June 18, 2024

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How private equity rolled in on Red Lobster

How private equity rolled in on Red Lobster

Are you angry that your favorite Red Lobster is closing? The magic of Wall Street played a big role in this matter.

Red Lobster was America's largest casual dining operation, serving 64 million customers annually at nearly 600 locations across 44 states and Canada. Declaring bankruptcy on May 19 and closing nearly 100 locations across the country has devastated its army of fans and 36,000 workers. The chain is iconic enough to be featured in a Beyoncé song.

Placing blame for a company's failure is difficult. But some analysts say the root of Red Lobster's problems were not the endless shrimp promotions that some blamed. It is true that the company lost $11 million due to the shrimp run, as its bankruptcy filing shows, and it also suffered from inflation and high labor costs. But the biggest cause of the company's problems is a financing method favored by a powerful force in the financial industry known as private equity.

This technique, known colloquially as asset stripping, has been part of the failure of retail chains such as Sears, Mervyn's and ShopKo as well as bankruptcies involving hospital and nursing home operations such as Steward Healthcare and Manor Care. All of them were owned by private equity.

Asset stripping occurs when an owner or investor in a company sells some of its assets, taking the benefits for himself and crippling the company. The practice is favored among some private equity firms that buy companies, load them with debt to finance the purchases, and hope to sell them at a profit within a few years to someone else. One common form of asset divestiture is known as a sale/leaseback and involves the sale of a company's real estate; This type of transaction hindered Red Lobster.

In recent years, private equity firms have invested heavily in all areas of the industry, including retailers, restaurants, media and health care. About 12 million workers work in private equity-backed companies, or 7% of the workforce. Debt-laden companies purchased by private equity are 10 times more likely to go bankrupt than companies that were not bought, according to academic research. Offers. in a report Leveraged buyouts like those pursued by many private equity firms lead to higher corporate defaults and reduce the amounts investors get back when companies are restructured, ratings agency Moody's said this month.

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The sale/leaseback that helped sink Red Lobster involved the July 2014 sale of premium real estate under 500 of its stores, which generated $1.5 billion. But that money didn't go back to Red Lobster; Instead it went to a private equity firm to finance its purchase of the chain, The Red Lobster press release said. That company was San Francisco-based Golden Gate Capital, with assets of $10 billion.

Golden Gate paid $2.1 billion for Red Lobster in May 2014, so selling the properties was crucial to financing the company. “Red Lobster is an exceptionally strong brand with an unparalleled market position in the casual seafood dining space,” Golden Gate Managing Director Josh Olshansky said at the time, in a press release announcing the deal. Offers.

The $1.5 billion sale crippled Red Lobster. After selling the property, Red Lobster was forced to pay rent on the stores it previously owned, significantly increasing its costs. According to the bankruptcy filing, by 2023, its rents totaled $200 million annually, or roughly 10% of its revenue.

Asked about the negative impact the sale/leaseback would have on Red Lobster, a Golden Gate spokeswoman declined to comment.

The company that bought the properties, American Realty Capital Partners, got a very good deal, the press release announcing the sale/leaseback said. It described the Red Lobster stores it acquired as “irreplaceable locations” and “quality properties located at key intersections in strong markets,” but noted that the properties sold “below replacement cost.” Under the terms of the sale, Red Lobster will also see regular rent increases of 2% per year, the release noted.

Realty Income acquired American Realty Capital Partners in 2021. Realty Income did not respond to a request for comment on the sale/leaseback.

The sale of Red Lobster stores hurt the company in several ways. Firstly, it meant that the chain would not benefit from any uptick in the commercial real estate market. In addition, it appears that the new owner of the property did not give Red Lobster good deals on rents. As Red Lobster's CEO noted in a bankruptcy court filing, “a significant portion of the company's leases are priced above market rates.”

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As is typical of private equity buyouts, Golden Gate's purchase of Red Lobster significantly increased the chain's debt, adding higher interest costs to its burden. In 2017, Moody's, an independent rating agency, downgraded Red Lobster to a negative outlook from stable. Moody's noted the “persistently high leverage” or debt that the chain has.

“Having a lot of debt and not owning your own property puts companies at a disadvantage,” said Andrew Park, senior policy analyst at the bank. Americans for Financial Reform, a non-profit, non-partisan organization that advocates for a stable and ethical financial system. “Red Lobster is another example of the private equity playbook hurting restaurants and retailers in the long run.”

In 2020, Golden Gate exited its investment in Red Lobster, selling to Thai Union Group, a Bangkok-based company, and an investor group. Thai Union calls itself “the world's leading seafood company,” and its brands include “chicken of the sea” tuna products and King Oscar sardines. Terms of the deal were not disclosed.

Regarding the bankruptcy, a company spokesperson provided a statement saying: “Thai Union has been a supplier to Red Lobster for more than 30 years, and we intend to continue this relationship. We are confident that the court-supervised process will allow Red Lobster to restructure its financial obligations and achieve Its long-term potential in a more favorable operating environment.”

Former Labor Secretary Robert Reich in Washington in 2019.File Mark Wilson/Getty Images

Robert said the bankruptcy of companies like Red Lobster has a ripple effect on the overall economy and contributes to feelings of unease among consumers and workers. Reichformer Secretary of Labor under President Bill Clinton.

“One of the reasons people feel insecure is that there are a lot of these financial games in the background, behind the scenes, that ultimately make the rich richer, and hurt the working and middle classes in America,” Reich said in a speech. interview. “All the people who were supplying Red Lobster, all the people who primarily provide services to Red Lobster, and small businesses in communities affected by mass layoffs, are next in line, and they are experiencing the ripple effect.”

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Red Lobster employees are bearing the brunt of the collapse. Austin Hurst is one of them, a former barbecue expert at Red Lobster in Arizona. He said in an interview that he learned from a friend that his store had closed and he had not heard from his manager or any higher-ups in the company. He said he was told his store was profitable until about 3 months ago.

“About a month before the closing, the district manager came in and said, ‘Yes, this Red Lobster looks really bright. You guys will definitely stay open,” Hirst recalls.

Hurst said he was offered a job at another Red Lobster location, but it required a longer commute and paid $17 an hour, less than the $19 he was paid before.

Senator Ed Markey, Democrat of Massachusetts, has proposed legislation that would require greater transparency from health care entities owned by private equity firms.Kevin Deitch/Getty Images file

Senator Edward Markey, a Democrat from Massachusetts, home to eight hospitals run by bankrupt Steward Healthcare, recently held hearings on private equity and health care. He has also proposed legislation that would require greater transparency from healthcare entities owned by private equity firms, including disclosure of sale/leaseback arrangements as well as fees collected by the private equity firm, and dividends paid by the healthcare entity to the private equity fund.

“My legislation is very simple,” Markey said in an interview. “To ensure that these financial shenanigans do not have a profound impact on communities across our country, the Department of Health and Human Services must determine whether or not selling the lands under these hospitals and then leasing those lands back to the hospitals does not have a negative impact on Providing health care in this community.

Markey added that private equity is emerging in all parts of our economy, but its most profound impact is in health care. “The more private equity gets into the hospital business, the more this becomes just a preview of the horrors to come that impact our health care system,” he said.