There is little doubt that the increasingly opulent hedge fund community–if there is one–is proud of William Ackman’s charge on McDonald’s Corp.
That an aggressive hedge fund manager like Ackman, general partner of New York-based Pershing Square Capital Management LP, can force an American corporate icon like McDonald’s to even listen to a dramatic restructuring proposal is a provocative development.
“These are managers who are extremely smart and aggressive, and armed with lots of money,” said Christopher Geczy, associate finance professor at the University of Pennsylvania’s Wharton School. “Most of all, they need to extract excellent returns quickly.”
In this age of shareholder activism, Geczy adds, hedge fund managers aren’t shy about pressuring corporate executives.
Part of the reason is that the stock market, by and large, is trading sideways. So the more demanding–and wealthy–investor is turning to hedge funds that regularly make large bets on a few stocks.
Whitney Tilson, who runs T2 Partners LLC and also is a McDonald’s shareholder, said that Ackman, rather than being vilified for audacity, should be applauded for doing what mutual fund managers rarely do: press what he deems to be an underperforming company to change.
“One of the great disgraces of the mutual fund industry is that they are incredibly passive,” Tilson said. “In all areas–capital allocation, executive compensation, options–rarely do you hear a mutual fund manager make a sound.”
In this case, Ackman, the 39-year-old whiz-kid son of a real estate magnate, wants McDonald’s to “unlock” value by carving out its capital-intensive company-owned restaurant division known as McOpCo. If the McDonald’s stock were freed of operating about 8,000 stores (an additional 22,000 restaurants are franchised worldwide), the remaining company, he argues, would generate mountains of free cash to be used for share buybacks and a larger dividend.
Politely but firmly, McDonald’s has rejected Ackman’s plan, calling it “financial engineering.”
Ackman doesn’t seem fazed. Over time, said David Palmer, an analyst at UBS Securities Inc., McDonald’s is likely to incorporate some or all of Ackman’s ideas.
“If investors believe a sum-of-the-parts multiple would be much higher than a stand-alone business, they’re going to make noise,” Palmer said, referring to the ratio between a stock’s share price and company’s earnings. “Hedge funds see that buried treasure, and want it.”
At the root of Ackman’s offensive, Palmer added, is a movement by value investors to force companies to focus on already invested capital rather than on expansion, as advocated by growth investors.
At Wendy’s International Inc., for instance, Ackman and others successfully prodded management to spin off its Tim Hortons doughnut shops. McDonald’s is doing something similar by spinning out its 461-store Chipotle Mexican Grill Inc. chain early next year.
Separating McOpCo, Palmer said, would allow McDonald’s to collect franchise fees from spun-out stores. From a stock around $33 a share, which UBS calculates is 9 times earnings excluding interest, taxes, depreciation and amortization, Palmer argues a restructuring would bump the stock’s multiple to more than 12.5, generating a price above $45 a share.
But while Ackman is anxious to see McDonald’s executives hold a news conference, say tomorrow, to announce a restructuring, Tilson says he can wait.
McDonald’s, Tilson acknowledges, is in the midst of a rebuilding process following the stock’s more than 70 percent drop between November 1999 and a low in March 2003. Like Ackman, Tilson commends Chief Executive Jim Skinner, on the job for just a year, for improving sales and profits while pledging to increase its dividend.
Nonetheless, Tilson said Ackman’s efforts have properly focused attention on the company.
“We think management is in the middle innings of a nine-inning game,” he said. “They’re doing a good job, but investors aren’t going to sit idly by if they believe management can do better.”
Welcome to the hedge fund-driven stock market.