MCD McDonalds Corp

By Julie Jargon 

For McDonald's Corp., the suggestion that it should spin off its vast property holdings poses an existential question: What are the Golden Arches without real estate?

As McDonald's approaches the third anniversary of declining sales, some analysts have been asking whether shareholders could get better returns if the company placed its U.S. properties in a publicly traded real-estate investment trust.

McDonald's has always maintained the importance of owning its own property. But executives responding to recent queries haven't ruled out the possibility of spinning off its real estate, with Chief Financial Officer Kevin Ozan saying last month that it will consider all financial options to boost shareholder value, and update investors in November.

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.

Many investors like REITs because they tend to trade at higher multiples than retail companies and pay little or no tax on their earnings as long as they distribute most of their profits through dividends. Macy's Inc. is under similar pressure from activist investor Starboard Value LP. Darden Restaurants Inc. in June became the first major restaurant chain to announce plans to transfer properties into a REIT. Doing so enables companies to collect an upfront sum that can be used to buy back shares or pay down debt.

That could make such a move attractive to McDonald's top management, especially since the fast-food chain's shares--at $92.87 as of Monday's close--are down more than 10% from their all-time closing high in April 2013.

McDonald's shares rose 1.6% the day Mr. Robbins issued his letter.

A number of analysts have since questioned McDonald's about its intent to do something with its real estate.

"We continue to evaluate opportunities to further enhance value for all shareholders and addressing our operational issues is our first and most critical priority," a McDonald's spokeswoman said.

Publicly traded Arcos Dorados Holdings Inc., McDonald's largest franchisee, which owns more than 2,100 McDonald's throughout Latin America and the Caribbean, last month said it is planning to outright sell or sell and then lease back some of its non-core real-estate assets, such as office buildings and distribution centers as part of a broad cost-cutting plan.

But some analysts say the arguments against a McDonald's REIT far outweigh those for it. For starters, the burger giant derives huge revenue from its real estate. Rental income from franchisees accounted for more than a fifth of McDonald's $27.4 billion in total revenue last year--when overall revenue fell 2.4% and profit dropped 15%--and represents a growing part of its business. Rent payments from franchisees have risen 26% over the past five years to $6.1 billion last year.

Sara Senatore, an analyst at Sanford Bernstein who has studied McDonald's real estate, estimates its world-wide property, including the U.S., is worth more than $42 billion. In the U.S. alone, home to more than 14,000 McDonald's restaurants, she estimates that the company's real estate is worth between $25 billion and $35 billion. McDonald's current market value is around $87.5 billion after the recent broad market downturn.

But she and others note that selling off the property would introduce new costs for McDonald's, which could have to start paying rent on the roughly 1,500 U.S. restaurants it operates on its own. "Adding lease costs at a time when there's been a deterioration in McDonald's fundamentals doesn't make a lot of sense," Ms. Senatore said.

Creating a REIT also could distract from the agenda of new Chief Executive Steve Easterbrook, who since taking over on March 1 has emphasized his desire to rejuvenate operations.

"McDonald's is facing a lot of headwinds, like minimum wage increases and more competitors," said Bob Schulz, managing director at Standard & Poor's Ratings Services. "This would be an additional complication for management's time."Standard & Poor's in May lowered its credit rating on McDonald's to "A-" from "A" after McDonald's accelerated a share repurchase plan.

Real estate has been a backbone of McDonald's business almost since its founding. McDonald's first chief executive, Harry Sonneborn, reportedly once told investors, "The only reason we sell 15 cent hamburgers is because they are the greatest provider of revenue from which our tenants can pay us rent."

All that property has attracted outside interest before. Nearly a decade ago, activist investor Bill Ackman pushed McDonald's to spin off some its real estate, but other shareholders didn't get behind his plan and he ultimately dropped it.

Splitting off the real estate would involve other complications. In some cases McDonald's owns the land and building for its restaurants outright. In others, it rents the building from another landlord and subleases it to franchisees. In the latter case, McDonald's pays its landlords a market rent of about 5% of the restaurants' sales and then charges its franchisees 10%, according to Ms. Senatore.

McDonald's franchise-disclosure documents, given to prospective operators, spell out that structure, saying that the company applies a finance fee on top of the monthly base rent "to produce an appropriate return for McDonald's."

"What's reported as rent is really rent plus McDonald's premium," Ms. Senatore said. A REIT wouldn't be able to charge that premium, meaning the property would effectively be worth less in a REIT.

Franchisees, whose relations with McDonald's already are strained, also likely would balk, said John Gordon, founder of restaurant consulting firm Pacific Management Consulting Group.

They fear a REIT might have more incentive to jack up rent over time than McDonald's, which wants to maximize rent but also wants franchisees to be financially healthy so its business can thrive. McDonald's sometimes gives rent breaks to franchisees who remodel or add new equipment, something a REIT wouldn't do, Mr. Gordon said.

"My prediction is they'll slow roll this forever," he said of McDonald's management.

Write to Julie Jargon at julie.jargon@wsj.com

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(END) Dow Jones Newswires

August 25, 2015 05:44 ET (09:44 GMT)

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