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McDonald’s Close to Deciding Whether to Change Structure of U.S. Real Estate

Some investors, analysts call for fast-food chain to spin off the holdings

McDonald’s Corp. is close to deciding what, if anything, to do with its vast U.S. real-estate holdings, board member Miles D. White said in an interview Thursday.

McDonald’s board and management haven’t made a decision yet, but “we have had a lot of review and a lot of debate,” said Mr. White, chief executive of Abbott Laboratories and head of the corporate-governance committee for McDonald’s board.

McDonald’s long has emphasized the importance of owning its property. But with its sales slumping recently, some investors and analysts have called for it to spin off the U.S. holdings—likely as a real-estate investment trust, or REIT—saying it would benefit shareholders.

McDonald’s has examined options for its real estate before. The current review began before Steve Easterbrook became chief executive in March and involved an evaluation by outside consultants and financial advisers, Mr. White said. Mr. Easterbrook is also on the board.

McDonald’s executives in recent months have said they are studying all financial options to boost shareholder value. Finance Chief Kevin Ozan in July said the company will update investors on its plans in November.

Mr. White said directors and executives have evaluated “the long-term role of real estate” in sustaining McDonald’s performance and its context in a global business model. “Regardless of where we come out, somebody is going to be unhappy,” Mr. White added.

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Investors often like REITs because they tend to trade at higher multiples than retail companies and pay little or no tax on earnings as long as they distribute most profits through dividends. Hedge fund chief Larry Robbins, of Glenview Capital Management, said in a March letter to investors that McDonald’s could unlock at least $20 billion in value if it were to spin off its U.S. real estate.

But some Wall Street analysts say the odds of McDonald’s spinning off its real estate are slim. McDonald’s derives a huge and growing part of its revenue from its real estate. Rent payments from franchisees have risen 26% over the past five years to $6.1 billion in 2014, accounting for more than a fifth of McDonald’s $27.4 billion in total revenue in a year when overall sales and profit fell.

That distinguishes McDonald’s from other companies that have spun off real estate, such as Darden Restaurants Inc., which doesn’t franchise its U.S. restaurants. The owner of Olive Garden in June became the first major restaurant chain to announce plans to transfer properties into a REIT.

Morgan Stanley analyst John Glass in a recent note called the possibility of McDonald’s forming a REIT “remote,” and said that doing so “does not create as much value as one might initially think.”

‘Regardless of where we come out, somebody is going to be unhappy.’

—McDonald’s board member Miles D. White

He estimated that McDonald’s U.S. real estate is worth $16 billion to $18 billion and said the combined value of a McDonald’s U.S. REIT and the company itself likely would be around $103 a share—the same as its current price. He also said companies seeking to spin off real estate could be hindered by a recent Internal Revenue Service announcement that it will stop preapproving such deals amid concerns they can be used to avoid paying taxes.

A major change to McDonald’s corporate structure also could distract from turnaround efforts, other analysts have argued. Mr. Easterbrook has been working on initiatives including simplifying the menu, adding customizable items, and switching to more natural and humanely raised meat.

This month, McDonald’s embarked on its biggest operational change in years when it began offering breakfast all day in the U.S. Early signs indicate the move is starting to pay off, though it is too early to know how long the benefits will last. All-day breakfast could boost same-store sales growth in the fourth quarter by 1.5 percentage points and by 1 percentage point over the next 12 months, according to a recent survey of 29 U.S. McDonald’s franchisees by Nomura Securities analyst Mark Kalinowski.

While they’ve been criticized for pocketing quick profits in the past, they are now seeing their portfolios battered as they stick around for a while — and the companies they’re invested in run headlong into controversy or other problems.

And as the stock prices of the companies they’re invested in tumble, the activists — Bill Ackman in Valeant, Carl Icahn in Hertz and Dan Loeb in Sotheby’s — are trapped and can do little but stand by and watch helplessly as their portfolios tank.

Case in point is Ackman’s 5.7 percent stake in Canadian pharmaceutical giant Valeant, which announced late Wednesday that it is under investigation by federal prosecutors in New York and Massachusetts regarding its pricing of drugs.

The news was just the latest in the controversy over high drug prices to hit Valeant, a hedge fund darling that has lost 36 percent of its value since Aug. 1.

Ackman, with 20 percent of his $16.5 billion Pershing Square fund in Valeant, is down nearly $600 million over that time.

“He’s stuck with that position,” says Stanley Altshuller of Novus Partners, a hedge fund consultancy. “If he tries to unload it, he will move the price [down] in a very major way.”

Ackman doesn’t disagree. “Activists give up some trading flexibility,” he told The Post.

“It’s inherent to our strategy,” he said. “We buy large stakes and we tend to own them over the long term.” Although Novus calls Pershing Square the best-performing activist hedge fund over time, it is down 7 percent this year through Oct. 13.

As for Icahn, he has lost 30 percent of his $1.4 billion, 11 percent year-old stake in Hertz — down 22 percent this year. Meanwhile, his new bet, Cheniere Energy, is down 20 percent since he announced a $1.8 billion, 12 percent position in August.

Icahn Enterprises, his holding company, is one of the five worst activist stocks this year, according to Novus. It has fallen 15 percent.

Then there’s Loeb’s bitter — and costly — battle with Sotheby’s. Loeb’s Third Point, with a 9.5 percent stake, gained three board seats, but the stock is down 22 percent since he bought it two years ago. Third Point is off 4.4 percent this year.

Another glaring example is Ackman protégé Mick McGuire of Marcato Capital, which has a 6.5 percent stake in, and a board seat on, the troubled ATM-maker NCR. The company has twice failed at selling itself.

Marcato has lost 11 percent on NCR and is off 12 percent this year through Sept. 30.

Board seats make things more difficult because the activists have inside information. The problem starts because activists taking a 5 percent “control” interest have to report any 1 percent change in their holdings.

That works well on the way up, as other investors follow them in — but not so much on the way down.

“The 1 percent rule broadcasts that a large holder is hitting the market with a large supply of stock,” says hedge fund manager Robert Chapman, who left activist investing in 2008.