Lehman Says McDonald's Could Benefit From Real Estate Spinoff

By Eric Gillin ,

The Happy Meal conglomerate wears two hats -- burger maven and real estate mogul.

Global fast-food giant

McDonald's

(MCD) - Get Report

has $8 billion in property, which earned it $1.4 billion in rent during fiscal 2000. Now,

Lehman Brothers

says a new ruling from the

Internal Revenue Service

might encourage the company to spin off its real estate portfolio.

Late Monday night, the IRS ruled that corporate real-estate assets could be spun off tax-free in the form of real estate investment trusts, known as REITs. Essentially, this would allow companies to get land off their books and pay rent to a self-created REIT.

Sixty percent of franchises pay rent to McDonald's. "The risk is the elimination of a steady income stream. But, the value of a REIT is the tax benefit and higher returns to McDonald's. Lower McDonald's earnings would be more than offset by ownership of the REIT and its tax-free benefits," Lehman analyst Mitchell Speiser wrote in a research note this morning.

In a rough, "back-of-the-envelope" analysis, he said McDonald's could glean $270 million in value for the company, adding 20 cents a share to its bottom line. Analysts, on average, currently expect the company to make $1.49 a share in 2001 and $1.67 a share in 2002, according to earnings tracker

Thomson Financial/First Call

.

That said, however, McDonald's revenue would fall by $856.7 million without its U.S. real estate revenue (it had $14.2 billion in total revenue during fiscal 2000), while earnings would drop by $501.1 million. That translates into 37 cents a share in earnings. But Spieser said the lost earnings would be transferred to the REIT, which McDonald's would own and use for tax benefits. The savings, as he calculated, could total $269.9 million -- the 20 cents a share he estimated.

In his note, Spieser reiterated his strong buy rating on McDonald's stock and kept his price target at $38. McDonald's was up 2.4% to $30.10 in early trading. It has a 52-week high of $36 and a low of $29.41.

McDonald's has been a victim of its own success. The burger chain has been relentlessly successful for the past 50 years in an industry it not only dominates, but created. Over the last year, however, tarnish has speckled the Golden Arches as profitability has slowed for the first time, European sales slumped in part because of hoof and mouth disease and the company got embroiled in a brouhaha over meat byproducts ending up in its adored french fries.

To return to growth and diversify its revenue stream, McDonald's has already announced a slate of new initiatives, including its "McDonald's With a Diner Inside" concept rolling out in middle America and the decision to sell off its U.K.-based cafe chain, Aroma. If Lehman turns out to be correct, the company may also turn to its vast real estate holdings for help.

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