Angry that your favorite Red Lobster closed its doors? The magic of Wall Street has a lot to do with it.
Red Lobster was America’s largest casual dining company, serving 64 million customers annually at nearly 600 locations in 44 states and Canada. Its May 19 bankruptcy filing and closure of nearly 100 venues across the country devastated its legion of fans and 36,000 workers. The chain is iconic enough to be featured in a Beyoncé song.
It is difficult to assign responsibility for business failures. But some analysts say the cause of Red Lobster’s woes isn’t the endless shrimp promotions that some have blamed. Yes, the company lost $11 million because of the shrimp escapade, its bankruptcy filing shows, and suffered from inflation and rising labor costs. But a major cause of the company’s problems is a financing technique favored by a powerful force in the financial industry, known as private equity.
This technique, colloquially known as asset stripping, has been the cause of bankruptcies of retail chains such as Sears, Mervyn’s and ShopKo, as well as bankruptcies involving hospital and nursing home operations. retirement such as Steward Healthcare and Manor Care. All were privately owned.
Asset stripping occurs when an owner or investor in a business sells some of their assets, taking the profits and hampering the business. This practice is favored by some private equity firms that buy companies, put them in debt to finance the purchases, and hope to sell them at a profit in a few years to someone else. A common form of asset stripping is known as a sale-leaseback and involves the sale of a company’s real estate; this type of transaction hampered Red Lobster.
In recent years, private equity firms have invested heavily in all areas of the industry, including retailers, restaurants, media and healthcare. Some 12 million workers are employed by private equity-backed companies, or 7% of the workforce. According to academic research, companies bought and indebted by private equity fail 10 times more often than companies not bought by private equity. In a report released this month, Moody’s Ratings said leveraged buyouts, like those practiced by many private equity firms, lead to higher defaults by companies and reduce the amounts recovered by investors when companies are restructured.
The sale-leaseback that contributed to Red Lobster’s sinking involved the July 2014 sale of high-end real estate beneath 500 of its stores, which generated $1.5 billion. But that money didn’t go back to Red Lobster; instead it turned to the private equity firm to finance its purchase of the chain, Red Lobster’s press release said. That company was Golden Gate Capital, based in San Francisco, with $10 billion in assets.
Golden Gate paid $2.1 billion to buy Red Lobster in May 2014, so the real estate sale was crucial to financing the company. “Red Lobster is an exceptionally strong brand with an unrivaled position in the casual seafood restaurant market,” Golden Gate CEO Josh Olshansky said at the time, according to a press release announcing the deal.
The $1.5 billion sale crippled Red Lobster. After selling the real estate, Red Lobster had to pay rent on the stores it previously owned, which significantly increased its costs. According to the bankruptcy filing, in 2023 its rents totaled $200 million per year, or about 10% of its revenue.
Asked whether the sale-leaseback would negatively impact Red Lobster, a Golden Gate spokeswoman declined to comment.
The company that purchased the properties, American Realty Capital Partners, got a very good deal, the release announcing the leaseback said. She called the Red Lobster stores she purchased “irreplaceable locations” and “high-quality real estate located at prime intersections in strong markets” but noted that the properties were sold “at below cost of substitution “. Under the terms of the sale, Red Lobster would also benefit from a regular rent increase of 2% per year, the release said.
American Realty Capital Partners was acquired by Realty Income 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. First, it meant the chain would not benefit from any upside in the commercial real estate market. Additionally, the new owner of the property does not appear to have given Red Lobster a good deal on rent. As Red Lobster’s CEO pointed out in a bankruptcy court filing: “A significant portion of the Company’s leases are priced above market rates.” »
As is often the case in 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 Ratings, an independent rating agency, lowered Red Lobster’s rating from stable to negative outlook. Moody’s cited the chain’s “consistently high gearing” or “leverage.”
“Being heavily in debt and not owning your real estate puts businesses at a disadvantage,” said Andrew Park, senior policy analyst at Americans for Financial Reform, a nonprofit, nonpartisan organization that advocates for a stable and stable financial system. ethics. “Red Lobster is yet another example of this private equity strategy that hurts restaurants and retailers in the long run. »
In 2020, Golden Gate exited its investment in Red Lobster and sold it to Thai Union Group, a Bangkok-based company and a group of investors. Thai Union bills itself as the “global seafood leader” and its brands include Chicken of the Sea tuna products and King Oscar sardines. Terms of the transaction were not disclosed.
Regarding the bankruptcy, a company spokesperson provided a statement saying, “Thai Union has been a supplier to Red Lobster for over 30 years and we intend to continue that relationship. We are confident that a court-supervised process will allow Red Lobster to restructure its financial obligations and realize its long-term potential in a more favorable operating environment.
Bankruptcies of companies like Red Lobster have a multiplier effect on the overall economy and contribute to a sense of unease among consumers and workers, said Robert Reich, former labor secretary under President Bill Clinton.
“One of the reasons people feel so uncertain is that there are in the background, behind the curtain, a lot of these financial games that ultimately make the very rich even richer. and harm America’s working and middle class,” Reich said in a statement. interview. “All the people who supplied Red Lobster, all the people who essentially provided services to Red Lobster, the small businesses in the communities affected by the mass layoffs, are next in line, they’re experiencing the ripple effect.”
Red Lobster employees are hardest hit by the collapse. Austin Hurst is one of them, former grill master at Red Lobster in Arizona. In an interview, he said he learned from a friend that his store had closed and had not heard from his manager or anyone higher up at the company. He said he was told his store was profitable until about 3 months ago.
“About a month before closing, the district manager came in and said, ‘Yeah, that Red Lobster looks really brilliant.’ And you’re definitely going to stay open,” Hurst recalls.
Hurst said he was offered a job at another Red Lobster location, but it required a longer commute and paid $17 an hour, compared to the $19 he previously made.
Sen. Edward Markey, a Democrat from Massachusetts, home to eight hospitals run by bankrupt Steward Health Care, recently held hearings on private equity and health care. He also proposed legislation that would require greater transparency from health care entities owned by private equity firms, including disclosure of sale-leaseback agreements as well as fees collected by the private equity firm -investment and dividends paid by the healthcare entity to the private equity fund.
“My legislation is pretty 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 selling the land beneath these hospitals and then re-leasing them to them Hospitals do not negatively impact the delivery of health care in this community.
Private equity appears in every sector of our economy, Markey added, but its most profound impact is in health care. “The more private equity invests in the hospital sector,” he said, “the more it is just a taste of the coming atrocities affecting our health care system.” »