $1.5 billion. Darden used proceeds of the sale to
give dividend payments
to shareholders like Starboard Value. And Golden Gate made back most of
the investment in a blink with the real estate sale. But Red Lobster
now has to pay exorbitant rents on its restaurants. “The sale-leaseback
will cut their net earnings roughly in half,” Eileen Appelbaum
estimated.
If Olive Garden has to cut its earnings in half to pay
rent on properties it previously owned, you can forget about upgrading
the menu or making any of the other improvements Starboard Value
suggests. The restaurants will barely be able to keep afloat. But Olive
Garden’s continued existence is of minimal importance to Starboard
Value. “These are shareholders, they don’t really care what happens once
they make their money,” said Eileen Appelbaum.
Take the example
of Mervyn’s Department Stores, which in 2004 had 30,000 employees. A
private equity consortium bought it that year, and split off the
company’s real estate holdings. Mervyn’s saw no money from the sale, and
had to lease back its stores from the property company at high rents.
The stores immediately cut 10-15 percent of payroll, shedding thousands
of jobs. When the recession hit, the company suffered like its
counterparts in retail, but its annual loss in 2007 – $64 million – was
less than the $80 million in rent it had to pay. In 2008, the chain went
into bankruptcy, eventually dissolving all its remaining stores and
putting the last 18,000 employees out of work.
The Mervyn’s case
reveals the key problem with the sale-leaseback scheme. “The reason
these companies own their real estate is because they’re a buffer in
times of recession,” Eileen Appelbaum said. Restaurants and retail
stores are highly cyclical; new clothes and nice dinners are the type of
expenses that consumers immediately cut during tough times. If these
stores don’t have to pay rent, they can better weather the downturns,
which inevitably come with the business cycle. “Strip them of the buffer
and you put them at risk,” Appelbaum concluded.
Olive Garden and Red Lobster may not be destinations for hipster Internet journalists, and they have seen
revenue declines amid stagnant middle-class wages and
increased competition.
But they are still profitable businesses. Thousands of Americans work
there. Why should they be bled dry by predatory investors in the name of
“shareholder value”? What of the value of worker productivity instead
of the financial engineers?
Not salting your pasta water may be
scandalous. But the real scandal here is what this hedge fund wants to
pull off, which can only be called legalized theft.
David Dayen is a contributing writer for Salon. Follow him on Twitter at
@ddayen.
More David Dayen.
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