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McDonalds, Wendys and Hedge Funds Hamburger
Hedging?

• Perspectives on Management
• February 7th, 2008

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Class format

• Hedge Fund
• Activist investment
• Pros
• Cons
• Motives
• Carl Icahn
• Pershing Square/Bill Ackman
• Wendys
• McDonalds

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Hedge Fund

• An aggressively managed portfolio of
  investments that uses advanced investment
  strategies such as leverage, long, short and
  derivative positions in both domestic and
  international markets with the goal of
  generating high returns (either in an absolute
  sense or over a specified market benchmark).
  Legally, hedge funds are most often set up as
  private investment partnerships that are open to
  a limited number of investors and require a very
  large initial minimum investment. Investments
  in hedge funds are illiquid as they often require
  investors keep their money in the fund for at
  least one year.   For the most part, hedge funds
  (unlike mutual funds) are unregulated because
  they cater to sophisticated investors. In the
  U.S., laws require that the majority of investors
  in the fund be accredited. That is, they must
  earn a minimum amount of money annually and have
  a net worth of more than 1 million, along with a
  significant amount of investment knowledge. You
  can think of hedge funds as mutual funds for the
  super rich. They are similar to mutual funds in
  that investments are pooled and professionally
  managed, but differ in that the fund has far more
  flexibility in its investment strategies.   It
  is important to note that hedging is actually
  the practice of attempting to reduce risk, but
  the goal of most hedge funds is to maximize
  return on investment. The name is mostly
  historical, as the first hedge funds tried to
  hedge against the downside risk of a bear market
  by shorting the market (mutual funds generally
  can't enter into short positions as one of their
  primary goals). Nowadays, hedge funds use dozens
  of different strategies, so it isn't accurate to
  say that hedge funds just "hedge risk". In fact,
  because hedge fund managers make speculative
  investments, these funds can carry more risk than
  the overall market.
• Source Investorpedia

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More on Hedge Funds

• A hedge fund is a private investment fund that
  charges a performance fee and is typically open
  to only a limited range of qualified investors.
  Hedge fund activity in the public securities
  markets has grown substantially as it constitutes
  approximately 30 of all U.S. fixed-income
  security transactions, 55 of U.S. activity in
  derivatives with investment-grade ratings, 55 of
  the trading volume for emerging-market bonds, as
  well as 30 of equity trades. Hedge Funds
  dominate certain specialty markets such as
  trading in derivatives with high-yield ratings,
  and distressed debt.1
• The assets under management of a hedge fund can
  run into many billions of dollars, and this will
  usually be multiplied by leverage. Their sway
  over markets, whether they succeed or fail, is
  therefore potentially substantial and there is a
  continuing debate over whether they should be
  more thoroughly regulated.
• Management fees
• As with other investment funds, the management
  fee is calculated as a percentage of the net
  asset value of the fund at the time when the fee
  becomes payable. Management fees typically range
  from 1 to 4 per annum, with 2 being the
  standard figure. Therefore, if a fund has 1
  billion of assets at the year end and charges a
  2 management fee, the management fee will be 20
  million in total. Management fees are usually
  calculated annually and paid monthly.
• Performance fees
• Performance fees, which give a share of positive
  returns to the manager, are one of the defining
  characteristics of hedge funds. In contrast to
  retail investment firms, performance fees are
  prohibited in the U.S. for stock
  brokers.citation needed A hedge fund's
  performance fee is calculated as a percentage of
  the fund's profits, counting both unrealized
  profits and actual realized trading profits.
  Performance fees exist because investors are
  usually willing to pay managers more generously
  when the investors have themselves made money.
  For managers who perform well the performance fee
  is extremely lucrative.
• Typically, hedge funds charge 20 of gross
  returns as a performance fee, but again the range
  is wide, with highly regarded managers demanding
  higher fees. In particular, Steven Cohen's SAC
  Capital Partners charges a 50 incentive fee (but
  no management fee) and Jim Simons' Renaissance
  Technologies Corp. charged a 5 management fee
  and a 44 incentive fee in its flagship Medallion
  Fund before returning all investors' capital and
  running solely on its employees' money.citations
  needed
• Managers argue that performance fees help to
  align the interests of manager and investor
  better than flat fees that are payable even when
  performance is poor. However, performance fees
  have been criticized by many people, including
  notable investor Warren Buffett, for giving
  managers an incentive to take excessive risk
  rather than targeting high long-term returns. In
  an attempt to control this problem, fees are
  usually limited by a high water mark and
  sometimes by a hurdle rate. Alternatively, the
  investment manager might be required to return
  performance fees when the value of the fund
  drops. This provision is sometimes called a
  claw-back.

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Activist Investing

• They do enormous research to find out where there
  is hidden value. Activists typically go into
  situations where the value isn't immediately
  clear and they press management to unlock that
  value (for instance, trying to get MCD to sell
  real estate holdings, etc).
• They are typically long-term holders. Activists
  tend to take 5 or greater positions in a
  company. They aren't able to nimbly trade out of
  those positions.
• They usually publish their research in 13D
  filings in order to convince shareholders to vote
  their way.
• They use their own equity to invest (as oppose to
  LBO funds that use the target company to raise
  debt)
• Often demand share buybacks (dont like excess
  cash on the balance sheet)

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What drives Shareholder Activism?

• Excess cash on corporate balance sheets-615 BB
  in 2005
• Deploy cash elsewhere
• Share buybacks, dividendsespecially if company
  management can not find projects with an
  acceptable (R) return.
• Excess executive compensation
• Opportunities to restructure/recapitalize
• Eliminate unprofitable divisions
• Increase leverage
• Lack of adequate corporate governance
• Worldcom, Tyco, Enron, etc

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Cons

• What was the motive of the hedge fund manager?
• Management time wasted on appeasing hedge fund
  managers not running the business
• Increase leverage could effect cash flows, credit
  rating, ability to raise capital
• Short term vs long term

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24 Carl Icahn Net Worth 8.5 billion
Source Forbes
Source Investments, leveraged buyoutsSelf
madeAge 69Marital Status Married, 2 children,
1 divorceHometown New York, NYEducation
Princeton University, Bachelor of Arts / Science
Obsessive corporate raider up to old tricks with
purchase of a small stake in Time Warner trying
to strong-arm media giant into dumping publishing
assets and buying back 20 billion in stock.
"Shareholder activist" grew up middle class in
NYC's Queens. Studied psychology at Princeton,
then NYU med school dropped out because he
didn't like working with corpses. Got job as
stockbroker for Dreyfus Co. moved into
securities arbitrage. Borrowed to buy NYSE seat
1968 bought firms, forced managers to improve,
buy him out or spin off at profit. Big scores in
1980s with takeovers of Texaco, USX. Latest
vehicle hedge funds. Icahn Partners fund
manages 2.5 billion in assets. Also owns Las
Vegas' tallest casino, the Stratosphere, through
stake in American Real Estate Partners shares
worth 2 billion
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Bill Ackman
Who Hedge fund manager, Pershing Square Capital
Management Current Residence New York, NY
Spotlight Young people are bright people. They
are not indentured to received wisdom Enemies
MBIA, the insurance giant. According to a story
in The Edge Singapore, MBIA chairman Jay Brown
summoned Ackman and other Gotham associates to a
meeting after Gotham published a series of
reports criticizing MBIAs bookkeeping. Brown
supposedly accused Ackman of manipulating the
market and emphasized that MBIA had friends in
high places. The meeting ended with Ackman
offering a handshake and Brown recoiling. Soon
after, the SEC began to investigate Gotham.
Ackman bore out the investigations, which found
nothing suspect, and eventually used the
relationships he developed with the SEC to
instigate an investigation into MBIAs
accounting practices. He later enjoyed the
sweet, sweet taste of revenge when MBIA was
forced to restate six years of earnings, reducing
profits by 60 million. Quotable The truth
wins out eventually. If Ive got my idea and
basic facts right, Ill be fine. If nothing
else, Im a persistent cuss. Never has pursuit
of the truth been this (financially) rewarding.
Zillowed When Ackman isnt living in a 26
million co-op on Central Park West in New York,
he spends time in his home on 73rd street, a
neighborhood with 4-5 million houses. Source
www.01138mag.com
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Bill Ackman

• Ackman Devoured 140,000 Pages Challenging MBIA
  Rating
• By admin - Posted on February 1st, 2008
• Source vinvesting.com
• It was the 109,000 photocopying bill that hedge
  fund manager William Ackman says made him realize
  how much he'd read and underlined before betting
  against bond insurer MBIA Inc. in 2002.
• His law firm charged him for copying 725,000
  pages of financial statements and other
  documents, 140,000 of them about MBIA, to comply
  with a subpoena. Following New York and U.S.
  probes of his trading and reports, Ackman
  persisted in challenging MBIA's AAA credit rating
  for more than five years, based on his own
  research.

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WENWhat Ackman Saw in April, 2005?

• WEN trading at 39
• Tim Hortons-The Growth Driver
• 50 of Wendys Operating Profits
• Wendys share price did not reflect the
  contribution
• Lehman
• Wendys P/E of 14X vs Tim Hortonss of 24x
• Ackman-owns 10 of Wendys

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WEN

• Ackmans recommendation
• Spin off Tim Hortons
• Increase share repurchases
• Sell company owned stores to Franchisees
• Wendys management
• Refused to discuss his recommendations
• ..but they announced
• Sell 15 to 17 of Tim Hortons in a tax-free
  spinoff
• 1B in stock repurchases
• Increase dividend by 25
• Reduce debt by 100 MM
• Sell 200 real estate sites
• Close 60 poorly performing stores
• Sell hundreds of company owned restaurants
• WEN trading at 61 in March 2006..up 55

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MCDWhat Ackman saw in late 2005

• Market value (market cap) of 45 BB
• Share price-low to mid 30s since 2001 (48 in
  late 1999)-Ex. 5, 6
• Real Estate-undervalued
• 30 BB on the balance sheet
• Pershing Square believe RE to be worth closer to
  46 BB
• Trading at a discount to peers-Exhibit 7
• 3 Distinct Businesses
• Franchising Operation
• Fees 4 of sales
• RE Business
• 9 to 10 of sales-in 37 of the stores
• Company owned stores-25 of stores
• Key to understanding franchisee concerns/issues
• Did not pay franchise fees of 4
• Pro-Forma (PF) MCD has characteristics of a much
  more highly valued company-Ex. 11
• Better (R)-Returns and (M)-Margins
• Own 90 of Chipotle-Mexican Restaurant

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Ackman-MCDWhat he did

• Acquired call options on 4.9 of MCD
• Met with MCD management
• Believed he could get price increase of 15 per
  share-a 50 share increase
• translates to a potential gain for MCD of over
  1 Billion

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AckmanMCD-Proposal

• Sell shares of company owned restaurants-IPO
• Increase leverage (ie. debt), secured by RE
  holdings
• Share repurchase by MCD-using proceeds from IPO

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MCDManagement Response

• Rejected
• exercise in financial engineering.
• unique business model
• long term health
• relationship with customers, franchisees, and
  suppliers
• upset the three-legged school the company,
  its franchisees, and its suppliers

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MCDStakeholders

• Franchisees
• Concerns
• Concern about long term impact
• Unintended consequences
• Potential benefits
• Franchisees could potentially own more stores
• Less competition from company owned stores (who
  did not have to pay 4 franchise fee)
• Credit Agency
• Ratings downgrade-near junk/high-yield status

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What happened-MCD

• Ackman hosts conference for MCD shareholders-Sept
  2005
• He praises MCD management-strong operational
  executionbut indicates that MCD management could
  be doing more for shareholders
• Revises his plan in Mid-January..which MCD
  management rejects
• Truce January 2006
• Sell 1500 underperforming company owned stores to
  franchisees
• Provide better information to shareholders about
  store performance
• Ackman backs off
• MCD up 20
• IPOs-(2006)
• Chipotle -5 year record in terms of opening day
  gain
• Tim Hortons-up 42 in first day of trading

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AckmanStated Investment Strategy

• Homework
• Find a discount between price paid and actual
  value
• Public companies
• Focus on high quality businesses

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MCD
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WEN
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THI
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CMG
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Takeaways/Thoughts/Questions

• Hedge Fund-Activist Investors
• Villains or Heroes?
• Is there a long term benefit?
• The rationale behind activism?
• Reduce corporate liquidity
• Reposition of assets to unlock value
• How does company management respond?
• What is the value to the greater good?