Is a Restaurant REIT the Right Move for Darden’s Olive Garden?

By Vladik Rikhter

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Is it a matter of financial success or a move that indicates a larger operational problem lurking beneath the surface? Ultimately, that’s what investors are trying to determine regarding Darden Restaurant Inc.’s decision to transfer approximately 430 of its more than 1,500 Olive Garden restaurants to a publicly traded real-estate investment trust (REIT) and lease them back.

Darden is the first major restaurant chain to take such a step, reported the Wall Street Journal. Prodding by Darden’s activist investor, Starboard Value LP, contributed to this decision (more information on this below).

Switching to an asset-light model via a REIT is becoming an increasingly popular move among large chains.The WSJ article sites Bob Evans Farms Inc. and McDonald’s Corp. as two companies who have recently explored this financial option. Notably, all of these brands have something important in common. They have all made recent headlines for financial and brand struggles.

Here are three examples: 

  1. McDonald’s is closing more restaurants that its opening for the first time in nearly 40 years. 
  2. Bob Evans Inc. will close 20 underperforming locations and eliminate 60 positions as part of $14 million cost cuts.
  3. In October 2013, an activist investor group won all 12 seats on Darden’s board of directors after arguing the Olive Garden chain is poorly run. It is true that 2014 Olive Garden sales plummeted. This is a big problem since Olive Garden reportedly accounts for 56% of Darden’s total sales.

Through the REIT, Olive Garden will pay back $1 billion in debt. It raises the question, is a real estate investment trust a sign of bailing out the sinking ship?

It could be, according to one analyst for Motley Fool, who calls an REIT a short-term solution to a long-term problem. Darden owns more than 1,500 U.S. restaurants, so “being a landlord is a sideline business that distracts from its real purpose of serving food,” one analyst remarked.

“This REIT is ultimately just a gimmick -- financial engineering that does not address Olive Garden's real long-term problems, including a shift in consumer sentiment away from carb-heavy foods like pasta toward healthier fare,” he concluded.

Maybe that’s true about the healthy trend, or maybe not. It could also be that people were just getting bored with the brand or had a disappointing meal.

Olive Garden’s Silver Lining

Fortunately for Olive Garden, there’s a silver lining in this pasta bowl. The restaurant chain recently reported an increase in sales and profits, and experienced a  4% lift in stock prices.

For now, the REIT is resounding with investors as Olive Garden returns to the basics that gave its brand a national presence. The chain brought back its “Buy One [entree], Take One” program for a limited time in March and its new breadstick sandwiches have also seemed to resonate with customers.

Menu innovation might be the key to Olive Garden regaining market share and gaining new customers. Consistency across the franchise will be just as important.

Interestingly, when activist investors Starboard Value Partners took control in late 2013, they created a presentation about what Olive Garden was doing wrong. Problems included not salting the pasta water, putting excessive amounts of sauce on its food, and having non-Italian menu items, CNN Money reported.

It may be too early to tell if Olive Garden has raised the bar on its menu, but at least these consistency issues were noticed and documented. It’s further evidence that Starboard is righting the Olive Garden ship instead of merely bailing it out.

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