Though McDonald's ( MCD) management is currently refusing to spin off the company's real estate assets, such a transformation could unlock significant value for shareholders.

Last week, the issue picked up steam when Vornado Realty Trust ( VNO), a major real estate investment trust, disclosed that it recently acquired a 1.2% stake in the Big Mac giant.

Activist hedge fund Pershing Square Capital, a 4.9% owner, had previously urged McDonald's to consider spinning off some of its real estate to enhance value. The day before Vornado disclosed its ownership stake in a Securities and Exchange Commission filing, McDonald's CEO Jim Skinner said such proposals wouldn't be in the best interest of shareholders.

Right now, it appears there are two very different proposals being floated by Vornado and Pershing that aim to unlock McDonald's real estate value. Pershing's managing director William Ackman told TheStreet.com that he is pushing to have McDonald's sell off its entire company-operated restaurant business (which is faulted as being too capital intensive and low margin) into a new company, with McDonald's keeping a 35% ownership interest in that company. That would basically leave McDonald's as a real estate company that collected rent and fees from its franchisees, which operate 73% of its restaurants globally.

Vornado, on the other hand, seems to favor spinning off some or all of McDonald's real estate assets into a REIT, according to one analyst who follows the company. Ackman declined to comment on whether he's spoken to Vornado officials about the matter. A Vornado representative didn't make its notoriously tight-lipped executives available for comment.

In a sense, Pershing's proposal might be easier to navigate and would possibly unlock value through the market re-valuing McDonald's based on its new real estate-heavy business strategy. A conversion into a REIT, meanwhile, would be significantly costly, but also would likely result in a tasty treat being served to existing shareholders in the form of a special dividend that could total as high as $20 billion.

With Vornado in the picture, things have gotten rather interesting. Vornado CEO Steven Roth is considered one of the most powerful and well-respected real estate executives in the U.S. Last year, Vornado -- which owns about 87 million square feet of office and retail space mostly in New York and Washington, D.C -- disclosed a 5% stake in Sears just weeks before Ed Lampert's Kmart acquired the company and subsequently formed Sears Holdings ( SHLD). Vornado also was involved in the private equity buyout of Toys R Us.

But make no mistake, McDonald's represents a tremendously different real estate play for Vornado than Sears did, according to Deutsche Bank analyst Lou Taylor, who recently picked the brains of Vornado's management.

Vornado's plan for Sears was to unlock value by closing underperforming stores and selling or redeveloping the real estate.

With McDonald's, Vornado likes the retail space as it is, but it feels the company's real estate would be valued higher by the marketplace if it were held by a new publicly traded REIT, according to Taylor. Vornado's thesis is that the $30 billion of real estate on McDonalds' books (since the fast-food giant owns many of its locations) isn't being properly valued by the market, Taylor wrote in a recent research report.

How much is McDonald's real estate really worth? A simple way to value a real estate portfolio is to apply a cap rate, or rate of return, to a property (the cap rate equals operating income divided by asset price). In this case, Taylor used a 7% cap rate, which, he explained in a phone interview, is where a retail portfolio like that of McDonald's would trade in the private marketplace.

By applying this 7% cap rate to McDonald's EBITDA, Taylor calculates that McDonald's real estate could be worth about $64 billion. In most instances, in order to convert to a REIT, companies are required to distribute unpaid earnings and profits tied to real estate before conversion, likely in the form of a special dividend. If McDonald's entire real estate portfolio were converted to a REIT, about $20 billion of earnings and profits would be triggered and distributed to shareholders as a special dividend, Taylor says. Shareholders likely would pay a 15% capital gains tax.

This would be a huge payoff for the fast-food chain's shareholders. McDonald's already pays an annual dividend of 67 cents, which amounts to a 2% yield. McDonald's also has said it will return $5 billion to $6 billion to shareholders in 2006 to 2007 in the form of dividends and share repurchases. But a $20 billion special dividend would amount to a whopping $15.70 a share payout.

So what would a McDonald's REIT look like? As a REIT, the majority of the company's income would have to come from real estate sources, such as rents or interest on mortgages. Only 5% could come from sources such as franchise service fees or other non-real-estate business. That would mean McDonald's would spin off a real estate entity that owned a basket of the "golden arch" properties -- perhaps all the franchise locations, all the company-operated sites, or some combination of the two.

"The REIT couldn't make money from hamburgers," says Taylor. "It would make money from rent. They'd own the store and lease it to a McDonald's operating company."

Currently, about 73% of the company's global restaurants are franchises; in the U.S., it's 85%, according to McDonald's. The company owns 37% of the land underlying its restaurants, with the rest leased. Although fees can vary, franchises pay the company, on average, a service fee of 4% of sales in the U.S., and average rent of 9% to 10% of sales. The percentages are often higher globally and in high-priced real estate markets like Manhattan.

In the past, McDonald's weighed several options for REIT conversion, according to a McDonald's official involved in the proceedings. But in the end, none were chosen. "We concluded that the incremental value that potentially could be created was not significant enough to offset the direct costs that would be involved," the official says.

One proposal involved spinning off all the franchise sites into a REIT, which would simply collect the rental fees from the franchisees. Within that REIT would be a taxable REIT subsidiary that collected the franchise service fee income, since that is considered part of the non-real-estate income that can make up only 5% of a REIT's income.

Under Pershing's current proposal, the company-operated restaurants would be spun off, which could pose challenges. "Operating restaurants, we believe, is a good component of us being a franchisor," says the McDonald's official. The official argues that franchisees are more comfortable knowing that the corporate headquarters isn't just a landlord, and that it knows how to run a restaurant as well. Ackman acknowledges this issue and says that is why his firm is proposing that McDonald's keep a 35% interest in the new company.

Any transfer of the real estate properties into a new REIT could also involve significant costs from transfer taxes, recording fees, costs in terms of reassessment of property taxes and capital gains taxes on certain properties.

As well, there is a loss of control. Mike Frankel, national director of the real estate tax practice with Ernst & Young, says corporations are often hesitant about spinning off their real estate assets because they don't want to go from owning properties to renting them. "What happens when the lease expires, (and as a corporation) I need to have that property?" he says. "Do I want to take the chance that you (the new REIT) will gouge me?" This issue is avoided in the Pershing proposal, since the entire operations of the company-operated restaurants are being spun off, and not just the real estate.

With McDonald's management currently adamantly against any real estate spinoff, all this is currently just pie-in-the-sky talk. Taylor, the Deutsche Bank analyst, doesn't see Vornado as an activist shareholder like Pershing. He instead views the company as "a signal and support for other investors calling for change." Pershing might be farther along in the talks. Next week, the hedge fund plans to meet with hedge fund and institutional investors at a meeting in New York City to discuss the issue further.

But don't count out Vornado. With corporate America sitting on a whole bunch of prime real estate, Vornado and other REITs are likely to keep up their push to get their hands on it, whether it's McDonald's or other large retailers.

"We obviously know that the REITs, to the extent that there is an efficient way for them to acquire real estate from corporate America, they're very interested in doing so," says Frankel.

And if Vornado can convince more McDonald's investors to pay attention to this hidden real estate value, a special happy meal could be on the way. Pershing's proposal might hold some presents as well.

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