Lesson from the Red Lobster Acquisition:
Red Lobster is one of the biggest household names to fall victim to the slash and burn ways of Private Equity. The once renowned casual seafood restaurant that invented popcorn shrimp, has now been passed around by multiple private equity funds who each hoped to be the one to restore its former glory. After a tumultuous decade and numerous management teams, things are looking bright for the restaurant chain. Let's explore the rise, fall, and hopeful rise again of Red Lobster.
After the company was spun-off from general mills in 1995, it remained a part of the Darden Restaurant Group until its sale to Golden Gate Capital in 2014, who acquired the seafood chain for $2.1 Billion. Golden Gate Capital financed the deal via a $1.6 Billion sale-lease back agreement with American Realty Capital Partners, where Red Lobster would sell the land under all 600+ of its restaurants, and then lease it back at a rate that grows 2% every year. Considering Red Lobster’s real estate sold for $1.6 Billion, Golden Gate Capital must have thought the non-real estate parts of the company were worth about $500 Million—which include the restaurant’s net debt position and its economic assets like supplier relationships and brand name. Red Lobster has always been either a private company, or a subsidiary of a publicly traded one that doesn’t break out its numbers, so exact figures are hard to find, though with some available figures it is possible to triangulate some key numbers. It appears that American Realty Capital Partners advertised the deal at a 9.9% GAAP cap rate, which means that Red Lobster would now pay $158 Million in rent annually to American Realty. Prior to this sale-lease back, Red Lobster was most likely paying just a 1% property tax in order to service its real estate, which would have amounted to $16 Million using the assessed property value from the transaction. This represents an additional $142 Million in annual expenses Red Lobster would have to service in the first year after the sale-leaseback. When accounting for the 2% annual rent growth in the deal, Red Lobster would be paying $170 Million in rent in 2018. According to Forbes, Red Lobster’s entire revenue as of 2018 was $2.6 Billion. This means that the restaurant chain would have to find an additional 6.5% in margin in order to pay its rent. An additional 6.5% worth of margin is extremely difficult to find in the razor thin margin profile of the restaurant industry, where even the most profitable brands report a 10-15% net income margin.
One should assume that Golden Gate Capital did their due diligence on Red Lobster’s ability to pay their leases. That being said, even if on paper Red Lobster historically had the profit generating capabilities that would allow it to afford its lease payments to American Realty, it doesn’t justify the existential risk to the core business that a sale-lease back entails. Due to how nearly every Red Lobster was corporate owned as opposed to franchised, if secular headwinds blow the profits out of Red Lobster’s sails, there is nothing in between the debtors of its real estate and the entire company. If Golden Gate Capital could get away scot-free, then they would have extracted $1.6 Billion out of Red Lobster’s business, but if Red Lobster cannot make the payments at any point in time then it would put the whole business in jeopardy.
This is exactly what happened. According to their Chapter 11 filing, the restaurant was hit hard by covid, and their annual guest count today is still only 70% of 2019 levels. This has significantly hampered their profitability, causing a 60% drop in adjusted EBITDA. When you resort to using adjusted EBITDA figures to report your profitability downturn, you know it is practically game over. The company’s 2023 lease payments were $200 Million, and it reported a $76 Million loss in 2023. The company then filed for Chapter 11 bankruptcy, and in its filings it famously blamed its endless shrimp promotion.
The Endless Shrimp promotion was only responsible for an $11 Million loss, and was likely engineered to generate a loss anyways. If you can get customers in the door with endless shrimp as a loss leader, they are likely to order other more profitable items on your menu. It is from this perspective that the blame on endless shrimp is entirely baseless. Do not blame your loss leader product for bankrupting your company because it generated a miniscule loss in the grand scheme of things. If Red Lobster didn’t do the sale-lease back, it would have saved $200 Million in lease payments, and reported a net profit of $100 Million—assuming lease payments are substituted by 1% property tax. Without money to pay its creditor, American Realty, the entire business just cannot operate. This is what sent the company into ruin. The sale-leaseback saddled Red Lobster with large lease payments with respect to the core business that it couldn’t pay, causing the entire corporation to fall into Chapter 11 bankruptcy.
Even though the once great Red Lobster is now bankrupt, Golden Gate Capital should have still done surprisingly well on its investment. In an effort to cut costs and exit some of its investment, Golden Gate sold 25% of Red Lobster to seafood supplier Thai Union. From the perspective of Thai Union, they would be able to realize major synergies with the restaurant chain, which justified the $525 Million price tag they paid for just a quarter of the company. These efforts failed, as Thai Union began to be more involved in supplying Red Lobster, their supply chain issues rippled deeper into Red Lobster’s business. In their bankruptcy filing, Red Lobster blames Thai Union’s supply chain issues and also the pressure it had to ruthlessly promote endless shrimp to customers. It seems Thai Union had a total disregard for the well-being and longevity of Red Lobster, and just used the restaurant chain to pedal more of its own product. Nevertheless, Golden Gate Capital’s $525 Million exit for 25% of the company already recoups the $500 Million of its own money it spent on the chain. There existed an additional clause for Thai Union to purchase Golden Gate’s remaining 24% of the company, which one can assume was likely in the ballpark of another $500 Million. Thai Union activated this clause in 2020, buying Golden Gate Capital out of Red Lobster. In total, Golden Gate spent $500 Million of its own money to buy the chain, and most likely received ~$1 Billion from Thai Union. The moral of this story must be: if you can find an investor stupider than you are to catch the falling knife, it doesn’t matter if you run the company into the ground.
Red Lobster is now undergoing a major transformation under its new CEO, Damola Adamolekun, who took over in 2024 after the company was pulled out of Chapter 11 Bankruptcy by Fortress Investment Group. Known for successfully revitalizing P.F. Chang's, Adamolekun brings a new strategic focus to the struggling seafood chain. His approach centers on menu innovation, operational efficiency, and leadership restructuring to restore the company’s financial health and brand reputation. The company will most likely never be able to build back its real estate assets, so it must find a way to exist in its current lease-paying form. Since emerging from bankruptcy, small cost cuts like the reevaluation of endless shrimp will no doubt add up and help the company restore profitability. Adamolekun has also been trying to cut back on the firm’s lease payments by closing underperforming locations. Red Lobster has reduced active locations by almost 20% after going bankrupt. These new cost cutting measures are designed to allow the company to payback creditors, and stop the franchise from bleeding EBITDA every year. That being said, the lease model will likely stand in the way of Red Lobster being restored to its former glory as a seafood real estate empire.
