To spin or not to spin? The question has led to head-scratching at companies with considerable real estate holdings, thanks to a recent decision by the Internal Revenue Service to approve tax-free spin-offs of such property through real estate investment trusts (REITs). McDonald’s Corp. had planned to take advantage of the new ruling, but negative reviews from analysts made the fast-food giant think twice. Credit Suisse First Boston analyst Janice Meyer estimates that the rent payments to a REIT, plus the loss of $1.4 billion in rental income from franchisees, would slice up to $5 per share off McDonald’s current earnings.
Such prospects have left another potential beneficiary, Wal-Mart Stores Inc., wary of the idea. “Our earnings multiple is in the 30s, so transferring $1 to a REIT gives you less shareholder value than if that dollar stayed in the operating company,” says Wal-Mart treasurer Jay Fitzsimmons.
Perhaps. But Lehman Brothers tax analyst Robert Willens sees it differently. “Anytime real estate comprises several hundred million dollars or more of a firm’s assets, a REIT spin-off is doable, and even advisable,” he says. “It’s a way to convert what would have been tax payments into dividends.”
In McDonald’s case, Willens says, the idea that cash dividends might be unpopular with investors “doesn’t move me at all.” In fact, he’s predicting the comeback of the dividend as ordinary tax rates come down relative to capital gains rates. Willens is somewhat more sympathetic to Wal-Mart’s argument, but counters that the improved returns could boost the parent company’s multiple enough to outweigh the REIT’s lower multiple.
So the jury is still out on whether the tactic will catch on. McDonald’s isn’t expected to decide before year-end, and other candidates have only begun analyses. Meanwhile, the IRS says it will continue to be vigilant about the business rationale companies cite for their REITs. And even Willens concedes that “the big hurdle will be convincing the IRS that there are other objectives to be accomplished that outweigh the tax issue.”