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How Darden let the Yard House brand slip through the cracks in China

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Last week Zacks Investment Research published its updated research report on restaurant operator Darden Restaurants, Inc. (NYSE: DRI) (hereinafter “Darden”), noting that despite strong growth over the past year Darden has been slow to expand into emerging markets. While Darden has proven that it still has room to grow in the United States, overseas expansion is a must in today’s increasingly globalized economy, and domestic focus is no excuse for Darden’s failure to adequately prepare for that reality. Case in point, Darden does not own one of its leading brands, Yard House, in The People’s Republic of China (the world’s largest emerging consumer market).

Yard House Sanlitun

Yard House China opened last year in Beijing’s premiere shopping and nightlife district.

Darden Valuation

Publicly-traded shares of Darden have widely outpaced the Zacks categorized Retail-Restaurants industry over the past year. Darden’s March 28, 2017 announcement that it had acquired Cheddar’s Scratch Kitchen and “lifted its full-year earnings outlook” made Darden the biggest gainer on the S&P 500 that day, with share prices jumping nearly 9 percent.

Darden’s valuation received a similar jolt five years ago when the company announced its previous acquisition — Yard House USA.

Yard House

Established in California in 1996 by Steele Platt, an independent restaurateur who funded the company’s first store with investments from three friends and his landlord, Yard House USA is a casual dining chain that boasts the world’s largest selection of draft beer. The company derives its name from a “yard” glass — a type of very tall beer receptacle said to have originated in 17th-century England.

On August 23, 2007, private equity giant TSG Consumer Partners (hereinafter “TSG”) announced that it had purchased Yard House USA (for a price sources said was under $200 million) in a majority recapitalization that included a modest amount of leverage, enabling rapid and geographically-diverse unit expansion. At the time, Yard House USA operated 16 restaurants across Southern California.

On July 13, 2012, TSG entered into an agreement to sell Yard House USA to Darden (for $585 million in cash). At that time, Yard House USA operated 39 restaurants across 13 states. Darden executives said they expected the Yard House USA chain to eventually expand to 200 units.

In 2015, well-known investment advisor The Motley Fool published an article featuring Yard House USA entitled “Forget Olive Garden, This Is the Chain Darden Restaurant Inc. Investors Should Be Watching” noting:

  • Yard House USA “generates half of Darden’s division sales” and “represents one of Darden Restaurants’ best growth prospects.”
  • Nation’s Restaurant News pegged Yard House as the sixth fastest-growing chain in the country, coming in at No. 91 in its top 100 restaurants of 2015.”
  • “These are all factors that combine to make Yard House the concept Darden Restaurants should be focusing on.”

So if Yard House USA is such a key component of the Darden portfolio, how did Darden let slip the “Yard House” brand in China?

China trademark woes

Steele Platt

Prior to launching his first Yard House restaurant in 1996, Steele Platt had opened two small restaurants and a night club in Colorado, but does not appear to have had experience helming a large-scale business (e.g., multi-unit chain). To his credit, Mr. Platt’s company did apply for the “YARD HOUSE” trademark in the United States on July 28, 1999, securing United States Trademark Registration No. 2441608 on April 3, 2001.

Given his limited corporate professional experience, Mr. Platt’s failure to apply for trademark protection abroad might have been excusable during Yard House’s early years. However, as the company expanded into a regional success it no doubt had ample means and opportunity to invest in developing an international trademark portfolio.

TSG Consumer Partners

TSG’s failure to develop an international trademark portfolio for Yard House USA is harder to fathom. TSG is one of the largest and oldest private equity firms primarily focused on growth capital investments in middle-market companies in the branded consumer products sector (as of December 2015, TSG had a total of $5 billion in assets under management). Among TSG’s other notable historic investments are such well-known brands as Famous Amos Cookies, Prestige Brands, Energy Brands (Vitamin Water), Voss, Pureology, Met-Rx, Smart Balance, Arrowhead Mills, BrewDog, Popchips and Pabst Blue Ribbon Brewing Company.

Clearly TSG boasts substantial experience, if not expertise, in global brand management. Due diligence during its acquisition of Yard House USA must certainly have alerted TSG to the restaurant chain’s dearth of international trademark registrations and corresponding lack of brand protection overseas.

By the time TSG acquired Yard House USA in 2007, China was already considered the world’s largest emerging consumer market, and the primary target of overseas expansion for American brands across a wide range of industries, with food and beverage at the forefront. China was also by that time already a leading market for trademark squatters, e.g., domestic entities that for the purpose of extortion apply for trademark registration in China of brands already in use by other parties abroad. Given that TSG’s acquisition of Yard House USA was both high-value and high-profile, the companies should really have prioritized international trademark registration — if not at the time of acquisition then certainly in the intervening five years before Yard House USA’s subsequent acquisition by Darden.

Darden Restaurants, Inc.

The acquisition of Yard House USA by Darden in 2012 was even more high-value and high-profile than the restaurant chain’s prior acquisition by TSG. Widespread media coverage of the deal could potentially have alerted many Chinese trademark squatters to the value of the “Yard House” brand.

At the time, Darden owned seven other casual dining restaurant chains: Red Lobster, Olive Garden, LongHorn Steakhouse, Bahama Breeze, Seasons 52, Eddie V’s Prime Seafood, and The Capital Grille. Even after spinning off Red Lobster, Darden is the world’s largest full-service restaurant company, with more than 1,500 restaurant locations and more than 150,000 employees. As such, Darden no doubt flagged Yard House USA’s lack of international trademark registrations, but nevertheless proceeded with its acquisition.

On May 2, 2013, Darden-owned Yard House USA finally applied to register “YARD HOUSE” word and device trademarks in China (Trademark Application Nos. 12514964 and 12514963, respectively) for restaurants and bars (International Class 43). Both of these applications were rejected by the China Trademark Office (CTMO) on April 26, 2014.

Third-party trademark application

Yard House USA’s China trademark applications were rejected based on a prior China trademark application for the “YARDHOUSE” word mark (Trademark Application No. 12128971), filed by a French national (hereinafter “Applicant”) just three months earlier on February 1, 2013.

Lacking sufficient grounds for an opposition, even with the benefit of recent changes to China’s first-to-file policy under the Third Amendment to the China Trademark Law, Yard House USA could only observe as the Applicant received a China trademark registration for “YARDHOUSE” on April 27, 2014.

Whether or not the Applicant is actually a trademark squatter is difficult to say. After all, from a trademark perspective “YARD HOUSE” seems more likely descriptive than arbitrary, and even Yard House USA derived its name from well-known, centuries-old beer paraphernalia.

Yard House in Sanlitun SOHO

Yard House China is positioned alongside international brands Starbucks, Patagonia, Subway and The New York Times.

Domestic use

The Applicant’s intentions aside, a Yard House (丫号) store (hereinafter “Yard House China”) opened last year in Sanlitun SOHO, a new commercial development in the heart of Beijing’s premiere shopping and nightlife district. Labeling itself a beer garden, vape lounge and vegan cafe, Yard House China is positioned in Sanlitun SOHO alongside such international brands as Starbucks, Patagonia, Subway and The New York Times. Yard House China’s website indicates that the company is currently franchising, and opening a second branch soon across town in Wudaokou — Beijing’s university district and “Center of the Universe” (宇宙中心).

Yard House China does not appear to be affiliated in any way with either Darden or Yard House USA. Also, it is unclear whether Yard House China has licensed the Applicant’s “YARDHOUSE” trademark. What is clear is that Darden and Yard House USA have few, if any, legal options for shutting down Yard House China as long as they do not own a domestic trademark registration in China for the relevant goods and services. In fact, anyone can now use the “YARD HOUSE” brand in China, to the extent that the Applicant does not diligently enforce his exclusive trademark rights.

Furthermore, Darden and Yard House USA are essentially frozen out of the China market, to the extent that neither company would knowingly expose itself to liability for trademark infringement.

Conclusion

Three simple lessons that companies should take away from Yard House USA’s story are:

  1. In an increasingly globalized economy, it is more important than ever for companies to register their key trademarks early and broadly.
  2. When performing due diligence in connection with acquisitions (and mergers), companies should be sure to include a review of international trademark portfolios (or lack thereof).
  3. If international trademark portfolio coverage is found to be inadequate, companies should take immediate steps to ensure strategic global protection of key brands (i.e., through trademark registration) — especially before announcing any big deal that alerts the world to the value of those brands!

As noted by Zacks Investment Research, “over the last few quarters, the U.S. restaurant space has not been too enticing. Same-store sales growth has also been dull in a difficult sales environment. Traffic too has been weak. As a result, [Darden’s] sales have come under pressure. In fact, the first quarter of 2017 marked the fifth consecutive quarter of negative comp sales for the restaurant industry as a whole, continuing the somber mood.”

Furthermore, “while several other restaurateurs including Yum! Brands, Inc. YUM, McDonald’s Corporation MCD and Domino’s Pizza, Inc. DPZ have opened their outlets in the emerging markets, Darden seems to be slow on this front.”

As Darden prepares to release its fiscal 2017 fourth quarter financial results before the market opens on Tuesday, June 27, 2017 (with a conference call to follow at 8:30 am ET), Gene Lee, CEO, and other senior management will discuss fourth quarter results and conduct a question and answer session.

Questions about the company’s plans for international expansion are sure to be asked. Questions about the company’s plans for international brand protection should be asked first.




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