September 28, 2005
Ronald McDonald Part II
As I noted in my post entitled "Will Ronald McDonald Put on His Smiley Face for the Hedge Funds...", Pershing Square has acquired a 4.9% or nearly a $2B stake in McDonalds. Today in the Wall Street Journal on the front of page C1 (the report can be found here, but a subscription is required), the Journal, in a piece by Jesse Eisinger, discusses what Bill Ackman, the hedge fund manager of Pershing Square, would consider doing with Mickey D's. (MarketWatch.com's coverage on the Journal report can be found here.)
Basically, Ackman sees McDonalds as three separate businesses: A franchising operation accounting for nearly 3/4 of its restaurants, a restaurateur that owns and operates the rest of its operations, and a real-estate company that owns the land beneath nearly 40% of all of its restaurants. According to the Journal, Ackman wants the Golden Arches to sell off a majority stake in the company-owned restaurants as a separate, publicly traded entity, making the entity one big McDonald's franchisee, and keep the franchise operation and the real estate. Ackman would then have McDonald's borrow against its real estate's untapped value and give the money to its shareholders.
Between the two business's that Ackman wants to keep, the franchisor business charges 4% of franchisee revenue generated and the real estate company gets an additional 9-10% in rent. These businesses have high returns and low cost of capital. However, the restaurant management side of McDonald's demands huge capital spending and produces low profit margins.
Ackman values McDonald's real estate assets at $60 billion, based on the cash it produces, yet the company's market cap is approximately than $41 billion.
The Journal report compares Ackman's idea to when Coca-Cola divided its syrup business (NYSE: KO) from its bottling operation (NYSE: CCE). This move created immense shareholder value for Coca-Cola shareholders, and Ackman hopes to do the same for the shareholders of McDonalds.
The Journal article concludes with the statement "Critics of hedge funds deride them as vultures that swoop in for short-term feasts. But Mr. Ackman has been at this since 1997. And now we will see whether he ends up with a happy meal." As I stated here, with regards to Wendy's (NYSE: WEN), and here and here, with regards to Dan Snyder's tender offer for Six Flags, this appears to be another case where the hedge funds are not only giving advice on how to create value -- they are willing to back their advice with skin-in-the-game (cash). Their advice comes with much more weight than the advice of the consultant paid by the hour. Of interest is why McDonald's internal management team does not already have such a plan on the table -- why does McDonald's compensation structure for their managers not give their managers sufficient incentives to unlock shareholder value in sensible restructuring? Why does this kind of restructuring need to come from the outside?? Silly me, sorry, I got carried away -- the obvious answer is that traditional management compensation rewards company size, not company value.
TrackBack URL for this entry:
Listed below are links to weblogs that reference Ronald McDonald Part II: