Fast-Food Giant Mulls
Establishment of a REIT

DES MOINES, Iowa -- McDonald's Corp., viewed by many as a real-estate company as much as a fast-food chain, said it will revisit the possibility of putting its U.S. restaurants into a real-estate investment trust following a recent tax-law change. 

Securities analysts put the value of McDonald's domestic restaurant real-estate assets at about $8 billion. "Given the change in the tax structure, we'll be reviewing the REIT alternative again," a McDonald's spokeswoman said. There has been speculation on Wall Street about whether what some are calling a "McREIT" would be a positive step for investors. 

However, spokeswoman Anna Rozenich said chances of McDonald's moving its thousands of restaurant properties off its balance sheet and into such an investment vehicle are far from certain. "Tax savings alone wouldn't justify going to a REIT," she said. "The tax issue is only one issue out of many that need to be addressed." 

REITs don't pay federal income taxes if they pass on their income to their shareholders. So by moving its real estate into a REIT, McDonald's would avoid the taxes it now pays on rental income it receives from franchisees.  "For McDonald's, the nontax business issues are a more material factor in assessing the merits of any potential business separation," Ms. Rozenich said.

Noting that 85% of its 13,000 U.S. restaurants are franchised and that the real-estate leases on those properties "are an integral part of our franchise relationship . . . any change in our real-estate arrangements would have to make sense for our franchisees and provide benefits for our business structure and our shareholders," the McDonald's spokeswoman said. 

Speculation that a McREIT might be in the offing came after the Internal Revenue Service ruled in June that a company's real-estate assets could be spun off tax free into a REIT. 

Some contend that a McREIT would unlock the intrinsic value in those assets, but there also would be a significant impact on McDonald's income statement.

Lehman Brothers Inc. restaurant analyst Mitchell J. Speiser estimates McDonald's earned about $1.4 billion in rental income last year. After taxes are paid, overall earnings would decline by $501.1 million, or 37 cents a diluted share, Mr. Speiser figured -- although that income would be transferred to the REIT. For 2000, the company reported overall revenue of $14.2 billion and net income of $1.97 billion, or $1.46 a diluted share. 

Mr. Speiser calculated that the income loss would have saved McDonald's about $269.9 million, or 20 cents a share, in taxes last year, assuming a 35% tax rate. 

Besides the tax savings, "There is likely additional value to be reaped by creating a REIT for the ownership of real estate under company-operated stores," he said.

But some analysts are circumspect. Janice L. Meyer at Credit Suisse First Boston said the loss of rental income, "combined with the higher cost of renting vs. owning company stores alone," would equate to a loss of $5 a share for McDonald's shareholders at the stock's current multiple. 

"Therefore, the REIT would have to be valued at substantially more than [that] to make it worthwhile," she said in a research note. 

Besides being a tradable security on its own, shares of a McREIT presumably would be distributed to holders of McDonald's common stock. 

Ms. Meyer said that while the IRS's recent ruling "does broaden McDonald's options, it isn't clear whether the transfer of assets, and the loss of control that could entail, would be worth the effort." 

She also says that "the lack of diversification in the asset base and the sheer size of the offering could limit demand" for a McREIT among investors. 

Deutsche Banc Alex. Brown analyst John Glass noted the loss of control of the company's rent structure, "ultimately could hurt the franchise system."  

"McREIT? Don't think so," said Merrill Lynch analyst Peter Oakes in a research report. He says the "risk/reward profile does not currently justify a REIT structure." He said the "embedded `mark to market' value is not as great as is perceived," while the "incremental return from redeploying capital is not clear cut." 

Mr. Oakes also wondered what McDonald's would do with the proceeds from a REIT. They could be used to "either acquire a growth vehicle [their plate is full for the time being] or shrink its capital base. The long-term returns of owning bricks and sticks, even in a low-inflationary environment, are still compelling," he concluded. 

Several years ago McDonald's studied the possibility of a REIT but concluded that, given the potential risks associated with such a transaction, its rewards might be minimal. In revisiting the issue now, Ms. Rozenich said that "for McDonald's the nontax business issues are a more material factor in assessing the merits of any potential business separation." 

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