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Professor's Lounge: A Deeper Look Inside McDonald's

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THEY have the Bic Mac... WE have the Big Mic

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The following is a transcript of a discussion I had with Professor Fil:

Succo: Pershing announces they buy stake in McDonalds (MCD). Why is that positive? They say they will sell assets - but who is going to buy them at what price?

Zucchi: Lemme look because I don't know much about MCD other than I like McFlurries.

Succo: This assumes the company is being run poorly and that the assets are worth more separately.

Zucchi: There are a couple of possibilities I think - 1) is the old "real estate play - MCD real properties were believed to be worth as much as $13/share some years back - could be a whole lot more now; the other is to nudge MCD closer to a spin-off of Chipotle, which could be a hot commodity on a stand alone basis.

Succo: I would think MCD property would not be worth more to buyers 'cause they are mostly corner lots that are perfect for fast food.

Zucchi: Bolted down stuff is worth a lot if you call it real estate - just look at Sears Holdings (SHLD)

Succo: This logic assumes company management wants to do the wrong thing and they need a big shareholder to tell them what to do

Zucchi: Don't know what the m.o. of Pershing is but some real estate focused funds are so IRR driven they don't really care about the operations - they'll buy in, flip the land and get out - if the operations get destroyed it's someone else's problem. These guys went after Sizzler and Wendy's before . . .there may be something operationally they don't like as well - but as far as assets, real estate and Chipotle are the only two I can think of off the top. With Chipotle at a run rate of about $1.3b in sales and growing SSS 14% and rev. 14% - there could be a nice chunk of change there.

Succo: Yes but why do people assume just 'cause these guys take a stake that the management wouldn't sell it anyway or is doing the wrong thing by not selling it?

Zucchi: That I am not sure - in fact I thought that management had let it be known that they are thinking about IPOing Chipotle - maybe they were just bluffing and testing the market. Chipotle is the only realistic brand that could give these guys growth once it reaches critical mass. That could plug a lot of holes in the primary brand.

Succo: So when they sell it what do they have left? The bulls say stock prices have enterprise value, that the sum is worth more than the parts and then others come in and say the parts are worth more than the whole.

Zucchi: Figure the IPO goes for 1.5x sales that's a cool $2 bln in the bank vs. ballpark of $50-60M of cash flow from Chipotle right now.

Succo: $2 billion = 1.5 per share today, but what is it taking from the enterprise value of the company tomorrow? They lose future cash flow that may grow.

Zucchi: Yeah, but free cash flow right now is only about $50-60M / yr - you monetize that cash flow at 20x-30x vs. it being lost in MCD mid teens multiple. I am not passing judgment on the wisdom of it - but I can see the thinking

Succo: Right but doesn't assume growth, which is why someone pays $2 billion. Someone is paying 2 billion or 30x current cash flow obviously because they think cash will grow.

Zucchi: Right - and Chipotle's CF will grow

Succo: Stock price discounts the future. Maybe selling chip now at 2 billion is mistake - certainly the buyer thinks so. My belief is that these things make stock prices pop, but later they deflate.

Zucchi: That's certainly been the case with American Express (AXP) and Viacom (VIA.B)


There is a great shuffling of paper going on. In the mid-1980's a combination of cheap stock prices and falling rates gave rise to LBO funds. They found that the stock market was not bidding up public stock prices fast enough relative to asset values: the enterprise value was not reflecting the new value of separate assets as interest rates dropped.

We could do an analysis where the cumulative value of separate assets was worth more than the current stock prices. LBO funds made sense.

Today, this is not true. LBO funds now are willing to buy companies and slice them up, but they have to make growth assumptions and attach enterprise value to the rest of the company to make their numbers work. But when you sell off assets, enterprise value is likely to fall or go away altogether. What is MCD worth if it sells off its real estate and cannot sell food?

It is now a perception game. MCD can get $2 billion today for Chipolte, which equals $2 billion / 1.3 billion shares outstanding = $1.50 per share. But what happens to MCD enterprise value when it sells off its fastest growing asset?

My big point is that the LBO business of today is not the LBO business of the 1980's when the Icahns and the Boeskys pulled no brainers and made easy money.

Today's LBOs or partial LBOs have many more assumptions and soft spots.

No positions in stocks mentioned.

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