Welcome to the 113th Pari Passu Newsletter,

In recent years, restructuring has only become more complex. Whether it be out-of-court LMEs, or complex and lengthy in-court negotiations and litigation, we often see restructuring have the goal of ‘giving breathing room’ to a company to figure out their problems, rather than completely solving their problems in the restructuring itself.

The case of Red Lobster is fascinating - it incorporates all of these complex elements - including RSA’s, credit bids, and in-court litigation - but has been able to complete a restructuring in the span of a few months while successfully resolving many of the company’s issues and truly providing a pathway for a brighter future. 

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Red Lobster Overview

Red Lobster is an international seafood restaurant chain with over seven decades of history, firmly established as a leader in casual dining. Founded in 1968 in Lakeland, Florida, Red Lobster grew from a single family-owned location into one of the most iconic seafood brands globally, operating approximately 551 locations across 44 U.S. states and 27 in Canada, along with 27 franchised restaurants in markets such as Mexico, Japan, and Thailand (see Figure 1 below). Headquartered in Orlando, the company generates around $2 billion in annual revenue and serves more than 64 million customers each year.

In terms of sales, Red Lobster owns and operates most of their properties. However, for 27 additional restaurants outside of the United States/Canada, Red Lobster has entered into third-party franchise agreements. These franchise agreements remit 5.5% of sales as royalties. In 2023, these franchised units generated a total of $1mm in royalties.

Corporate History

As stated, Red Lobster was formed in 1968 by Bill Darden and was subsequently sold in 1970 to General Mills. For the next 25 years, the company expanded across the nation, until General Mills spun off their restaurant division into Darden Restaurants in 1995. Darden Restaurants put Red Lobster up for sale in 2014.

Red Lobster Leveraged Buyout

In 2014, private equity firm Golden Gate Capital acquired a 51% stake in Red Lobster through a $2.1bn LBO transaction. This buyout was interesting for two reasons. First, Golden Gate Capital primarily financed the buyout with a $1.5bn sale-leaseback transaction. [2] 

As a review, a sale-leaseback transaction enables a company to sell an asset and then lease it back from the purchaser. The seller of the asset becomes the “lessee,” and the buyer becomes the “lessor.” To put this into context, let’s look at a quick example.

Let’s say Company A wants to engage in a sale-leaseback transaction with $500 of assets. Company A can sell that $500 to Company B and then lease it back, paying x% per year. If we assume that Company A agrees to lease it back for 10% of the total asset price annually (or $50 in lease expense per year), a common but incorrect assumption would be that the lease would only last for ten years ($50 × 10 years = $500). However, in reality, the lease is likely to be significantly longer.

The reason is twofold. First, as discussed in our previous analysis of sale-leasebacks, these transactions typically involve long-term lease commitments, often spanning 15–20 years with additional renewal options. This protects the lessee from the landlord changing terms or leasing to someone else, ensuring business continuity. Second, the financing structure reflects the fundamental time value of money principle. The $500 received upfront by Company A is worth more today than its future lease payments due to the discounting effect, meaning Company B—acting as the buyer-lessor—expects a return exceeding a simple payback period.

The second point that makes this buyout fascinating is its contentious nature. At the time of the purchase, the activist investing firm, Starboard Value LP, who owned a 5.5% stake in Darden, displayed substantial opposition to the buyout. Starboard investors argued that a separation of Red Lobster from Darden was not enough - they rather wanted a split that lumped the seafood restaurant with Olive Garden and LongHorn Steakhouse, and create a new subsidiary with those three companies that Darden owned [3]. 

Ultimately, this opposition did not amount to any material changes to the sale of Red Lobster, but it provides us with an opportunity to look in hindsight and understand the perspective of an activist perspective. To do so, we must consider why a conglomerate like Darden would consider a spin-off vs. a sale in the first place. From Darden’s perspective, Red Lobster was likely underperforming compared to their other restaurant companies, namely, Olive Garden. It likely made sense from a valuation standpoint to sell the company, as financial projections had the Red Lobster business declining in the future.

If this was the case, why did Starboard want a spin-off? The reason most companies engage in a spin-off is because they believe the spun-off entity can be more representative of true valuation. Spin-offs usually occur within conglomerate companies, where investors are unable to reach a fair valuation because the conglomerate entity is made of so many different divisions that it is too difficult/complex to figure out the true value. A great example of this occurred in 2023, when Endeavor Group Holdings spun off its WWE division and allowed it to merge with the UFC, with hopes that the new entity (NYSE: TKO) would be more reflective of its true value. Starboard likely advocated for this as a spin-off would allow the new entity to be re-evaluated by the market to adjust to its fair market value, leading to immediate appreciation in Darden’s stock price [4]. Additionally, from the perspective of an activist investor, they likely had a motive to be involved in the spin-off, where they substantially increase their investment stake and have an opportunity to take over the ‘restaurant division’ if needed. Effectively, a spin-off would have maximized Starboard’s optionality [3].

2016 & 2020 Ownership Transition

As we mentioned above, in 2014, Golden Gate purchased a 51% stake in Red Lobster via a $2.1bn LBO transaction. Looking at this transaction, we can use some rough napkin math to find the implied equity and enterprise value of Red Lobster at the time of the deal. We know that the transaction enterprise/purchase price was $2.1bn. The specific financials of Red Lobster at the time of the transaction are unavailable, but sources show that $1bn of the $2.1bn purchase price was used to pay down outstanding debt, meaning that Red Lobster had, at minimum, $1bn of debt. This would imply an equity value of approximately $1.1bn. It is likely that Red Lobster had more debt outstanding than $1bn, however, which would incrementally reduce the implied equity value at the time of the deal.

In 2016, Golden Gate Capital began selling part of its ownership stake in Red Lobster. Specifically, they sold approximately 25% of their 51% stake to the Thai Union Group for $575mm [1],[9]. 

In 2020, members from Red Lobster’s management team, Thai Union, and other investors purchased the remaining stake from Golden Gate Capital under the name Seafood Alliance, effectively giving Thai Union and the Seafood Alliance group a majority stake in the company The specific ownership breakdown from 2014 to 2020 can be seen below in Figure 2.

Causes of Distress 

Financial Issues

As we will discuss below, Red Lobster’s financial weakness stemmed from 3 different sources: Thai Union, the ‘endless shrimp campaign’, and the effects of the 2014 sale-leaseback transaction. However, before diving into these 3 components, we want to highlight that the main driver of cash burn was the incremental lease expenses from the sale-leaseback transaction, which led to $177mm of additional annual lease expenses for Red Lobster as of 2023. While the other 2 drivers of distress undoubtedly contributed and worsened Red Lobster’s situation, these effects were in the tens of millions of dollars in total. The sale-leaseback created over…