REE6306C-Corporate Real Estate Management

The McDonald’s Corporation uses its real estate to make money. A large portion of their revenues comes from the fact that they own space and then lease it out to their franchisees. 

McDonald’s (“corporate”) receives two streams of cash flows from franchisees’ operations. First, there are the royalties paid to McDonald’s for the packaging, food and other things purchased by franchisees directly from McDonald’s. Second, the lease agreements stipulate that franchisees pay a percentage of monthly restaurant revenues (maybe 8.5%) to McDonald’s in their capacity as the lessor. 1 . This is revenue to McDonald’s on top of and separate from royalties (See Exhibit 1 for McDonald’s Corporation 10-K disclosure). 

1. What are the risks that McDonald’s Corporate is exposed to?

2. What do you think of this business model? 

In 2005, Bill Ackman, the managing partner of Pershing Square Capital Management, proposed splitting up the restaurant business and real estate holdings of McDonald’s Corporation. He argued that the company is fundamentally undervalued and splitting up the company would add value to shareholders. According to Ackman, some 90% of the economic earnings McDonald’s generates come from the land and franchising business, where the real estate alone is worth more than McDonald’s market capitalization

Ackman proposed spinning off the restaurants that are directly owned and managed by McDonald’s while holding the real estate and franchise business (See attached presentation for proposal details). He argued that what would be left would be a much more valuable high-margin real-estate owner and franchisor with stable cash-flows.

3. McDonald’s is not in the fast food business but in the real estate business. Do you agree or disagree with this statement and why?

4. Do you agree with Bill Ackman that McDonald’s shares could be mis-priced? What is the connection between McDonald’s mis-priced shares and their real estate holdings? Specifically, how is their real estate holdings potentially causing shares to be mis-priced?

5. Finally, what do you think of Bill Ackman’s proposal? For example, if you were in the position of McDonald’s management, would you accept it or not and why?