Could Olive Garden Franchise?
Olive Garden doesn't franchise. But it could, if a group of investors gets its way.
Starboard Value, a New York-based hedge fund, has been pushing for major changes at Olive Garden's parent company, Darden Restaurants, for months now. Starboard, an activist investor that owns 8.8 percent of Darden stock, is gunning to replace Darden's full, 12-member board at the company's annual meeting next month.
The investor late yesterday released a massive, 300-page proposal on how to fix Darden. We won't go into that here. (We've been covering that proxy fight in full at our sister publication's blog, restfinance.com.)
But the plan does include this: A proposal to franchise the company's brands, notably Olive Garden and LongHorn Steakhouse, beginning in certain markets where the brands are underpenetrated.
Darden doesn't franchise, though it does franchise internationally. But there have been some suggestions that the company should start.
Many investors love franchising, because royalties are more stable, and profitable, forms of income than restaurant sales. They're more resistant to recessions and franchisors are somewhat immune to food cost fluctuations and they have lower capital requirements. As such, activists and others have pushed franchisors to sell more units to franchisees, and many franchisors have done so.
But in this case, it would largely start a franchise system at Olive Garden and LongHorn from the ground up, except for the company's international franchising arm—which is itself fairly young.
Starboard argues that "large, successful franchise operators have expressed serious interest" in becoming franchisees of the company's brands. And indeed, Olive Garden's unit volumes of more than $4 million a year would clearly be attractive to numerous operators.
The investors also argue that franchised restaurants generate higher restaurant-level margins and higher same-store sales than company-operated stores, at least among peer companies. Starboard also says that, domestically, LongHorn and Darden's Specialty Restaurant Group—which includes brands like Yard House, Seasons 52 and Capital Grille—could grow faster with higher returns on capital through franchising.
"Franchising can improve growth, operating performance, returns on capital and valuation," the activist argues.
Starboard is proposing that Darden franchise in markets where it has relatively weak penetration, asking franchisees to commit to developing new restaurants in those markets. The investor thinks Olive Garden should start franchising in Alabama, Ohio, Pennsylvania, North and South Carolina and Missouri. Starboard thinks LongHorn should start franchising in 12 markets.
Starboard proposes that Darden could use funds from the sale of the restaurants to repay debt and repurchase shares, which could help the company's stock.
Whether this happens, of course, depends on the outcome of the shareholder vote next month. But if Starboard somehow gains control of Darden's board and names its next CEO, it could result in an interesting influx of high-volume restaurants into the franchising space.