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On Reactions to My Olive Garden Story

I’m way too late to this, but last week FT Alphaville’s Sujeet Indap had a long piece commenting on my story on Starboard Value and Darden Restaurants. So I should probably respond to it.

First of all, one of my points about the real estate deal is that its implementation would directly contradict the other SV recommendations about improving the core business. If you immediately siphon off half the earnings potential into rent, you’re going to be very challenged if you also want to implement improvements. A substantial part of those “improvements,” by the way, are cost-cutting. So whether it’s extracting value through charging rent or extracting value through laying people off, it’s value extraction all the way down.

As Indap notes, SV actually wants to make three companies: a property company, Olive Garden, and one for the “Specialty Restaurant Group,” a collection of Darden’s other restaurant chains (which happen to be doing well from a same-store sales perspective). So, while I thought it was easier to focus on Olive Garden in the piece, the play is to split off all the real estate, including from restaurants that are profitable and growing. We’ll see how adding rent contributes to their diminution in quality. If re-organization and efficiency were the main focus, it wouldn’t make sense to split the real estate on performing businesses. As Indap says, “the incremental value from monetizing the real estate is easier to snatch.”

In fact, Starboard has had this idea for a while; their original plan was to pair Olive Garden with Red Lobster in a chain version of a “bad bank.” And this is what I meant by a line that has been pointed out on numerous occasions. I know SV didn’t like the outcome of the Red Lobster sale. It’s my fault for using bad word choice, but what I meant by “Starboard Value forced Darden to sell … Red Lobster” is that the hedge fund was putting pressure on the company, which forced management to seek a way to generate something positive for their bottom line. They hit on the Red Lobster sale. Starboard effectively advocated the exact same thing; the only reason they didn’t like it is that Golden Gate Capital got the full benefit from the deal, not them. Although, the deal allowed Darden to stabilize their dividend, so SV did benefit slightly as well.

So I was well aware that SV was mad about the Red Lobster sale. My issue on that sentence was one of word choice.

As for this idea that shareholders hold stock in both companies (the operating company and the property company), and SV wouldn’t want to materially damage Olive Garden because they remain invested in it, I’m pretty sure Indap knows that, once you get cash flow going to a company, it’s not hard to use financial engineering to leak it out to shareholders. That can be done through a dividend or any number of other ways. Over time, if Starboard can recoup its investment through the real estate sale, they can leave the dying husk of the operating company by the side of the road and still make money on the deal. Eileen Appelbaum made precisely this point to me in our interview; an activist shareholder is arguably more dangerous in this situation than, say, a private equity fund, because at least the PE fund might want to sell the company someday.

It’s true that installing members on the board will hook in Starboard relative to other shareholders. It will also create space for management to work with the sole interests of shareholders in mind above workers or communities. 

And that’s Starboard’s clear mission. Just yesterday they unveiled their strategy for Yahoo, which involves a massive tax avoidance scheme, to sell off shares in Alibaba and Yahoo Japan without paying capital gains taxes. Their stock in trade is financial engineering, which rose as a strategy in the late 1970s, right around the same time productivity split off from wages. Over-financialization should be targeted as a primary cause of this problem. I don’t really care how Darden Restaurants want to run their company, except in the way it shortchanges those who work for them for the value they generate. That’s a problem for our economy, which gets lost amid excitable discussions of how shareholders can game the system to make a profit.

It could be our best chance to learn what really happened during the financial crisis.