Module 6 Discussion Prompt: Rethinking McDonald's

• Due By Class on Tuesday, November 18th, 5:30 pm.
• There is a 1 Point Deduction for Late Submissions.
• Counts as 5 Points Towards Participation Grade.

The McDonald’s Corporation utilizes its real estate to generate revenue. 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, royalties are paid to McDonald's for the packaging, food, and other items purchased directly by franchisees 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. This is revenue to McDonald's, in addition to and separate from royalties.

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 that splitting it up would add value to shareholders. According to Ackman, approximately 90% of McDonald's economic earnings 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. He argued that the move would return value to shareholders by making McDonald's a much more valuable, high-margin real estate owner and franchisor with stable cash flows. Review the attached "Pershing Square McDonald's Proposal" and work by yourself to answer the questions below.

Download Pershing-Square-McDonalds-Proposal.pdf

1. (1 point) 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? Hint: What are the risks that McDonald's Corporate is exposed to?
2. (2 points) Bill Ackman is stating that the market capitalization of McDonald's does not accurately reflect the company's true or intrinsic value, and that restructuring the company will unlock hidden value. 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? Be specific, what is the mechanism or connection, according to Bill Ackman, between McDonald's real estate and the mis-pricing of their stock, causing shares to be mis-priced? A complete answer includes whether you agree or disagree that McDonald's is potentially mispriced and the connection being drawn between the company's value and its real estate.
3. (1 point) Finally, what do you think of Bill Ackman's proposal? If you were in the position of McDonald's management, would you accept it? Why or why not?

Supplemental Resources

• McDonald's 2005 form 10-kLinks to an external site.
• Ackman Drops McDonald's IPO Demand (MarketWatch)Links to an external site.
• Hedge-Fund Man at McDonald's (WSJ)Links to an external site.

Rubric

• Each part or answers to 1 (1 pt.), 2 (2 pts.), and 3 (1 pt.) are graded for completeness
• 1/2 point for having an effective write-up (clear and free of grammatical errors)
• 1/2 point for thoughtfulness of your answer (demonstrate knowledge and critical thinking)
• Keep in mind that posts are public

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