Rogue investors on Big Mac attack
McDonald’s Corp., world’s largest fast-food chain, has been turning cartwheels to please investors. But to little avail.
It’s one of many blue-chip firms in the United States and Canada coping with a speculative assault that in some ways has eclipsed the buccaneering exploits of T. Boone Pickens and his ilk in the 1980s.
After a dismal half- decade of sluggish sales in which McDonald’s seemed to be reaching the limits of growth, the 50- yearold company successfully revamped its menu and streamlined operations to produce its biggest sales gains in 17 years in 2004 — up 11 per cent, to $ 19.1 billion ( U. S.). Profits jumped 55 per cent, to $ 2.3 billion. To goose “ shareholder value,” the Holy Grail for short- term investors, the firm based in the Chicago suburb of Oak Brook, Ill., bought back $ 1 billion worth of its shares, and promises to further reward investors with an additional $5 billion to $6 billion in share buybacks and dividend hikes over the next two years.
McDonald’s could reap another $ 1 billion by following through on a hinted partial spin- off of its Chipotle Mexican Grill chain. Not good enough, says a New York hedge fund with a mere 4.9 per cent stake in one of the most consistently well-run companies of the past half-century, which has overcome the only rough patch in its history despite the tragic deaths of two able CEOs in the past 17 months.
U. S. hedge fund Pershing Square Capital Management, which presented its proposed makeover plan for McDonald’s at an investor conference earlier this month, wants McDonald’s to sell off its company-owned restaurants, which make up 30 per cent of McDonald’s total 31,000 outlets worldwide. ( The rest are operated by franchisees.) The recent emergence of realestate speculator Vornado Realty Trust as owner of 1.2 per cent of McDonald’s shares suggests that the firm might also soon be pressured to spin off the land under its restaurants into a real estate investment trust
( REIT).
Yet, bending to the demands of its arriviste investors would distort, if not destroy, a McDonald’s business model that has worked since Ray Kroc founded the company in 1955.
McDonald’s is a rarity in the fast- food world in its harmonious relations with franchisees, who have long appreciated that head office has an astute knowledge of market conditions by running many of its own outlets. And owning land at high- traffic locations has always given the parent company the advantage of not being forced by third- party leaseholders to surrender valuable sites.
If it’s any solace to the burger giant, McDonald’s joins a multitude of prominent firms currently under assault. Persistent low interest rates have created an abundance of cheap capital to finance marauding. And sluggish business conditions in many industries have created a proliferation of substantial enterprises whose undervalued stock makes them vulnerable to interlopers.
In Canada, the largest institutional investors, hedge funds and specialized buyout firms have some $86 billion ( Canadian) with which to rearrange the corporate landscape. And their U. S. peers boast a war- chest of roughly $100 billion ( U. S.), even after spending $ 130 billion so far this year on snapping up corporate assets. The predators storming the ramparts of Corporate North America come in two varieties.
Conventional, long-term acquirers — or “ strategic” players — have targeted smaller firms in their industries for the familiar purpose of consolidation. Among the undervalued companies that have attracted such bidders are steelmaker Dofasco Inc.; gold producer Placer Dome Inc.; B. C. gas utility Terasen Inc.; forestry giant Georgia-Pacific Corp. of Atlanta; and the Mississaugawine combine Vincor International Inc. ( Inniskillin, Jackson- Triggs).
While much of this activity has been hostile, the relatively benign objective has been to create a larger enterprise with greater critical mass and the usual costsaving synergies. More novel are the speculative, or “opportunistic,” players — newly aggressive institutional investors and hedge funds whose method is to buy a minority stake in a major enterprise in the hope of provoking management to take drastic steps to quickly boost stock value.
While the earlier generation of 1980s raiders tended to prey on mid- sized firms, today’s speculative agitators are taking on some of the largest companies in the world, including General Motors Corp. and Time Warner Inc. And while yesterday’s raiders seldom sought to actually gain control of a targeted firm, the latest generation of hedge funds and impatient institutional investors has not hesitated to acquire firms outright. Among the companies that have already succumbed to these unconventional buyers are Sears, Roebuck & Co., acquired earlier this year by hedge- fund operator Eddie Lampert and merged with his Kmart Corp. to create Sears Holdings Corp.; Hertz Corp.; hotelier La Quinta Properties Inc.; Geac Computer Corp. Ltd.; and Masonite International Corp. Rumoured targets of the buyout firms are Tommy Hilfiger Corp. and donut- shop operator Dunkin’ Brands. And victims of speculative investors pressuring companies to deliver windfall profits include Hudson’s Bay Co.; Algoma Steel Corp.; the Blockbuster Inc. movie- rental chain; OfficeMax Inc., the U. S. No. 3 office supplies retailer; Knight Ridder Inc., the U. S. No. 2 newspaper company whose 32 dailies include the Philadelphia Inquirer and the Miami Herald; and Fairmont Hotels & Resorts Inc., which operates Toronto’s Royal York, the Chateau Laurier, and the Banff Springs Hotel. And it was a frustrated U.S. money manager, Tweedy Browne & Co., whose complaints about underperforming shares in Hollinger International Inc. ultimately brought about the dismantling of Conrad Black’s newspaper empire.
There’s a downside risk to the frenzied dealmaking, of course, which is that the heady returns of the recent past may not endure much longer. Already there are too many players chasing too few targets.
Result: the average multiple paid in buyouts has soared from 6.5 times earnings before interest, taxes, depreciation and amortization ( EBITDA) to as much as 12 times.
In its offer for Dofasco last week, European steel industry consolidator Arcelor SA is offering almost twice the firm’s book value; at the best of times in the volatile steel industry, Dofasco shares trade at 1.4
times book value.
And the favourable
economic cycle for
buyouts is due for a
downturn after 14 consecutive interest-rate
hikes by the U. S. Federal Reserve Board and
worries that the U.S.
economy will soften
next year.
“ There’s no question
this is going to end badly for some,” business professor Colin Blaydon of the Tuck School of Management at Dartmouth College told a U. S. newspaper last week.
Noting the excessive debt in many recent deals, Blaydon said: “The question becomes: Does it crash like a rock or is there an adjustment down over time?” Veteran buyout specialist Henry Kravis worries that dealmakers are poised to reap a sour dividend from too much of a good thing. “Unfortunately,” Kravis said in a recent speech, “ there is a flip side to having access to plentiful capital. It means that too many people without experience in building businesses have too much money.” Then again, today’s dealmakers need not worry
about relying solely on
their two conventional
exit strategies, which
would be abruptly
closed to them in the
event of an economic
downturn: taking their
recent acquisition
public in a lucrative
IPO, or finding a traditional corporate buyer to take an over- priced purchase off their hands.
China and India are eager to make North American inroads. Cash-rich China’s enterprises alone have bought IBM Corp.’ s faltering PC business and, were it not for a parochial U. S. Congress, would have snapped up Maytag Corp. and oil giant Unocal Corp. as well in the past year.
India, for its part, boasts two dominant consolidators — Mittal Steel Co. NV, which recently acquired three subsidiaries of Stelco Inc.; and Wipro Technologies, which has set up shop in Southern Ontario to be closer to its growing roster of U. S. customers. The Chinese, with their massive holdings of U. S. bonds, have developed a reputation as exceptionally motivated buyers (read spendthrifts) when opportunities arise to snap up venerable North American brand names and distribution networks. The only obstacle to their ambitions is lingering political sensitivities in both Canada and the U. S. toward offshore buyers of iconic businesses — notably when the prospective buyer is a branch of the Communist regime in Beijing. Which means that the key exit strategy for today’s dealmakers may turn out to be overcoming the xenophobic instincts of North American lawmakers.