Darden Credit Default Protection Cost Soars After Board Shake Up, Downgrade to High-Yield

Credit-protection costs on bonds backing Darden Restaurants, the operator of Olive Garden, have spiked higher again this morning after Moody's yesterday cut the company's credit rating to high-yield territory, following a dramatic boardroom shake-up instigated by activist shareholder Starboard Capital. The board selection and subsequent downgrade sent ripples across the credit markets, after previous statements of intent from Starboard to defend the restaurant operator’s high-grade borrowing status.

Five-year CDS referencing Darden debt rose roughly 40 bps this morning to test the 215 bps area, or a high since the first quarter last year, according to data provider Markit. This morning’s highest readings represented a more than 40% increase in protection costs over the last week.

Shareholders last week elected all 12 of the board-of-director nominees of shareholder activist Starboard, pushing the company closer to the edge of the high-grade/high-grade divide. While S&P and Fitch on Friday took wait-and-see approaches on their respective BBB- ratings, Moody’s yesterday cut the rating on Darden by one notch, to Ba1.

"The downgrade reflects Moody's view that executing a sustained and profitable turnaround at Olive Garden in the intermediate term and adoption of a more moderate financial policy is not likely due to persistently soft consumer spending and unprecedented changes in Darden's leadership," Moody’s stated in ratings rationale published on Oct. 13.

"Overall, Moody's believes Darden will not be able to generate the level of earnings and credit metrics that are representative of a Baa3 rated company on a sustained basis while the potential for additional asset sales or brand divestitures that could further impair the company's credit profile remain a concern," the agency added.

S&P has a negative outlook on the cusp-level BBB- rating. “We could lower the ratings if it appears that Starboard Value's board control lead to more aggressive financial and/or operating strategies in the near term, resulting in meaningfully weakened product/concept diversity or higher leverage,” S&P analysts said last week.

Fitch at present maintains a stable outlook on its BBB- rating on Darden, which it said last week comes in recognition of a “highly qualified” new slate of board members, and Starboard’s “public intent to maintain and strengthen Darden's investment-grade rating and dividend.”

However, Fitch warned that it concerned about Starboard's ambitions to monetize Darden's real estate. “In particular, any increase in rent expense due to leasing versus owning property would have a negative impact on Darden's rent-adjusted leverage metrics,” Fitch said on Friday.

Darden was already under scrutiny for a fall to high-yield status since last December, amid sliding operating performance across its core banners, which included Olive Garden, Red Lobster, and LongHorn Steakhouse. But the company this spring briefly earned plaudits from creditors and ratings agencies under the assumption that it was on a path to a better liquidity position, after Darden agreed to shed its growth-challenged Red Lobster business, via a sale to Golden Gate Capital for $2.1 billion. At the time, proceeds of that asset disposition were expected to be weighted in favor of debt retirement over share repurchases.

The company is conducting a search for a new permanent CEO, following the exit of previous CEO Clarence Otis.

Prior to the Moody’s downgrade, Starboard’s CEO, Jeffrey Smith, on Friday stated that the new board was dedicated to “maintaining and strengthening the investment-grade rating and dividend, and emphasizing a restaurant- and operations-centric culture” at Darden, with the goal to “enhance value for all of Darden's stakeholders.”

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