Why The Red Lobster Multiple Is Too High

Darden Restaurants this morning unexpectedly sold Red Lobster to Golden Gate Capital for $2.1 billion—a deal that will not likely sit well with activists, given that Golden Gate is turning around and unloading the chain's real estate for $1.5 billion.

On the same morning that Darden announced the restaurant sale, Golden Gate announced that it sold the real estate for 500 properties in a sale-leaseback transaction for $1.5 billion to American Realty Capital. The cap rate on that deal is 9.9 percent.

That sale-leaseback deal means that the multiple Darden has been touting today is overstated. The Orlando-based casual dining giant said in a release that it sold Red Lobster for 9x earnings before interest, taxes, depreciation and amortization. On the surface, that's a ridiculous price for a reclamation project like Red Lobster—further proof that the M&A market is too inflated.

But a deeper look at that multiple shows the price to be more reasonable for Golden Gate—with a true multiple of 7.4x EBITDA.

Here's why: More than 71 percent of Red Lobster's value was in that real estate, given the price that Golden Gate received for those 500 locations. So the real value of Red Lobster is $600 million.

If the $2.1 billion was 9x EBITDA, then the chain's earnings were about $230 million. Subtract the rent that Red Lobster will be paying after that sale-leaseback deal, using that 9.9 percent cap rate, and then the EBITDA is an estimated $81.5 million. Conclusion: Darden more or less received market value for that seafood concept.

Multiples are an imperfect yet nevertheless closely watched measure of a chain's price. They have been inflated lately, thanks to demand from buyers and readily available debt that's cheap. Traditionally, buyers like to tout lower multiples. Sellers like to brag about higher multiples.

The sale of Red Lobster has turned upside-down the battle between Darden and its activists, Starboard Value and Barington Capital, and sets up a potentially contentious battle in the coming months. Starboard has already indicated that if Darden goes ahead with a divestiture of Red Lobster that it would seek board seats.

Darden has been pushing a spinoff of Red Lobster, which has struggled with weak sales and rising costs—food costs have risen from 31 percent of sales in 2011 to 33.7 percent in 2013. As such, net earnings for Red Lobster have declined 21.5 percent between 2011 and 2013.

But activists want Darden to take a broader look at its company and sell off real estate, and the sale of Red Lobster includes that real estate, and they believe that getting rid of Red Lobster would hammer Darden's value. Indeed, Darden's stock is down nearly 4 percent on the news of the sale. That's not exactly a ringing endorsement.

Neither Starboard nor Barington has commented on the sale publicly at this point.

The sale of Red Lobster does explain why Darden has been reticent in calling a special meeting since shareholders easily voted in favor of such a meeting to discuss the chain. Starboard has been publicly questioning why Darden has yet to call the meeting.

Darden said in its release today that it would hold a meeting "as promptly as practicable."

It will be an interesting atmosphere at that meeting now.

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