While Ray Kroc is known to many as the man behind McDonald’s (MCD), the concept was originally developed by two brothers, Mac and Dick McDonald. While the brothers still maintained an interest in McDonald’s after striking a deal with Ray in 1955 (who franchised their restaurants around the U.S.), this arrangement eventually became burdensome and fraught with problems; the biggest concern from Mr. Kroc’s perspective was that the brothers were holding the company back from reaching its potential. As a result, Ray approached the brothers in 1961 about purchasing their interest in McDonald’s.
At the time, the McDonald’s brothers were receiving 0.5% of sales as a royalty, which wasn’t too bad of a deal; with 1960 sales equal to $37.5 million, the payout (dividend) for that year would have been equal to $187,500. However, the brothers didn’t anticipate the explosive growth that McDonald’s would achieve in the next half-century: 2011 revenues came in at $27 billion, which understates the actual company-wide sales that the McDonald brothers' royalty figure was based on (revenue from conventional franchised restaurants as reported in filings only includes rent and royalties based on a percent of sales). Using rough data from the beginning of each decade and assuming straight-line growth intra-period, we can estimate the back of the envelope fees income of roughly $1.95 billion forgone over the past 50 years:
Obviously, this figure needs to be discounted; the McDonald’s received their money 50 years ago, which is obviously preferable to an equivalent dollar amount today. Using Excel, I put together the following IRR chart, which determines the initial value (the NPV) that would need to be paid (from Ray Kroc’s perspective) to achieve the stated IRR:
As we can see here, the McDonald's interest held by the brothers was worth a substantial sum; they could easily have sought $16 million, which would have left the new owners (Ray Kroc and his partners) with a fat 20% annualized IRR through 2011. Unfortunately for the McDonald brothers, they were not privy to the data that we have to date and seriously underestimated the potential success of the franchise: They sold their stake for the meager sum of $2.7 million; the estimated IRR on that cash outlay has been an astounding 43%, compared to an annualized return from the S&P 500 of roughly 10% over that same period.
The biggest reason has been decades of unimaginable growth: From 200 locations at the start of the 1960s, the company had well over 1,000 restaurants by 1970, and opened its 10,000th and 20,000th locations in 1988 and 1996, respectively. As of 2011, the company had more than 33,000 locations across the globe, equal to a compounded annual growth rate in store count of nearly 11% over the past 50 years. Because of this, an investor could have paid $35,000,000, or 180 times the fee income received in 1961, and still have achieved an IRR of 15% through 2011.
This story has a broader lesson as well: Since the IPO in 1965, McDonald’s has encountered countless problems, many of which looked highly problematic at the time. Despite this, anybody who has purchased a stake in MCD at any point over the 57 years since the initial offering has been handsomely rewarded (those who have held it the entire time have attained 15%-plus annualized returns); that should put the importance of monthly sales data into context.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, "Patience followed by pretty aggressive conduct."
I run a concentrated portfolio, with a handful of positions accounting for the majority of my equity holdings (currently two). From the perspective of a businessman, I believe this is adequate diversification.