McDonald’s

Episode Transcript
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(00:00):
If you could be chairman andCEO of McDonald's for a year

(00:02):
Mhmm.
What would you do toturbocharge the business?
What would you do to double thevalue the intrinsic value of
that business in three tosix years or or maybe more?
If I could be the chairman andCEO of McDonald's for a year or
for, what, a couple years,
what I would wanna do isreinvest more in building
out our restaurant business.

(00:24):
And the way that I would dothat is I would look for any
brand in my space that Ithink is competitive or
could become verycompetitive with my backing.
Today, I thinkthat's Shake Shack.
And what I would do is I wouldborrow the money to buy Shake
Shack.
Let me tell you

(00:46):
why.
Welcome to the inauguraledition of the Power Law
Investing Podcast.
I'm your host,Porter Stansberry.
I'm the chairman andCEO of MarketWise, Inc,
which is one of the largestpurveyors in the world of
independent financial research.
And I'm your cohost,Whitney Tilson.

(01:07):
I ran a hedge fund for a lotof years and have been part of
Stansberry Research now for the lastsix years as an editor and
director of research.
And we're here to help you guysfind the kind of investments
that you can holdfor a lifetime.
What we have discoveredthroughout our
25-plus years as researchersand investors is that strength

(01:27):
tends to accrue to thestrongest companies,
and that most of the gainsin the market, therefore,
accrue to a very small numberof power law winning stocks.
We're here to do some deepdives and to introduce you into
some new ways of analyzing the verybest investments on the public markets.
One of the most interestingthings about the financial

(01:48):
markets is that they arenot normally distributed.
Lots of studies have been done over theyears about the median investor result,
and it's usually something like threeand a half to four percent a year.
Meanwhile, there are a handfulof investors who have made
outlandish returnson the stock market,
returns like fifteen percentannualized, 17% annualized,
twenty two percent annualized,

(02:10):
and we know someof these investors.
And the striking thing isthat the the financial markets
follow a power law wheremost of the gains accrue to a
very small number of people,
the Pareto principleis in full effect.
The results are notnormally distributed.
I've seen studies goingback 50 years or 70 years.

(02:32):
Something like two percent ofall the stocks in the public
market account for80% of all the gains.
Eighty% is low. Exactly. Andthis year is no exception.
Right?
If you look at thebig five tech stocks,
they're now responsible forsometimes it's even more than
the total return of themarket because net basis,
the other stocks havenot done as well.
Right.
So what we're trying to dowith this podcast is help you

(02:55):
understand what kinds ofbusinesses are winners in this
power law distribution.
Where should we start?
Well, let me just give alittle bit of background,
and then we can share withour audience the company we're
gonna talk about today.
Over the years, I ownedhundreds of stocks of all
different types beatendown low quality companies.

(03:16):
I also owned some of thegreatest businesses of all time.
And foolishly, I knew they wereobviously great businesses,
but I sold them much too soon.
And 25 years into my investingcareer, I'm convinced
that the surest route to longterm wealth creation is to
first identify thelong term compounders,
the greatest businesses in theworld that can grow and grow,

(03:40):
and then be patient and waitfor the opportunity to get into
them at reasonable prices,and then hold them for 10
years or more.
And that's a biggoal of this podcast.
The other thing I would echois going to open and shut very
quickly because ofthe advent of AI,
because of quanttrading systems.

(04:00):
It is very hard to get greatopportunities that last.
The the windowcloses very quickly.
When we recommendedDomino's about a year ago,
I think you had twelve tradingdays to buy under our buy
price, which was $300.
Now it's at 550.
It was 12 trading days.
So we want you to know whichcompanies that you want to own

(04:20):
for the long term and be ready tobuy them at the appropriate price.
And we've been around themarkets long enough to know
what it looks like andwhat it smells like,
and we're gonna help you findthose stocks so that you can
move more and more ofyour investable assets into the
power law winners.
And, of course, we'll help youidentify when that moment arrives too,
but it's awfully hard to doa deep dive on twenty four

(04:41):
different businesses in a week longperiod when the market's crashing.
And those stocks tend to havesome common characteristics
that you and I haveidentified over the years.
My mentor, Charlie Munger,said the way life and investing
work, you can getimpatient and frustrated.
He says it's duringthose flat periods,
maybe when you're gettingimpatient and frustrated and

(05:01):
all, that in fact, you're doingall the things to be prepared.
This is not a great time todayand with the market hitting
thirty something alltime highs this year,
there aren't a lot ofhuge bargains out there,
so it's harder to find,
attractively priced likethe ones we're looking for,
but we intend to bedoing this for a while.
Every episode, we're gonna do a deep diveinto one company that fits that category.

(05:24):
May not be a buy at today'sprice, but you've got to
develop a knowledge that you're readyto act and add them to your portfolio,
when the market makes a mistake andgives you a great chance to get in.
And as we thought about companiesthat may be able to do that,
if I had to bet on one companythat could outperform the
market over the next thirtyyears, it might be McDonald's.

(05:46):
And so we're here today to talkabout what makes McDonald's so
special as a business,
and we wanna start withhow it was created.
So we're gonna go back in timeto the two brothers, Dick and
Mac McDonald.
Dick and Mac grew upin rural New Hampshire.
They grew up in a family thatwas obnoxiously religious,

(06:08):
and they rejected all that.
So as soon as they werefinished with high school,
they drive across the countryto Southern California because
they both wanna be inthe movie business.
And you think about how hard itmust have been to drive across
the country at that time.
There's no highways.
They've probably got modelt's or something like that.
They're changing thetire every twenty miles.

(06:30):
They drive all the wayacross the country,
and they get a job workingfor this, comedian,
Ben Turpin, building hissets and moving them around.
They save up enough moneyworking for Ben Turpin to lease
a nineteen thirtysix, a movie theater.
It was their first business.
And they can't makeany money with it.
In fact, they they ran thisbusiness for three years,

(06:52):
and they never made enoughmoney to pay the monthly rent,
which is a hundred dollars.
So it was only theirlandlord's forbearance that that kept them
in the movie business.
Meanwhile, car crazy LA isbooming, and there's a new kind
of restaurant calledthe the drive in.
And the first one wascalled the Pig Stand,
and then opened innineteen thirty two,
right at the bottom ofthe Great Depression.

(07:14):
The brothers, Dick and Mac,saw the success of this,
and they thought, I bet youwe can do the same thing.
So they opened their veryfirst drive in 1937 in
Pasadena, And ironically,it didn't even
serve hamburgers.
It sold hot dogs and milkshakes.
Three years later,
they'd made enough money doingthat to buy what they thought

(07:34):
would be a better locationin San Bernardino,
which is 50 miles east of LA,
and they got a place thatwas big enough for 125 cars.
It has 25 items on themenu, including slow cooked
barbecue, beef, and pork,but the business boomed.
They did two hundred thousanddollars in annual sales during

(07:55):
the nineteen fortiesat this restaurant.
They made enough money thatthey were able to buy the
biggest house in town.
It was a twenty five roommansion set on a hill
overlooking the restaurant.
And famously, they both boughtbrand new Cadillacs every year.
Now, you and I know how difficultit is to start a business from

(08:16):
scratch, any business.
It's doubly difficult to starta restaurant because to start a
restaurant requiresboth capital and labor.
So they had a lot of capitaltied up in buying the the the
real estate andall the equipment,
and then they had tohave all these car hops.
And there are dozensand dozens of car hops.
Apparently, most of the people atthe restaurant are playing grab ass
with the car hops.

(08:37):
And so they keep havinglots of HR difficulties.
Later, when they createdtheir new version,
they only hired menbecause they the female
employees causedthem so much trouble.
Right.
And they got ridof the car hops,
which hurt them initially becauseall the customers expected Yep.
To come and beserved in their car.
But just imagine this.You've got a business.
It's doing two hundred thousanddollars a year in revenue.

(08:59):
It's earning $50,000 foryou and your brother,
which is more money thananybody else is making in the
nineteen forties.
So what do you do?
You shut the entire businessdown for three months.
You rebuild theentire restaurant,
and you come out with a new formatthat no one has ever seen before.
So the kitchen grill wentfrom three feet to six feet.
The service windows wereexpanded to accommodate the

(09:20):
customers walking up,not just the carhops,
and the menu was cut from25 items to only nine.
The hamburger was shrunk.
It went from ten patties toa pound, from eight to a pound.
So they got they went downto one tenth pound burgers,
but the price was cut in half tofifteen cents down from thirty cents.
And what I like so muchabout this is much like Henry Ford,

(09:43):
the McDonald's brothers didn'tallow their customers to decide
what they wanted because they knew thecustomers don't know what they want.
So they served everyburger the same exact way.
It came with onions, pickles,ketchup, and mustard,
with or without cheese.
This allowed them to to preparethe burgers and the cheese
burgers beforethey were ordered,

(10:04):
and was the whole revolution of whatthey called their speedy system.
It was essentially the firsttime we'd really seen modern
fast food, and it didn't work.
Sales collapsed to only afifth of the previous volume,
and it didn't rebound untilthe brothers added one new menu
item, French fries.
Right.
They swapped out potato chipsand introduced French fries.

(10:24):
When they introducedFrench fries,
the volume immediatelybegan to increase.
By the nineteen fifties,
the restaurant was doing threehundred and fifty thousand
dollars a year, andthe brothers were splitting
$100,000 in profit.
You can imagine how busy thatone unit must have been to
generate three hundred andfifty thousand dollars and
fifteen cent hamburger andten cent bags of fries,

(10:46):
probably a nickel for the soda.
What was really interestingabout their original restaurant
and something we're gonna seecontinues through McDonald's today,
This restaurant existed ona third of the capital and a
third of the labor ofthe average drive in,
and it was sellinghamburgers for half price.
So this is a business that has unusualhas unusually small profit margins,

(11:06):
but has unbelievable volumecompared to the assets.
And we put a little bitof leverage in that,
and that becomes a very highreturn on equity business,
which is what McDonald's is.
Right.
And it may not look like a goodbusiness in the same way that
Costco, for example,
a super low margin businessthat has very thin margins,
but very high assetturnover, inventory turnover,

(11:28):
is in fact a fabulous businessand can be almost impossible
for any competitors to dislodge becauseit depends on super high volume.
So if you're trying tostart up and compete,
how do you get that volume?
One of the things I think isa myth is that the McDonald's
brothers and the the successof their Speedy system was some
kind of a secret thatRay Kroc discovered.
The whole restaurant industrywas well aware of what the

(11:50):
McDonald's brothers were doing.
Their restaurant was on thecover of American Restaurant
Magazine in 1952, the year theystarted to sell franchises.
Now this is so interesting tome because just because you're
really good at restaurants does notmean you know anything about business.
And they didn't understandbusiness or franchising at all.
Their idea of selling afranchise was to take a
thousand dollars, and then togive somebody their manual.

(12:11):
The first guy theysold to was Neil Fox.
He was a restauranteurin Phoenix,
and they were shocked thathe wanted to use their name.
They're like, what the heckare you using our name for?
Our name doesn't meananything in Phoenix.
Why don't you call it Foxes?
And he, of course, was verywise and was like, no way, man.
I'm copying every singlething you guys are doing.
The store in Phoenixbecame very iconic.

(12:33):
They went to their localarchitect, Stanley Mesto,
and they said, designa modern store for us.
Us because this isthe fifties now.
We've been doing thissince the thirties.
We want a modern look.
And the guy built this midcentury classic design glass
rectangle box, and hecolored it garishly
white and red tiles, soit looked circus like.

(12:54):
And then famously, DickMcDonald drew the golden arches.
Dick expected that thearches would be structural.
They would be made of steel,
and they would help support theroof and anchor the building.
But wouldn't agree to drawthem into the building.
He hated them.
And so the McDonald's brotherstook the plans away from him,
and then went to a friendwho was a signmaker,

(13:17):
George Dexter. Georgemade neon signs.
So, the Golden Archerswere lit neon arches.
They weren't structural.
And, of course, unbelievablyimportant to the brand.
Just fascinating that so manythings in great businesses get
discovered almost by accident.

(13:38):
So, Tilson, how wouldyou like to be 54 years
old and have been workingat a startup for the last
four years that has madeessentially no money to the
point that you have never beenable to take a salary from it,
and now you have to mortgageyour house and borrow against

(13:59):
your life insurance justto meet your payroll.
And you realize about fiveyears into the process that you
don't even have aviable business model,
and you're already up toyour ears in debt both at the
corporate level andthe personal level.
This does not seem like themoment from whence great
fortune spring, but that isexactly where Ray Kroc found

(14:22):
himself in the earlymonths of nineteen sixty.
Why don't you take usback to Ray Kroc? Sure.
So Ray Kroc was a travelingsalesman selling milkshake
machines that had a niceadvantage relative to the
technology at the time.
A typical machine would makeone milkshake at a time,
and this had the circulardesign run by one motor.

(14:45):
You could put six milkshakesall around and do it at once.
And so he wastraveling the country.
And keep in mind,
he was fifty one years old atthe time when he encountered
McDonald's and met theMcDonald's brothers.
And, you know, his career,
he was sort of a travelingsalesman who would never
achieved any kindof huge success.
He had sold he had been asalesman for paper cups earlier

(15:07):
in early in his career anda number of other things.
And so he discovered that hegot an order for eight machines
from one restaurant,
and that was unheard ofbecause a typical restaurant would just
order one machine, could makesix milkshakes simultaneously,
and that was plenty for prettymuch any restaurant in America.
And so he was intrigued.

(15:28):
Who are these McDonald'sbrothers ordering eight
machines from me?
And he correctly surmisedthey must be have a heck of a
business, and he went outthere and was blown away.
And so he persuaded them toallow him to be a franchisee
and start opening upMcDonald's restaurants.
Ray Kroc did a number ofthings that were brilliant,
innovative that got McDonald'slaunched on a trajectory.

(15:51):
He was very aggressive inwanting to expand the concept.
So I think, you know,
Neil Fox just went and builtone restaurant in Phoenix.
Ray Ray Kroc wasdetermined to grow it.
He was very aggressivein doing so.
He hired some great peopleearly on who helped him
understand, for example, thatthis was a real estate business.
We'll get to that.
We're getting we're gettingahead of Let's go back to where

(16:12):
Ray Kroc is a multimixer salesman. Yeah.
Because there's a veryimportant part of the story.
I think the reason whyMcDonald's succeeded where
Dairy Queen didn't becauseremember Dairy Queen was
already out franchisingby that point.
Right?
The people behind Dairy Queenwanted to make money on their
franchisees, andRay Kroc didn't.

(16:33):
He desperately wanted thefranchisees to succeed.
The McDonald's brothersalso were very modest.
They demanded that Ray sellfranchises for no more than
nine hundred and fifty dollars,
and that the franchise feebe less than two percent.
So Ray Kroc had to buildMcDonald's Corporation by only
getting one point ninepercent as a franchise fee,

(16:56):
and half a point had to goto the McDonald's brothers.
So he had to build thisfranchise system with only one
point four percentof the revenues,
which is extraordinary.
The the franchise fee fora long time was four percent,
and it just recently wasincreased to five percent today.
So it's amazing that he wasable to get his side of the
business to work at all becauseso much of the efforts were at

(17:19):
first spent on making sure thefranchisees were successful.
I don't think that would havehappened in any other situation
except for the Multimixerbecause Kroc had the right to
distribute Multimixersacross the United States,
And his company, thefirst company he started,
he he walked out ofthe paper cup business,
and I wanna say it was 39,
and set up Prince Castle Sales,

(17:41):
which owned the rights todistribute the Multimixer.
Prince Castle was an ice creamshop in Chicago, and Ray had
been selling them paper cups becausehe convinced them to make milkshakes.
And so he got them into themilkshake business because he
was trying to sellthem paper cups.
And the guy was a mechanicalengineer and said, oh,
I can I can make a lot moremilkshakes if I have a multi mixer?
So he built the multi mixer.
He was friends with Ray who gothim into the milkshake business.

(18:05):
So Ray got the entire licensefor the country to to sell
these Multimixers,
and Prince Castle sales as abusiness continued to support
Ray while he wasbuilding McDonald's.
He didn't take a salary fromMcDonald's until nineteen sixty one.
And at one point in the late1950s, he had to mortgage his
house and sellhis life insurance

(18:27):
as, like, a 54 year old manat this point because there is no
money coming to him from theagreement he has with the
McDonald's brothers because thefranchise fees are so small.
And that, of course, opens thedoor to Harry Sonborn and his
incredible breakthrough thatthe only way to make money from
this situation is if we applieda whole lot of leverage and we

(18:50):
own the real estate.
Right.
And that was partly a wayto finance the growth of the
business because you can borrowagainst real estate etcetera
and create a lot of value.
But also very importantly,
it gave theMcDonald's corporation
an exceptional degree ofcontrol over its franchisees,
which was critical in buildinga consistent brand and

(19:11):
delivering a consistent product.
So you any customer anywherein the country to this day,
anywhere in the world knowsthat they're gonna get a
standard hamburger and fries.
It's gonna be thesame no matter where.
And so keep in mind, back inthe day when this was happening,
a typical franchise agreementwould be someone would get a
license for an entire region,the state of California,

(19:34):
the West Coast ofthe United States.
And so franchisees would have anunlimited ability to open up restaurants,
and so they these franchiseesbecame very powerful,
and they could, in many ways,
sort of talk back to corporateheadquarters and not do what
corporate wanted them to do.
Ray Kroc, by controlling thereal estate and by only giving

(19:55):
out franchisees one at a timeas opposed to these broad
licenses, was able toimplement his innovative ideas
around everything relatedto the product, the brand,
pricing, etcetera.
To this day, McDonald's has a lotof control over its franchisees,
and that's been acritical element as well.

(20:17):
There's all kinds ofreally legendary stories about Ray
Kroc and his dedication to his visionof what every McDonald's should be.
And I think a lot of peoplemisunderstand the advantages of this.
If there are no rules about whatyou can serve in your McDonald's,
then your creativity as anentrepreneur is gonna go into
maximizing that menu,

(20:37):
making your place perfectfor your little environment,
and you're gonna losethe ability of the continuity
across the system.
But if all of the systemthings are set in stone, now
your entrepreneurial creativityhas to go into things that can
improve the whole system.
And so by locking in everybodyto exactly the same system, Ray
unlocked a really big secretto this business, which is,

(21:01):
as you mentioned earlier,
the franchisees themselves thenwere the key key to improving
the system itself.
Even though Ray insisted on oncontinuity across the system,
he was very open to suggestionsfrom anybody on how to improve it.
He also famously, quote, neverforgot and never forgave.
If you crossed him, you wouldnever get another franchise

(21:24):
ever again, and your franchisewould not be renewed.
In the very beginningof McDonald's,
the first the very firstfranchisee who hit it out of
the park was a guynamed Sandy Agate.
And Sandy Agate hadthe McDonald's franchise in
Waukegan, Illinois.
He lived directlybehind his unit,
and he was there every morningat six o'clock and worked every
night until eleven o'clockand was the quintessential

(21:46):
McDonald's owner operator.
And as a result, his storedid two hundred and $50,000 in
revenue in his very first year,
and they used to hand out thefinancials from that McDonald's
location when they were sellingfranchises to everybody else.
You know, it's obviouslytheir most extraordinary unit,
and they're sort ofpassing it off as average.
But Sandy was an importantpartner for Ray for many years,

(22:07):
and then he made a mistake.
The local Pepsi distributor offeredhim the sun and the
moon and the stars to put Pepsiin his McDonald's instead of
Coke, and he took the deal.
And as a result, Sandy never evergot another McDonald's franchise.
And in 1975, McDonald's refusedto renew his license, and he
was out of the system.
Likewise, Crocs sold eighteen franchisesto his friends from his country

(22:29):
club, the RollingGreen Country Club.
And they didn't work very hardbecause they were all wealthy
and mostly retired, so theirstores didn't perform very well.
And as a result,
only five of them ever gotanother McDonald's franchise,
and only one of the eighteenwent on to any significant
success in the system,Phil and Vern Vineyard.
And they were successfulbecause they were poor,
hardworking accountants, andthey worked in their units.

(22:51):
They went on tohave 21 different franchises in
Florida.
But I love that I wasreading behind the arches,
and there was a seniorexecutive at McDonald's who got
fired for one reason or another,
and he had started sometrouble for Ray, basically.
And And when he got fired, hewas all surprised about it,
and his wife said in thepress that it's Ray's company,
and Ray never forgetsand he never forgives.

(23:12):
And I can imagine it's pretty toughworking in an environment like that.
But if you accept the groundrules, a lot can be accomplished.
And you see this in really determinedentrepreneurs quite frequently.
They have a vision of whatthe business could be,
and they're pushinginto that vision.
And they're willingto, make things better,
but only if itmatches their vision.
Right.
And they can be very harsh.

(23:34):
And the biographies writtenabout them can make them look
like Steve Jobs.
Yeah.
Bill Gates, Elon Musk,Jim Senegal at Costco,
Warren Buffett at BerkshireHathaway, Reed Hastings at
Netflix.
Mhmm.
And they're always smart enoughto surround themselves with
some exceptional people,
and they're focused like alaser on having across the
organization only a players.

(23:55):
But you better have theright person in charge.
They better be they'll bewilling to surround themselves
with a players who willchallenge them and who will and
be willing to change theirmind and listen to the ideas
percolating up from below.
But at the end of theday, it's not a democracy.
It's a dictatorship of one.
And that's how McDonald's andbasically every great business

(24:17):
I can think of was built.
I think the key isthat the founders
understand the valueproposition to the
customer better than anyoneelse because it's something
that they have an intuitive,emotional feeling for.
Think about the $1.50 hotdog and a Coke at Costco.
Jim Sinegal understands whatthat means to the customer.

(24:40):
It's not about ahot dog and a Coke.
It's about, the feeling you get whenyou can enjoy something that simple
and that pleasurable,
and it becomes part of your routineand your visit to the store.
It's part of the brand.
It's it's absolutelypart of the brand.
Yeah.
But it's it's about it's abouttriggering an that emotional
bond with the customer.
Yeah.
It's a signal to them thatwe here at Costco are about

(25:03):
the basics at a betterprice than you can find.
You will never see a lowerprice for something we're
selling anywhere else.
And when you walk in the doorand you see the little food
court there and the pricethat's the same as it's been
for thirty, forty years, that'sthat's a commitment to that.
That is.
And even if it becomes a lossleader for them, doesn't matter.

(25:24):
Doesn't matter. Youyou gotta keep that.
You think about Jeff Bezos.
He understood more than anyone everbefore, and probably even today,
that what the customer wantsis unlimited selection and
immediate delivery.
Everything shouldbe and needed to be
risked to to drive that valueproposition more completely and

(25:46):
more thoroughlythan anyone else.
And they did.
They put the entire companyat risk in 2000, 2001.
They famously borrowed $2billion or something to build
out all the warehouses to makethis happen and could have
easily gone bankrupt.
But Jeff knew someone is gonnado this, and it had better be
us because whoever gets therefirst will be the winner.
Think about Fred Smith at FedEx.

(26:06):
Overnight packaging withair freight is now possible,
and that is what we do.
Costco, you'vetalked about price,
Amazon selection and delivery.
So what is what lies at theheart of the McDonald's magic?
And I think that,
this was what Ray Kroc figuredout better than anybody is
number one, we need to beon every corner as fast

(26:27):
as we can because the best realestate in every town is only
gonna be available once.
And once it's built out, it'llbe very difficult to acquire.
The second thing is, andthis is unique, somehow,
Ray Kroc figured out,
or maybe it was the McDonald'sbrothers figured out,
that if your store wasclean enough, safe enough,
and friendly enough,
people will let theirchildren walk up to order.

(26:48):
And by doing so, children gottheir first experience of doing
something that was adult like.
And for kids, that's a magicalmoment to realize that, oh,
I can go and order at thecounter and get my food and my
drink and my French fries.
And if you go to McDonald's andyou watch kids doing that for
the first time, you seethat magic happening.
And that's one of the reasonswhy McDonald's has done things

(27:10):
like put playgrounds in therestaurants because if you get
a love for that French fryand that Coke and that burger when
you're seven years old,it won't ever leave you.
Kinda like the hot dog atCostco, there is something that
hits the emotional buttons inyour brain that make you feel
safe and happy whenyou eat that food.
And that is a link thatnobody can describe, but

(27:32):
everyone has felt if they had thoseexperiences when they were kids.
And Ray Kroc understood that.
So he made sure that thoserestaurants were always super
clean, always super safe,always super friendly,
and always welcome kids.
That is a huge partof that secret.
Right. And then youcombine always tasty food.
It's consistent andcritically, it's affordable.

(27:53):
It's great value.
Yep.
I mean, look, this discussionreminds me of how Charlie Munger once
outlined Coca Colaover a hundred years.
He started with the premisethat every human being on Earth
needs to consume certain numberof ounces of liquid a day.
And the default is,of course, water,
but you're providing something thatis necessary for humans to survive.

(28:15):
So it's one of the world'sbiggest markets that you're
entering into, serving afundamental human need,
and you could make thethe exact same arguments about
McDonald's.
When I learned more aboutRay Kroc, I was just so
fascinated that he spent timein Miami because I've lived in
Miami Beach for twenty years.
Miami is still theplace where if you

(28:37):
make a lot of moneyin the Midwest,
you go and you buya fancy second home.
And there's a lot of peoplein the Midwest who have fancy
homes in Miami Beach alwayshave from the industrialists
back at the last centuryto this very day.
Anyways, I was fascinated that hewas such a hustler that when the
land boom was going on innineteen twenty five and
nineteen twenty six, he went downto Miami to sell real estate.

(28:58):
And to make ends meet,
he played piano and a speakeasy that was on Palm Island,
and he got arrested when theyall got busted by the federales.
And I just think it'sreally fascinating,
the idea that Ray Kroc was aconvict at a point in his life.
I also thought it wasfascinating that he dropped out
of high school whenhe was a sophomore,
and he volunteered to go driveambulances in World War one,

(29:19):
which is the same thing thatHemingway did and the same
thing that Walt Disney did.
And you think about the role thatMcDonald's played in California's
ambulance troop,during World War one.
It's also just fascinating

(29:39):
modern world that Ray Krocand McDonald's helped create.
Yes. Interesting youmentioned Disney there.
In the early days of McDonald'shappened to be the early days
of Walt Disneybuilding Disneyland.
And Ray Kroc, they had met atsome conference years earlier,
and Ray Kroc wrote to WaltDisney proposing that they have
a McDonald's restaurantin Disneyland.

(29:59):
According to the McDonald'sside of the story,
Walt Disney was open to it,but wanted to charge fifteen cents,
not ten cents fora bag of fries.
And Ray Kroc wasn't willing togouge his customers and said
no, and the deal fell apart.
There's no evidencefor that story.
It was probably the dealfell apart for other reasons.
But, I suppose the reason thestory exists is because one of the

(30:22):
things that defined RayKroc was determination
to keep costs low,to keep prices low,
to deliver value to customers,and to make it up in volume,
basically, which is sortof stories you hear about,
Jim Senegal, thefounder of Costco,
that kind of maniacal focus.
Jeff Bezos. Jeff Bezosof Amazon as well.

(30:42):
You know, the those stories onlyarise about those type of people
because it's rootedin in the truth,
whether or not the apocryphalstory is true or not.
One other point, Ijust wanna make about,
raising prices and the$1.50 at Costco and all.
I remember reading in RayKroc's autobiography the
anguish that when it youknow, over, I don't know,

(31:03):
ten years or so,
they became known for theirfifteen cent hamburger,
but inflation over timehad made that impossible.
And so they needed to raiseprices, and they're like, look.
If we're gonna haveto bump our price,
let's just bump it to anice round twenty cents.
And he fought that and said, no.
I think we can make a goof it at eighteen cents.
They did bump the price upafter decades going back even

(31:24):
prior to Ray Kroc tothe McDonald's brothers,
it was always fifteen cents.
And that was hard.
It was risky. Theyhad no choice.
They delayed doing thatas long as they could,
and it eventuallyworked out beautifully.
The and it demonstrated thatthe company was delivering so
much value that they couldraise prices a little bit in
this case or twenty percent,
and the company still haspricing power to this day.

(31:47):
Enormous pricing power.
Exactly. Yeah. Becausethey deliver so much value.
For now, I wanna go back,and I want people to
understand how closeMcDonald's came to
never happening becausethe McDonald's brothers had
already failed onceto sell franchises.

(32:08):
They started in 1952.They sold 15 of them.
None of them ever reallywent anywhere because they weren't
doing anything for the franchisesexcept for giving them a manual.
Ray Kroc, on the other hand,
made his entire life about makingsure that these people succeeded,
and that happened because hewas selling them Multimixers.
So if he hadn't been thePrince Castle sales guy, he

(32:31):
would not have had abusiness model that could have allowed
him to sell franchises cheaplyenough for them to grow fast.
He wouldn't havebeen able to survive.
And that was the case,
and this was a quote ofhis in nineteen sixty one.
It was life or death for me.
If I lost out of McDonald's,I'd have no place to go.
Mortgages House had everythinga hundred percent committed to

(32:53):
making McDonald's work.
And one of the reasons whythey couldn't get any loans is
because it wasn'tmaking any money.
McDonald's didn't makeany money for a long time.
They started franchisingwith Ray Kroc in 1955.
By the beginning of 1958,McDonald's had a net worth of
only $24,000.
It had earned $26,000 the yearbefore, but most of that was in

(33:14):
one time licensing fees that werecharged to the new franchises.
The year before,in 1957, it lost
$7,000.
The beginning of 1958,McDonald's only had 34
locations and had no control over thereal estate at any of those sites.
The company was planningto add 50 stores in

(33:36):
1958, and it had a plan, eitherthrough lease or outright ownership,
to control the real estate atall of those new locations.
That amounted,lease and purchase,
to three and a half milliondollars worth of real estate
that they were planning to buyin nineteen fifty eight from a
base of $25,000 and noreal profits to speak of.

(33:57):
What are the odds thatgets done in 1958?
Three and a half milliondollars is an enormous fortune
back then, and they've gotabsolutely no collateral.
So this is this story, nineteen fiftyeight is when McDonald's really happens.
And how it happens is justunbelievable genius and also

(34:17):
some pretty significantaccounting trickery.
Harry Sonborn is McDonald'sreal estate guy, and he figures
out that Ray Kroc isn'treally in the burger business.
He's in the realestate business.
He just doesn't know it.
So what Sonborn managesto do is to convince
real estate ownersto lease McDonald's,

(34:37):
the site for the restaurants,
and then mortgage the same propertyto build the building for McDonald's.
Alright.
Keep in mind, this is McDonald'scorporation in these transactions,
not the actualrestaurant operators.
Right?
In fact, originally,
it was called Real Estate LeasingCorp or something like that.
It wasn't even calledMcDonald's at first.

(34:57):
The property owner had togive up the first lien to
McDonald's.
Let me get this straight.
You're you're gonna lease myproperty from me, and if you default,
I don't get to keep thebuilding because I also had to
give that right to the bank.
So what?
It's like a game ofsmoke and mirrors.

(35:18):
Right.
And I wouldn't call itaccounting trickery or anything.
It was it was simply demandingthat the people who owned the land,
he had to persuade them to dosomething that they probably
wouldn't normally do because youdon't lease your land to
somebody and then allow them to borrowagainst it to put a building on it,
but and then you're subordinateto the lender for the building.

(35:40):
Right?
It was risky for the landowners,
but Ray Kroc andHarry Sonneborn were,
were good salespeople,and by the way,
they were able to show aconcept that the landowners
believed in And Yeah.
Looked to be successful.
But they did all that bylying about the numbers.
Sonborn admits, when you'retrying to sell something like
that, a real estate deal,

(36:01):
you need a really goodfinancial statement,
and the DuPlane storestatement, quote,
wasn't that good.
So I understated expensesand overstated profits.
He basically admits toaccounting fraud, and the other
thing, of course,
they did was that when theyhad that Waukegan store set up,
they're like, oh, yes.
This is all of them very normal.
And, of course, itwas exceptional.
So there was some therehoodwinking going on.

(36:22):
Yes.
I can imagine that had they,defaulted on some of this,
the landowners might have hada good case in court For sure.
That you deceivedus, and therefore,
we shouldn't be subordinateor something like that.
But, of course,McDonald's was successful,
and they never defaulted.
And I guess we'll neverknow the answer to that.
This is a theme you andI have discussed often about how some

(36:45):
of the most successfulcompanies in the world at one
point or anotherduring its early days,
cash starved days or duringa time of crisis, practiced,
let's just say, very aggressive,
if not outright fraudulentaccounting in order to survive.
This is how they get started.
They get landowners to agree tothe double jeopardy situation,

(37:06):
and they're using sort of fudgenumbers to prove that the store
is gonna afford these expensiveleases and the mortgage payments.
And then they turn around,
they get franchisees to operatethe restaurants and make all
the payments for them.
The result of allthat is is over time,
McDonald's is gonna end up witha lot of very valuable real
estate as long as the as long asthe restaurants are producing.
So that they start that process.
And the reason why the localbanks went along with it was

(37:28):
because McDonald's is paying abouttwo points more than anybody else.
And by that time, theyhad a good reputation.
Everyone else isdoing these deals,
and so it becomes very normal,
the idea that McDonald's isborrowing a whole ton of money
from the bank andfrom the landowner,
and the franchisee ispaying for all of it.
Yep.
This was the early days of sortof high yield credit because
normally banks back in thosedays wouldn't lend to any sort

(37:49):
of dicey, unprofitablecompany like this.
But still, McDonald's reallyisn't generating any money.
They really need to get somereal institutional capital so
they can get better terms, sothey can continue expanding.
So in nineteen sixty, Sonbornstarts talking with some big
insurance companies,John Hancock,

(38:09):
the State Mutual LifeInsurance, and Paul Revere,
and they put together thisincredible financing package
where they're going to loanMcDonald's Corporation one and
a half million dollars,
and they're gonna get I thinkthis was a seven percent loan,
which was a lot ofinterest back then,
and they're also going toget the insurance company's gonna
get 22.5% of McDonald'sCorporation stock.

(38:32):
But think about whata risky loan this was.
The size of the loan wasfifteen times greater than
McDonald's net worth atthe end of fifty nine.
So this is really the beginningof high yield finance for
McDonald's.
They did the deal, and whenMcDonald's went public a
few years later, theymade an absolute home run.

(38:53):
That one and a halfmillion dollar loan ended up making
those insurance companiessomething like thirty million
dollars in profit.
Right? Because theygot some stock.
They got twenty two and ahalf percent of the company.
Right.
And had they held it, of course,be worth a fortune today.
But that was aninteresting thing.
A lot of the other fast foodbusinesses at the time that
were involved in the samerush to the suburbs that McDonald's

(39:15):
was, most of them ended upselling to major institutions.
Burger King sold out toPillsbury, and Burger Chef was
sold to General Foods.
Famously, Pizza Hut and TacoBell were were sold to PepsiCo.
But McDonald's, becauseof this insurance money,
was able to maintainits independence.
And I think that's anotherreason why it has become such

(39:35):
an iconic franchise because it's alwaysbeen in control of its own destiny.
It has never had tohave a corporate master.
It's amazing that even thoughMcDonald's is growing very fast
and even though ithad huge revenues,
McDonald's corporation didn't begin tomake any money for a
long time because it wasspending all of its cash flows
on interest to buymore real estate.

(39:56):
It wasn't even payingRay Kroc a salary.
And in 1960, itonly made $77,000,
which was less than thehundred thousand dollars the McDonald's
brothers were making on onerestaurant in San Bernardino.
It's fascinating how muchequity value that they were
building, but notin terms of cash.
And this is something that I've had areally hard time learning as an investor.

(40:18):
I was always so conservative.
I always wanted tosee the cash earnings.
But in our lifetimes, we havewatched people like Amazon
build enormously valuable businessesthat never had any cash earnings.
And so it it that has openedmy eyes to the idea that if you
have a really good business,
there's nothing at all wrongwithout having any cash flow as

(40:38):
long as those earnings arebeing plowed back in to
building a better andfaster growing business.
Alright. Tilson, we'renow back in 1961.
You're Ray Kroc.
You're leveraged up to your eyeballsin this McDonald's business.
You've taken your first oneand a half million dollars in
institutional money that'sallowed you to start paying

(41:00):
yourself a salary,
and you're continuing to plowall the company's profits and
earnings back intomore restaurants.
But you know you've gotta getrid of the McDonald's brothers
or you're never gonna have anychance to to do what needs to
be done to makethe business work,
like renegotiate thefranchise agreements.
Because the the brothers won'tagree to any changes whatsoever.
So if you can't get thebrothers out of the deal and

(41:22):
they maintain control over thefranchise agreements, you're stuck.
So you send them a blankcheck, and you say,
what's it gonna cost to getyou guys out of the deal?
And the brothers, in away, they're really sweet.
They're like, oh,
if we could have a milliondollars each after taxes,
that's more money than wecould ever use or need.
And they didn'thave any children,
and they as they said plainly,

(41:43):
we didn't wanna leaveour money to the church.
It was a good enoughdeal for them.
But where is Ray Kroc gonnaget $2.7 million to pay the
brothers what they want towalk away from the deal?
It's just inconceivable.
They've leveraged everythingtwo or three times already.
They've got phony accounting that'sat the root of the expansion.
And so what do theywhat do they do?

(42:04):
They go back out to theEastern Money people, and they tap into
the endowment funds ofthe Ivy League colleges
that that nobody knows that itwas the endowment of, Syracuse,
Princeton, Swarthmore,
and Colby that coughs up thetwo point seven million dollars
to buy the McDonald'sBrothers out of McDonald's.

(42:25):
The way they structuredthis deal was just extraordinary.
The high yield market didn'texist yet, and McDonald's
couldn't afford ahigh yield loan.
So how is this gonna work?
How if you're a reallyfast growing company,
how can you afford this loan?
They agreed that McDonald'swould borrow $2.7 million at
6% interest and pay off theloan with monthly payments

(42:48):
equal to 5% of the restaurantchain's total food sales.
And that was the same amountthat McDonald's is already
paying each month in royaltiesto the McDonald's brothers.
Basically, instead of payingthe McDonald's brothers,
you're gonna pay back the money youneed to get them out of the deal.
Here's the cool thing, though.
The length of time it tookMcDonald's to pay off the
entire principal and interestwould then determine the length

(43:11):
of a bonus period in whichMcDonald's would make
additional monthly payments to the lendersas an incentive for making the loan.
In this case, the high yieldpart of this loan was not the
rate, but the duration.
So as many months as it tookfor them to pay off the loan,
that many monthsthat would follow,
they'd have to continue paying.

(43:31):
It's a fascinatingidea, I think,
of of financing an acquisition.
There was one other trick to it,
which was ifMcDonald's needed to,
it could defer twenty percentof the payments during the loan
repayment period,
but then that would all have tobe paid again through a third
bonus period that would beginwhen the first loan was completed.
So in other words, ifMcDonald's got into a tight

(43:53):
spot, it could defer twentypercent of its payments.
But anything it deferred wouldthen create a third bonus
period where it'd have torepeat those payments at the
end of the loan.
Really ingeniouskind of financing.
And there's a story, of course,
that even after they thoughtthey had everything sewn up for
the note and Sonneborn had goneoff to celebrate with a trip to
Vegas, the lenders called himat the last minute and said,

(44:16):
nah, we're we'renot gonna do it.
And so he had to fly back toNew York overnight and convince
them that they were inthe real estate business,
not the hamburger business,
and that everythingwould be repaid.
Anyways, when the wholeloan was finally repaid,
the Ivy League collegesgot back $14 million.
That is a very highfinancing cost.
And it's it's just fascinatinghow much capital McDonald's was

(44:39):
willing to put into thisbusiness to make it work and
how much risk they took.
Yeah.
And it's it's also when when Ilook back at that, I was like, oh,
why didn't they just call upa venture capitalist or angel
investors orsomething like that?
It didn't exist.
It didn't exist, and it's somethingthat anyone who's grown up in today's
modern markets, you know,
I'd argue at least last twentyfive years or so since the

(45:00):
Internet boom and all.
One of the things that makesthe United States such a
vibrant and powerful economyand why our growth rate has
exceeded that of most otherwestern countries has been the
explosion since thesedays we're looking at 60,
70 years ago in, all sortsof capital debt equity hybrid

(45:21):
type of things where imaginesomeone today with an idea and
a concept like RayKroc, even crappy ideas,
something like sweet greensor something like that can get
funded through multiple rounds.
And, yeah, it's high risk,
but it's also beencollectively super high return.
And this does not exist even tothis day in most of the rest of

(45:42):
the world Or to the extentany foreign company,
often they're getting financedby the US system since there
are a lot of internationallyfocused venture capital
deal, the very interestingstructure you've laid out here
today is routine.
But back then, it wasvery innovative, unusual.
What occurs to me about this?
And I wanna go back just for asecond to accounting fraud issues.

(46:05):
What occurs to me about allthis is to create a really
fantastic business usually requiresan unbelievable amount of capital.
An amount of capitalthat is so large,
it would be virtually impossibleto get anyone to put up the money.
Think about how much moneyTesla was going to need to be
successful from two thousandand four when Elon got involved

(46:29):
with it till today.
A massive amount of capital,
and the fact that hewas able to raise it,
maybe through hook or crook,
is definitely largelyresponsible for the success
that that has then occurred.
Of course, you also had to havea mad genius at the helm who was
gonna design cars like thisthat that people would fall in
love with in thesoftware systems.
But the capital isabsolutely paramount.

(46:49):
Right. The dump. He didit again with SpaceX.
I just saw its privatevaluation Two ten billion.
Over, over two hundredbillion dollars,
and it's still losing money.
It's been losing moneyforever and ever.
It has almost gonebankrupt multiple times.
But people see the equity valuein it despite the lack of cash.
You bet. You bet.
And I'm sure there's a way forus to go back and figure out

(47:10):
exactly how muchcapital McDonald's
consumed between 1955 and'65 when it went public.
But it's the amount of capitaltoday is hard to even imagine
because the GDP isso much smaller.
It's more than just aconversion of inflation rate,
but this is an enormousamount of capital,
and it's all sort of being raisedin almost a pyramid like structure

(47:31):
where everyone's gettingpromised that, yes,
we've got earnings, and, yes,we've got title, and, yes,
we'll pay you over time.
It's all gettingpushed out and levered.
Let's talk about a couple ofthe other things that that has
made McDonald's such asuccess over the years.
One, we've talked about how creativethey were with getting capital.
Two, we've talked abouttheir unusual dedication

(47:55):
to the customer experience interms of the value proposition,
the cloniness and friendlinessof the restaurants.
But let's talk for a minuteabout the way they have
encouraged andenabled both their
franchisees and theirsuppliers to succeed.
And this is one thing thatRay's background as a salesman,

(48:16):
I think, was reallyconsequential towards.
If you're a good salesman,
you know that if you cansolve your customer's business
problem, he will buymore of your product.
Good salesman solve problems.
Red Kroc constantly washelping his franchisees solve problems.
And you look atMcDonald's history,

(48:36):
many you know, the,
the Big Mac, the wholeidea of a breakfast menu,
things like thatwere were, you know,
were dreamed up by the CEO.
They came from organic meat.
Yep.
The Egg McMuffin, the Filet OFish, and let's go to the Filet
O Fish.
So this was the Clevelandfranchisee where there was a

(48:58):
large Catholic community,
and they wouldn'teat beef on Fridays.
And so on Fridays, McDonald'sisn't doing any business.
So the guy starts buyinghalibut from Canada and serving
it on Fridays asthe filet of fish,
and it it it booms.
They have it's the best performingfranchises in the whole system.
Now, everybody wants tosell fish on Fridays,

(49:20):
and they go to Groton's, thefish company, and they say,
you gotta help us figure outhow we can distribute halibut
to all the people.
And the guys are mainlylike, well, that won't work.
Halibut doesn't youcan't freeze it.
You get, you know,blah blah blah blah.
And the other problem was theyhad to invent a new way of
getting the breading to stickon it when you were gonna
freeze it to distribute it.
But they got allthese problems solved,

(49:40):
and Gratens becomes theirmajor fish supplier.
And the investment that Gratensmakes with McDonald's in r and
d leads to a lot of success both forthe supplier and for the franchisees.
Right. Happened inpotatoes too. Right?
And and many other things.McDonald's really. Yeah.
The partnershipswith its suppliers.
The potato story iseven more consequential,

(50:01):
and it I think it goes to therole that McDonald's has played
in the entire economy.
You guys probably already knowthe story, but there was a guy,
Jack Smplot, who was a leadingIdaho potato farmer, and he
really wanted tohelp McDonald's solve
a core problem they were havingwith their french fry quality.

(50:22):
Because they're about threemonths out of the year during
the summer when russetpotatoes were not in season,
and McDonald's had to useCalifornia white potatoes,
which weren't nearly as good.
JR Simplot volunteered to spendfour hundred thousand dollars
of his own money, and he putthree hundred train load cars
of russets into cold storagearound the United States so

(50:44):
that McDonald's could be suppliedyear round with his russet potatoes.
Unfortunately, it was impossible tocontrol the storage of three hundred
carloads of potatoes indozens of different locations,
and almost all of themended up spoiling.
So Simplot took a huge hit,
but it got him thinking abouthow to make frozen French fries

(51:05):
that could have highquality and be controlled.
And by the way,
everybody at McDonald's wasagainst this because fresh
French fries was thehallmark of their business.
They knew howimportant it was to it.
But they said, if you wantto invest in this Simplot,
we'll work with you on it.
And so he investedthree and a half million
dollars building out a frozenFrench fry production line,

(51:28):
and McDonald's investedwith him in the r and d.
The patent wasactually belonged to McDonald's,
and Simplot didn't even demand aexclusive license to the patent.
He said, if I can't makethe best potatoes for you,
then you guys should haveas a separate supplier.
So he and Ray, on a handshake,built out an enormous

(51:48):
new production facility,
enormous brew productionline that by night so that by
nineteen seventy two,
every single French fry fryserved at McDonald's had been
produced and madeby Jack Simplot.
That's 600,000 poundsof French fries.
And they kept working on thesystem until everybody agreed
that the frozen french fries tastedbetter than the fresh french fries,
and then it allowed them to haveuniform distribution standards.

(52:12):
Even today, Simplot still supplieshalf of McDonald's fries and has
revenues of about sixbillion dollars a year.
Now, what's this got to dowith the American economy?
Simplot took the profits hemade selling French fries,
and he helped build a companycalled Micron Technologies,
which has been a absolutelykey innovator in solid state,
meaning microchipbased memory systems.

(52:34):
And those supplies today areabsolutely integral to the new
data centers that are being builtby NVIDIA and their other partners.
So it's prettyamazing, isn't it?
You do a better job ofmaking hamburgers and fries,
and next thing you know,
you've got venture capitalfor high-tech in your economy.
Yep. Yep.
Again, something that where successfulentrepreneurs in one area seed
entrepreneurs usuallyin the same sector.

(52:56):
It's most common in the techsector, but in this case,
in a completelydifferent sector.
There's sort of an ethos anda culture in American business
that's very powerful andnot completely unique,
but probably practicedbest here in the US.
Are there anything from thepast from the McDonald's
brothers or Ray Kroc story thatwe're missing that we need to
touch on to understand theunique franchise history and

(53:17):
the context of what makesMcDonald's special as a business?
I was looking through mynotes about the history,
and in nineteen sixty twoand nineteen sixty three,
that's when McDonald's launchedtwo of its most recognizable
logos, the golden double archesthat we talked about earlier,
but also Ronald McDonald.
And I believe it was a franchiseewho dressed some guy up.

(53:38):
Some guy, it was it was theguy who did the weather on NBC
for 30, 40 years.
Willard Scott was working as a clownfor a local television station.
And when his program gotcanceled, remember Bozo the
Clown? Right.
It was a Bozo the Clown kindaknock off that was done by
local television, and WillardScott played the the clown.

(53:58):
When they canceled the show,
McDonald's had been aprimary sponsor of the show,
and so McDonald's wentto Willard and said,
we still need a clown.
Come be a clown in our TV ads.
And that's how RonaldMcDonald was born. Yep.
Debuted in nineteen sixty threeon three separate tele local
television spots andadvertising agency,

(54:19):
a guy named Oscar Goldstein,
who created it for thefranchisees in Washington DC,
and they hired Willard Scott,
who was an employeeof Goldstein at the time.
And it wasn't justthat one character,
but now there's the whole worldof McDonaldland with Mayor
McCheese, the Hamburglar,Grimace, Birdie, the early
bird, and the Fry Kids.
Again, all this sort of innovationand brand building and creating

(54:40):
this sort of familywholesome family atmosphere.
And then while you wereasking about, you know,
other key things, I was lookingat the history here and,
McDonald'sinternational expansion.
Let's start in Boulder,
Colorado before weget to international.
In nineteen ninety eight, theboard of McDonald's was trying
to find ways ofreinvesting their capital at attractive

(55:04):
rates in therestaurant industry.
And they they funded a coupleof new restaurant concepts,
the names of which aren't importantbecause none of them really worked.
But through a friend of afriend, a college kid who has
started a littleburrito shop in Boulder,
Colorado got invitedto the boardroom of
McDonald's to makethem a burrito.

(55:26):
This guy was aclassically trained chef.
He'd been a a sous chef atthe finest restaurant in San
Francisco.
He, on a lark, has started aburrito chain, and And I think
at the time, he had I wanna sayhe had maybe six locations in
Boulder. He goes to Chicago.
He makes his burritos forthe board of McDonald's,
and they love it.
So they end upbuying his business.

(55:48):
They did so in tranchesand steps over time.
But by the time Chipotle goespublic in two thousand and six,
McDonald's ownsninety percent of it.
And it and when you werebuying McDonald's for your fun back in
o three, I'm willing tobet that you either didn't even
know about Chipotle or hadno idea what it was worth or

(56:09):
certainly had no idea of whatit was going to become worth.
I wasn't aware of it initially.
I did become aware ofit because of McDonald's
franchisee who told me whatall the incredible turnaround
that's going, on that gotme excited about the stock.
He later told me, hey.
This Chipotle thing'sreally got legs,
and McDonald's franchisees arescrambling to get the franchise
to open up Chipotle's.

(56:30):
And I wish I'd paid attention,
and I remember looking at it whenit went public in two thousand six.
It was trading at fiftytimes earnings at the time,
and I was too much of an old schoolvalue investor to understand.
Well, that's because just likeMcDonald's decades earlier,
the earnings are depressed bythe fact that it's investing
heavily in growth.
And, of course, what I missed was iseven if it really was trading at 50 times

(56:53):
earnings, it was offsuch a small base,
and this thing was a greatconcept, had room to run, etcetera.
So, you know, one of thebiggest mistakes that I made
much more frequently earlierin my career for sure is being
more focused on thecurrent valuation multiple,
whatever multiple of revenuebook or usually I was using
earnings, as opposedto thinking broadly,

(57:16):
how good a business is this andhow big could it be in What's
it gonna five or tenWhat's it gonna be weird?
Five or ten years.
Yeah.
And getting the answer to thatquestion right is ten times
more important than whatevercurrent valuation multiple
you're looking at.
Yeah.
But also very difficult to getright or even close to right.
Yes.
If you are investing in earlystage higher valued stuff that

(57:40):
I don't know only I I don't knowwhat the valuation was early on,
but I remember when I wasbuying Netflix at the bottom,
it had three billiondollar market cap.
If you invest in a basketof those, maybe only a few hit.
But those that hit where you maketen to fifty times your money Yeah.
Means nothing else matters as longas you're clever enough to hold on.
The two things aboutthe Chipotle scenario
are important in my mind,and that is number one,

(58:03):
most of the time, investorsdon't do a good enough job.
When I say investors,I mean you and me.
Most of the time,
people who really shouldunderstand what these other
businesses are worth or couldbe worth inside a company,
they just get ignored.
And that's why spin offstypically do very well because
most of the time,
investors aren't payingattention to the other
businesses that areinside a listed company,

(58:24):
and it's out it's notuntil they're spun off separately
that they really garner the valueand the attention that they deserve.
The other thing that is sointeresting to me is McDonald's
should have never sold Chipotle.
And I know why they did.
Because if you lookat any business,
there's really three ways youcan earn your return on equity.
You can earn your return onequity with profit margin.

(58:45):
You can earn your return on equityby having a high asset turn.
So in other words, havinglow assets compared to sales,
and you can earn your returnon equity with leverage.
McDonald's has always been a leveragestory and an asset turn story.
It's never had bigprofit margins.
So what McDonald's has donethrough their franchising
system is they have gotten ridof the asset base because they

(59:06):
use their franchise ease assets,
and they've applieda lot of leverage.
So the way that the McDonald'sCorporation looks on this
metric is very highprofit margins,
no asset base because they'reborrowing all the assets,
and leverage, which is anextraordinary return on equity,
which is how you get to twenty fivepercent of your return on equity.
But when you're looking atthe actual restaurant concept

(59:27):
itself, how does a McDonald'slocation make money?
McDonald's location makes moneyby having very small profit
margins and having very high turnon assets and having leverage.
That's the formula.
Chipotle has such adifferent formula.
Their formula isvery big margins.
They have great margins,
and they have tremendousvolume and very low leverage.

(59:49):
Right?
And those mindsetsdid not align.
And I've heard that thethe breaking point was that
Chipotle refused to put in adrive thru on on in its stores.
I know some of theChipotle people,
and they really see themselvesculturally as a restaurant,
not as a fast food location.

(01:00:09):
Very different culture,very different mindsets,
very different business models.
So I'm not surprised thatMcDonald's spun it out.
And Chipotle doesn'tfranchise. Right? No.
In order to make their margins,
they need to do it atthe restaurant level.
Just imagine the possibilities.
I suspect that if McDonald'sdidn't spin it out,
they would have franchised it.
Lots of things couldhave gone wrong.
It would have become the Mexicanversion of McDonald's over time,

(01:00:32):
and I don't think it wouldhave worked because there is
something very specialabout going to a Chipotle.
It's more like goingto a restaurant,
and the food isn't very goodif you take it out because the
corn tortillas and everythingelse, it doesn't age well.
You have to eat it fresh. Right?
If you look at Jack in theBox, Wendy's, other restaurant,
McDonald's competitors,
it became a thing to have yourown Mexican fast food chain.

(01:00:56):
Qdoba is one of them. And theythey they Baja Fresh. Yeah.
Baja Fresh is another.
I forget which one. Butnone of them Rich Chipotle.
And none none of them haveparticularly done well.
So I think it's likely thatif McDonald's hadn't spun it out,
they probably wouldhave broken it.
So I probably best that theydid, but I can't help but
wonder what if theyhad just left it alone.

(01:01:16):
Now keep in mind,
McDonald's shareholders got sharesin Chipotle when they spun it out,
and so McDonald's shareholders couldhave just held on to it.
So what is Chipotle's marketcapitalization right now?
Ninety one billion.And what's McDonald's?
Double that, one eighty six.
So in other words,
McDonald's could be fiftypercent bigger today if it had
held on to Chipotle.
Yes.
And the other thing keepin mind, the shareholders,

(01:01:39):
as you've correctly pointedout, that ninety one billion,
only a fraction of that wouldexist in all likelihood.
I agree. Spun it out.
Three shareholderscould've just kept both.
They they could've had both.
I'm bringing this up becauseMcDonald's continues to pay out
more than they're earningin free cash flow,
and they can afford to do sobecause they're keeping they're
growing the business,
and they're keeping leverage fixedas a percentage of the

(01:02:01):
growth of the business.
So even though it's a littlebit of a money puzzle,
it is it does make sense.
It is sustainable. Yes.
But as a shareholder,I wish they wouldn't.
I wish they would continueto seed new startups
because in my mental modelof how the market works,
and by this I mean stock market,
it is a power law distribution.

(01:02:23):
Some things like Chipotle endup garnering all of the value.
McDonald's, as people who areexperts in food and in restaurants,
they should have the ability tohave a venture capital arm that
is trying to build the nextwhatever it is, Chipotle,
the next Domino's, thenext power law winner.
I know that nine out of ten ofthem will fail, and I know that

(01:02:46):
only maybe one in a hundredwill become a power law winner.
But who better to do thatthing than McDonald's?
And you could also have them donot just restaurant startups,
but you could have themdo food equipment for you.
And and listen.
I know the dangerof this. Right?
You get the wrong youget the wrong board,
and you get the wrong CEO.
And next thing you know,
you're buying vineyards inRomania like Coca-Cola did.

(01:03:08):
Zuckerberg pissing away untold tens ofbillions of dollars on the metaverse.
Exactly.
I'm not saying that publiccompanies are great investors.
I'm just saying thatas a shareholder,
I take ten percentof those dividends
and let you try to figure out what thenext big thing in food is gonna be.
Mhmm.
And you should probably have a teamof really woke hipster dudes in,

(01:03:31):
London and New York and SanFrancisco who are keeping their
nose to the ground and sniffingout the next classically
trained chef whocooks a burrito.
And if we don't want McDonald'sto buy restaurant chains,
which hasn't worked out, theythey bought, Donatello's.
It didn't go anywhere.They bought Pret a Manger.
It didn't go anywhere.
And we recognized there'sa danger in them running

(01:03:51):
something like Chipotle becausethey might not understand that
secret core emotion that's linkingthe business to the customer.
What could they do instead of returningthe capital to to shareholders?
I'm not sure I'm not sure Iagree with you that I want
McDonald's doing a lot of this.
I mean, maybe a littlebit of it at the margin,
seeding some new ideas.

(01:04:11):
They generate almost tenbillion dollars a year in
operating cash flow.
That's because it's rent.
Right.
How much of thatIt's literally rent.
I get ten billion a year.
That would I allocate to their sortof internal How about a hundred gunk?
How about a hundredmillion? Hundred million.
That's the number thatpopped into my mind. Yeah.
One percent of youroperating cash flow.
And a hundred million dollars isstill it's a lot of money.

(01:04:33):
You might spin out andvalidate it externally
by if they need capital to grow,
don't just write an open checklike Google has spent untold
amounts of money on Waymo,developed some cool technology,
but I sense there's been noexternal market discipline on
the amount of money they'vespent because the Google just
generates so much cash alphabetnow that they that Waymo has

(01:04:57):
gone through a lot more cashthan it otherwise would have.
So I think you'd need tostructure the incentives right
and make sure that it doesn'tturn into a lot more money.
But, look, McDonald's,I still think,
has it's clearly nowa cash cow business,
but it's still got room to grow.
It's a big world out there.
We talked about howthrough the franchisee,

(01:05:19):
they discoveredthe filet of fish.
McDonald's in the earlynineteen eighties noticed,
like everybody else did,
that people are moving away from beefand eating more and more chicken.
And so they're they're tryingto figure out how to put
chicken on their menu.
They can't do fried chickenbetter than Kentucky Fried
Chicken's doing it, so theydon't wanna do go that way.
Instead, Ray Kroc hires afive star continental chef

(01:05:41):
from the fanciestrestaurant in Chicago.
And Fred Turner, who's theformer was Renee Arend Yep.
Native of Luxembourg. Yep.
Yep. Rene Arend. AndFred Turner is irate.
Fred's the chairman, and heis a former burger flipper.
And I think he's got a chipon his shoulder about the fact
that McDonald's doesn't need no fancyFrench chef in here kinda thing.

(01:06:03):
And originally, RayKroc has tasked him with
trying to figure out how tobring chicken into the menu,
and his firstattempts are failures.
And then Ray gets the ideawe're gonna sell onion
McNuggets.
You know, the fancy continentalchef fries the onions,
but there's no way todo the quality control.
Some of them come out terrible,some of them come out good.

(01:06:24):
It's not gonna work.
So on a lark, Fred Turner says, whydon't you try that with chicken?
And so the chef goes back,cuts chicken into squares,
and they all love them.
But now they don'tknow how to scale.
And it was a big issue because there wasno machine that could debone chicken.
And so they get withtheir suppliers,
and one of their meat supplierscomes up with an idea of using

(01:06:47):
a hamburger like metal toolto cut the chunks of chicken,
and then their their chickensupplier builds a whole new
assembly line to debonechicken by hand at scale,
and they come up withthe Chicken McNuggets.
The result was just phenomenal.
Within three years of thenational introduction, the bite
sized nuggets just toput the dates on this.

(01:07:08):
Yep.
They were launched in selectmarkets in nineteen eighty one,
then rolled out morebroadly in eighty three,
but they encountered all sortsof supply issues that took a
few years to resolve becausethey were so popular.
This is nineteen eighty five.
The king of the hamburger businessis selling McNuggets at scale,
and they account for seven and a halfpercent of McDonald's domestic sales.
That's seven hundred milliondollars in nugget sales in

(01:07:30):
nineteen eighty five,
thus making McDonald's thisworld's second largest chicken
retailer in the world behindKentucky Fried Chicken.
That, I just think that justspeaks so wonderfully to the unique
power of what McDonald's is.
Kentucky fried chicken,that's a chicken business.
Domino's pizza, that'sa pizza business.
McDonald's, that's a hamburger and afrench fry and a milkshake business.

(01:07:54):
No.
It's not. No. It's not.
It's a food that makes you feelgood and that makes your kids
feel good restaurant.
That's what it is.
And nobody can tell you a part ofthe chicken a nugget comes from,
although McDonald's did overtime introduce all white
chicken meat nuggets,but nobody cares.
Nobody also can tell you what partof the pig the McRib comes from.

(01:08:15):
But nobody cares because ittastes good, and it's cheap,
and it makes you feel good.
Should we talk a little bitabout international and what
they've done there?
It was only a couple yearsafter they started expanding
internationally thatthey launched breakfast,
which now accounts for aquarter of McDonald's sales.
Breakfast is a big issue,so we'll come back to that.
What I wanted to say isinvestors are missing something

(01:08:38):
really important aboutMcDonald's right now like they
missed Chipotle backin the early 2000,
and that is McDonald's doesnot own McDonald's China.
Horrifically and stupidly,
McDonald's divested McDonald'sChina, and they brought in a US
private equity firm and abig Chinese investment bank,

(01:08:59):
Citic, to own eightypercent of it.
And, of course, that's the fastestgrowing chain in the world in terms of
McDonald's. Right?
This is what you're talkingabout in two thousand seventeen
when they sold off controlof their restaurants in mainland
China, Hong Kong, andMacau for $2.1 billion,
part of a broader strategyto own fewer restaurants,
leaving it to franchisees withknowledge of local markets to

(01:09:19):
run their own locations.
I know McDonald's doesn'tnecessarily wanna be in the
restaurant business.
It wants to be in the But, bythe way, in twenty twenty three,
they bought back Carlisle's steakto own forty eight percent of it.
So now they own 48% of it.
Oh, got it.
But you won't findthat anywhere on their books
because they own itthrough the equity method,
and so it's not integrated.
So you're buying McDonald'sfor, what do we say,

(01:09:39):
a hundred and eighty billion,a hundred and ninety billion,
but they've got a twentybillion dollar business that
they own half of that's nowhereto be found on their books.
By the way, we do see theprofits at the bottom line,
but we're not seeingthe top line revenue.
Is that there the businessesare not consolidated with
McDonald's Corporation. Okay.
Because the franchise fees arepart of McDonald's Corporation.

(01:10:01):
Got it.
But the all of thoserestaurants and the earnings of
those restaurants are notconsolidated with McDonald's.
Okay. They're not.
They're owned bythe equity method,
which means McDonald's can showthe dividends they get from
those restaurants, but notthose restaurants' earnings.
Anyway, the point is that thisis one of the little magical,
wonderful things about these kindsof power law winning companies.

(01:10:23):
They're all sort of like thelittle Russian nesting dolls.
The deeper you diginto these companies,
the more good stuff you find.
Whereas, if you lookat most businesses,
when you start opening upthe kimono, it's, oh, gosh.
Oh, boy. Oh, no.
But these parallel winners,
I bet you that Google hasmillions of different closets
full of all kinds ofinteresting IP and tech stuff

(01:10:46):
and all kinds of differentassets they could spin off or
or monetize if they were in apinch, and so does McDonald's.
And so when you buythese kinds of companies,
these power lawwinning companies,
there's usually layer uponlayer upon layer of value that
as you begin to dig anduncover, you discover.
And for me, in this process,
the last couple ofweeks of research,

(01:11:07):
discovering that McDonald'sChina was not integrated into
their accountingwas news for me.
I think there's a lotof hidden value there.
Yeah.
So backing up, why don't we just give alittle bit of history to our listeners?
McDonald's first internationalunit was in nineteen sixty seven,
so just a couple years afterthey went public in British
Columbia.
Then in nineteen seventy,
first one outside North Americawas well, San Jose, Costa Rica.

(01:11:30):
Well, isn't Canada a state?
That's an inside joke. Mywife is Canadian. And Okay.
So if we count Canada asthe fifty first state,
we're gonna get some nastygraphs for that, I'm sure.
The first outside ofNorth America was one in
Costa Rica in nineteen seventy,
and then they really startedrolling things out in seventy one.
Wouldn't you love to know,maybe somebody out there does,

(01:11:53):
Who was the franchise ownerin Costa Rica in 1970?
I bet you that guy wasa groovy guy. Yeah.
1971, your first McDonald'sin Europe, in the Netherlands,
first in Asia, in Ginzaneighborhood of Tokyo,
first in the Southern Hemispherein Australia, in Sydney.
They were off to the racesinternationally, and there's, again,

(01:12:14):
what should investors belooking for here is companies
that have a product orservice that can, you know,
you prove out the concept andgrow it in the United States,
but then it cangrow for decades.
You know, getting back to the wholepoint of this podcast, of course,
is is finding the kinds ofbusinesses you can tuck away
and own long term compounders.

(01:12:34):
Generally, there's gotta bean international angle there.
So, obviously, all the big techcompanies are good examples.
I remember owning Netflix.
Right?
They hadn't really startedinternational back in two
thousand twelve when I wasloading up on the stock at its
lows, and internationalwas one of the big drivers.
I would say the second wouldbe developing original content,

(01:12:54):
and the third would beraising having pricing power over time
were the things that turnedNetflix into a ninety bagger.
But international wasa a big piece of that.
Coca Cola going back ahundred and something years.
But, again, it's it's easyto look back and say, oh,
it's obvious that Netflixwould be a hit elsewhere.
McDonald's wouldbe a hit elsewhere.
Everyone

(01:13:14):
but, you know, I could cite all sortsof examples of companies that fell
on their faces internationally.
Walmart, as greata company as it is,
has had a very mixedrecord internationally.
I I think the most interestinginteresting thing about
McDonald's internationally isMcDonald's was so successful
internationally that itessentially represents America
to most people inforeign countries.

(01:13:35):
Sure.
When they opened up for theirfirst restaurant in Moscow,
it was viewed as asymbolic detente.
And it brought amessage to peace. Yes.
And thirty thousand Russians on thefirst day went into that restaurant.
I have eaten in that restaurant.
I have spent a grand total of 15hours in Russia my entire life.
I had a long layover in in Moscowreturning home from Italy one year,

(01:13:59):
and the cheapest way to gethome was to fly Aeroflot from
Italy to Moscow with sixAM to eight PM layover or
something like that, and then anonstop It's true value at us, sir.
He's it is true.
By the way, he's a guy who knows the priceof everything but the value of nothing.
He's taking his own life inhis hands by flying Aeroflot.
Yes.
Well, interestingly, Idigress slightly here,

(01:14:20):
but I will pay up to fly nonstopto because it's quicker and all.
But if I do have to do alayover or if it's if there's
an opportunity to do a layover,
I deliberately schedule a longone so that I can go in and see
a new country or a new cityor something like that.
Power law analysisand travel tips Yes.
From your friends here, WhitneyTillson and Porter Stansberry.

(01:14:44):
I'm not sure what more thereis to say about McDonald's
international story other thanit's just been wildly successful.
And I I anotheraspect, by the way,
I should I do wanna mentionis another area of growth.
So they started togrow internationally.
Mhmm.
We can talk about breakfastin a little bit. Yeah.
But also another big step waswhen they they opened their
first restaurant in New YorkCity in nineteen seventy two.

(01:15:04):
So we can see this period from nineteenseventy to seventy two, let's say.
It was a period ofextraordinary innovation where
McDonald's was you know,
had grown the business now formany years just in suburbia.
Lather, rinse,repeat. Boom. Boom.
Just in the United States,just with its regular menu,
certainly wasn't open forbreakfast and in all these areas.

(01:15:26):
So incredible innovation here.
It's a good point becauseI think you could have fairly
said at any pointalong the way, oh,
the big period ofgrowth is now behind us.
But McDonald's managementcurrently says they plan to
continue to expand theirfootprint by four to five
percent a year, which is twothousand new stores a year,

(01:15:46):
so plan to reach fifty thousandlocations by twenty twenty seven.
And they say that means thiswill be the largest period of
growth in McDonald's history.
Yes.
Not on a percentagebasis, but, yes.
But that's pretty incredible.
I also wanna talk about how the theirbusiness model has really evolved.
This might be a little too muchaccounting for most listeners, but, again,

(01:16:08):
there's sort of three ways youcan make money in business.
And one is with justsimple profit margin.
The other one is with inventoryturns. Right. Asset turns.
Yep.
And then the third iswith with borrowing money,
replacing your capital withborrowed capital, with leverage.
Up until about ten years ago,
McDonald's owned about twentyfive percent of their stores.

(01:16:28):
The corporation owned the stores,and they franchise the rest.
Starting in 2014, theybegan to divest the stores.
That has had the impact ofreducing growth and revenue
because as they sell a store,
they lose that revenue outside ofthe franchise fees that it pays.

(01:16:48):
So now, they're down to only owningabout five percent of the stores.
So if you go back and lookover the last ten years,
the revenues look flattish,but look at the margins.
If you look at theoperating margins,
they've increased dramatically.
You know, going backto nineteen ninety,
let's call it let's useoperating margin, EBITA margin,

(01:17:09):
was in the 25%,very healthy range,
then we can talk more aboutsort of what happened from 1999
to the bottom in early othree when I had a great opportunity
and didn't miss it toload up on the stock,
and the stock went downby seventy five percent.
Margins went from operatingmargin went from twenty five
percent to eighteenpercent at the low.
And since then, it'sjust been since then,

(01:17:29):
it went up back up to, callit, thirty from, you know,
2010 to '15 or so.
And now it's in the forties.
Right?
And then they started takingtheir refranchising a lot of
their company owned units, andthat had the effect of reducing
the percentage of revenues thatcame from relatively low margin

(01:17:49):
business of operating arestaurant into the almost
perfect highest marginbusiness in the world of simply
collecting royalties fromboth owning real estate,
and franchise feeson top of that.
And so trailing twelve monthsoperating margin is forty six percent.
Incredible. Now,just as astonishing.
So Iowa after tax margins arethirty three percent and among

(01:18:12):
the highest of any businessof scale in the world.
Yes. Exactly.
So I would argue thatMcDonald's is in the most elite
group of businesses.
It has the highestquality brand recognition.
It has the highestquality operating margins.
It has the highest qualitycorporate credit rating.
Also, unlike many of the otherbusinesses in this group, it is

(01:18:35):
in one of themost stable industries and businesses
of all time that is veryhard to imagine a day
where people around the worldwill not wanna go out and get a
quick burger, fry, and a Coke.
No matter how much AI happens,
no matter how much changes areinto health care, transportation,

(01:18:55):
it's hard to imagine that mygrandkids and their grandkids
won't wanna get a burger,a fry, and a Coke.
Now will that beMcDonald's that's doing it?
Of course, that's harder.
You you've got it to have allkinds of good management decisions.
But when you're when youhave all the locations,
when you have theworld's leading brand,
it's not hard to imaginethat in a hundred years,

(01:19:17):
there will be a100,000 McDonald's, not 50,000,
and it and that their marginswill still be at 46% or 48%,
and that people will still beeating burgers and enjoying
Cokes and fries.
Yep.
I think I can tell youthat when I was raising my three
daughters, now 28, 25, and 22,
so rewind the clock 20 years.

(01:19:38):
The single favorite thing Icould do is take them to Disney
World, but that was maybeonce every year or two.
But what I could do on aregular basis was take them to
McDonald's.
Mhmm. And I have so manyspecial memories from it.
And it's funny because oneof my daughters is a vegetarian.
None of they'reall healthy eaters.
None of them would ever setfoot in McDonald's today,
but back in the day Waittill they have kids.

(01:19:59):
Well, here's the thing.
It is a hundred percent certainthat I will be doing the same
with my grandchildren.
Yeah.
I would argue it's 99%certain that the next
generation and 20 years later,
there aren't very many businesseswhere you can say that.
And, of course, if you're looking atstocks to hold for decades, of course,
the business has to exist.

(01:20:20):
I'll tell you something that Ithink is an another sign of of
just what a powerlaw winner it is.
It's it's really hard totake so much capital out of
a business withoutlosing control of it.
McDonald's borrows thecapital of their franchisees.
It borrows a lot of moneyto finance its operations.

(01:20:41):
It is an incredibly capitalefficient business even though
it's the largest brand inthe restaurant business.
And what an amazingbusiness this is.
Ninety six percent of Americans haveeaten at a McDonald's over their lifetime?
Over their lifetime.Yeah. Right.
Because I would say it's ninetypercent over the past year maybe.
Sure.
Virtually everyone in thecountry lives with that three

(01:21:03):
minute drive of a McDonald's.
So they've got incredibledistribution. How about this?
McDonald's is so powerful thatthe Coke that is served at
McDonald's is thelargest distribution of
Coke syrup in the world.
Coke's dominance over Pepsi andfountain distribution is incredible.
They do 50% more fountaindistribution than Pepsi does.

(01:21:26):
But if McDonald'sswitched to Pepsi,
Coke's dominancewould disappear.
So in other words, McDonald'sis so large that the syrup they
distribute in their restaurantsends up creating the entire
advantage that Cokehas over Pepsi Mhmm.
In terms of fountain sales,
not in terms of all theother kinds of distribution.
Right. But it'samazing. How about this?

(01:21:47):
One out of 15 Americanshas worked at a McDonald's.
I suspect that means it'salso the most common first job
that Americans have.
Yeah. Certainly for any onecompany, I have to imagine.
For any one company.
Now let's talk about what justan incredible business this is.
It collects $10billion a year in rent,
and it is currently ableto pay out 125% percent

(01:22:08):
of its free cash flow withoutweakening its balance sheet
because it's increasing itsleverage to maintain a steady
multiple of EBITDA to debt.
So there's a fixed leverageratio that allows it to to pay
out more than the cashit's actually earning.
Right?
Its current total debt to EBITDAratio is three point three now,

(01:22:28):
which is somewhere in the middleof large American corporations.
It's modest. It'smodest and appropriate.
They're not in the restaurantoperations business.
They're in In the realestate and branding business.
Hard to think of more stablecash flows than a fixed
percentage of sales ofbetter part of 40,000
McDonald's, all over the world.

(01:22:49):
You've got internationaldiversification.
You could safely put quite abit of debt on this business,
and that's actually one of thethings my friend Bill Ackman
was recommending.
This would have been almosttwenty years ago when he was
pushing McDonald's,
and McDonald's listenedto him and looked at
their balance sheet and said,
we're now a more maturecash flowing company.
We don't need to be financed asif we're a riskier growth company.

(01:23:13):
And so they've taken on alot more debt over the years.
In recent years, they just take ona little bit more debt each year.
In other words, they pay back,
just for the numbers ofthe trailing twelve months,
nine and a half billiondollars of operating cash flow,
two and a half billionof capital expenditures.
So that leaves 47 billion offree cash of which they pay out

(01:23:34):
$8 billion to shareholders,
about $4.5 billionin share repurchases,
$3.5 billion in what is a2.6% dividend yield today.
So they generate seven.They pay out eight.
So debt went up by a billion dollarsover the over the previous year.
But keep in mind, the businesshas grown. EBITDA is higher.
So the ratio, that's whatyou were talking about,
actually is the the leverageratio stayed out steady.

(01:23:56):
Yeah. That wasn't always true.
They have increaseddebt ten odd years ago.
For many years, debt was prettysteady around $10 billion,
and then they decided we cansafely carry quite a bit more
debt, and theystarted ramping it up.
It looks like in around2014, '15, They went from $10
billion up to $30 billion.

(01:24:16):
And then in 2019,they took it up to $46
billion repurchasinga lot of stock,
and it's stayed in that area.
Here's the thingthat's incredible.
If you ask me for one metricto measure the quality of the
business, it wouldn't beprofit margins or asset turns.
It would be return on equity,
which is a function of profit margintimes asset turn times leverage.

(01:24:38):
I looked at McDonald'sreturn on equity,
and it said for thelast bunch of years,
it says n m, not meaningful.
There is no return.
How can there be no returnon equity for McDonald's?
But there's a return oncapital employed. Right?
But in other words, back whenthey did a huge share repurchase,
when they took their debtup from $10 billion to $25
billion, that share repurchase,

(01:24:58):
when you return cash toshareholders via share
repurchase, itreduces your equity.
And in fact, McDonald's equityturned negative and has stayed
negative, which McDonald'sas recently as 2013
had $16 billion of equity.
And six years later,

(01:25:21):
minus $4 billion inshare repurchases.
Exactly. Equity very simplyis assets minus liabilities.
So when there's four pointeight billion of negative
equity today, that meansMcDonald's liabilities,
things they owe to other peopleis more than their cash and
inventory and land, property,everything, all the assets.
And that's almost unheard ofbecause it almost no company

(01:25:44):
does that because it's superrisky when your liabilities
exceed your assets.
But in McDonald's case,
it has one of those incredibly uniquebusinesses where they can do it.
Coke's the same way.
Yeah. That's really sortof an accounting mirage.
The one of the big thingsthat's missing on its balance
sheet is goodwill for its brand.
Right?
So the goodwill on McDonald'sbalance sheet is only $3 billion .
Right. What's hisbrand worth? Right.

(01:26:05):
Untold.
The reason why it collects $10billion in rent is not just
because it owns lots.
It's because those lotshave golden arches on them.
So let's ascribe the brandvalue to half of the rent value.
Right. Alright?
Now what's the multiple onon on 5 billion, at rent?
Let's say it's ten times.
That means it's a$50 billion brand,
and that's completely missingfrom the balance sheet.

(01:26:25):
Yes.
But for comparison, Ipulled up Coke right now,
and Coke has twenty eightbillion of equity right now.
So I thought they were in thesame position where they bought
back so much stock thatthey had negative equity.
I've got I guessI've got it wrong.
Yeah. I'm looking here.
I'm pulling up the spreadsheet,
But here's one of the reasonswhy I think McDonald's can do
it in Coke camp,
which is McDonald's runsa beautiful negative cash

(01:26:48):
conversion cycle in thatMcDonald's buys from its
suppliers all the meat andpotatoes and all of that.
They sell it ina matter of days,
then they instantlycollect the cash.
Most people are paying viacredit card, let's say.
And so the they're collectingthat cash within a matter of days,
but then they don't have topay their suppliers for whatever it

(01:27:09):
is, sixty or ninety days.
Mhmm.
So that creates a permanent,almost like float, where their
suppliers arefinancing the business.
That is verydifferent from Coke,
which it takes Coke quite abit of time to run everything
through the, the wholesystem of creating the syrup,
selling it out into the channel.
They're selling it to large corporationslike McDonald's or to supermarkets,

(01:27:33):
and those suppliers might not payCoke for thirty to ninety days.
Right?
So I think the answer,if we compare those two,
we would see it's thedifference in their the cash
conversion cycle, andMcDonald's has a beautiful one.
The other issue, though,
I think that's hidden fromMcDonald's balance sheet is I
suspect there are,gross exaggerations
of their appreciationof their buildings,

(01:27:55):
and I know that all their realestate has to be held on their
books at the acquisition cost.
I have a feeling that lots theybought in the suburbs in the
nineteen fifties and nineteensixties have appreciated somewhat.
Yes.
So I think there's somehidden assets there,
so I'd say that hasan impact as well.
Alright. Let's go to strategy.
Is McDonald's such a greatbusiness that you believe like

(01:28:18):
I do that it's apower law winner?
It is the kind of high qualitybusiness where if I were to get
back into running a fund again,which I did for eighteen years,
And but this is consistent with theadvice that I give to my subscribers.
Now at Stansberry Research islook for high quality businesses

(01:28:39):
concentrated portfolio with anaverage holding period of as
long as possible.
I'm increasinglyconvinced that in in,
that in a market that is pickedover by so many investors,
and I'm focusing onthe US stock market,
primarily, I'mtalking about here,
but also the rise of artificialintelligence and really even
prior to that, the quant funds,

(01:28:59):
the supercomputers thatare finding any kind of
inefficiencies in the market.
Because I remember 25 yearsago when I first started,
you could buy spin offs.
That was such easy money.
And there were all sorts sortsof market inefficiencies that I
was seeing back then.
I don't think it'ssurprising that my
first ten years from nineteenninety nine through the global
financial crisis were mybest performing years,
and then my worst performancewas in the last seven years.

(01:29:19):
So the question is,
and my worst performancewas in the last seven years.
So the question is,
how can you win in inincreasingly competitive game,
capital efficient,
high quality businesses thatstill have an incredibly long
growth runway, etcetera.
So McDonald's clearlyfalls into that category.
The challenge for all of usand for you and me and every
investor is every other person,

(01:29:41):
every other investoron the world,
in addition toevery supercomputer,
can see that McDonald'sis a great business.
Today, it's valued at ninetimes revenue, 15 times EBITDA,
22 times trailing earnings,21 times this year's
earnings estimates.
I would actually arguewhen you have the S&P 500,
depending on whether you'relooking at trailing or this year's

(01:30:05):
So the S&P 500 todayis it's hit thirty
all time highs this year.
It's run up a bunch.
McDonald's is tradingat a market multiple.
So if you ask me,
do I think McDonald's stockpurchased at today's value
valuation, today's price,versus just buying the S&P 500,
I think McDonald's stockis over, let's say,
five years at least,certainly over ten years.

(01:30:27):
I think I would say it's eightyto 90% likely to do better than
the S&P 500.
I happen to own some of theS and P five hundred in my
retirement accounts inaddition to some stocks.
So you might ask, well,
why do you own the S&P 500 if youthink McDonald's gonna outperform?
And, obviously, the S&P500 is more diversified.
You're not takingsingle company risk.
Where I really get excited andwhat I'm looking for and what

(01:30:49):
I'm trying to deliver to mysubscribers is if you can get
into one of these stocks andthe long term compounders and
build a ten stock portfolio ofstocks acquired when they're
beaten up and out of favor,
and you can buy them at halfof what they're worth or less.
And then from that point,hold for ten or twenty years.

(01:31:09):
Exactly.
That's what you really needto look for because buying a
portfolio, let's just justoffer we've talked about
McDonald's, we'vetalked about Coke,
we've talked aboutBerkshire Hathaway,
we've talked about Costco.
You mentioned Amazon.
I might throw Googleinto that mix as well.
You buy those six stocks toHershey Hershey. Alright.
Let's add that. We caneach add our favorites.
So now you've got seven stocksto a ten stock portfolio.

(01:31:31):
I'm willing to betthose seven stocks
would mirror what the oddsI just gave you on McDonald's,
which is eighty to ninetypercent likely to outperform
the S&P 500 over thenext five to ten years,
but not by a large margin.
Let me caveat that. Not at all.
I think the S&P from today'sprice might compound at, call
it, 5% or 6%.

(01:31:51):
So I think that basket ofstocks, including dividends,
might do eightpercent, nine percent,
which is Seventyfive or six percent.
Yep. Yeah.
But that's only a couple two,three percentage points maybe.
I'd say three percentagepoints outperformance.
So that's, you know, month in,month out, we're churning out
good ideas like that that we tryand share with our subscribers.

(01:32:13):
But where you really getexcited is McDonald's in early
2003, Meta Platforms, I eFacebook, less than two years ago.
Twenty twenty two. Yeah. Okay.
That was a year and a half agoMhmm. And it's gone up 5x. Yep.
And we should talk about thatbecause I absolutely nailed
that and gave it tomy free subscribers,
not even my paying subscribers.
It was it was such a layup.

(01:32:34):
Netflix back in 2013, which isa higher risk, higher reward
kind of thing, but aninety bagger off the lows.
And I went on nationaltelevision and gave that idea
away to all themillions of viewers on
CNBC and at my investing conference,the very day it bottomed.
Right?
So that's what youwanna look for,
but those are harder to find.

(01:32:55):
Sure.
And I don't remember itwasn't you weren't with me,
but you did exactly thesame thing that I did,
which was on or about Marchtwenty third or twenty fourth
in twenty twenty Sure.
When the tires stockmarket was down 30%.
Yeah. I think at the Ithey were down 35% at six weeks.
I recorded mine, I think, aday or two before the bottom.

(01:33:17):
You happen to record yoursthe day of the bottom. Right.
I think you were on the Friday,and I was on the Monday.
But we were soclose to the bottom.
It doesn't it doesn'tmake any difference. Yes.
And those are the moments.
Yes.
And I don't believe we're anywherenear that right now with McDonald's.
And here's aninteresting question.
Would you rather own Metafor the next 25 years or
McDonald's assuming you could buy bothof them for the same relative price.

(01:33:41):
By the way, they happen to be tradingat roughly the same price if you
back out Meta'scash and so forth.
I mean, it might be acouple P/E turns higher,
but they are similar price.
The answer is clearlyMcDonald's in my mind.
It doesn't have quite thesame growth prospects.
It's a more mature business.
I believe Meta today,
its economic characteristicsare just inherently better as a

(01:34:04):
tech businesswhere the customers
a question two years ago,
when Meta had declinedby seventy five percent,
and I was justpounding the table.
Mhmm. That's the nice thingabout a stock like Meta.
It's gonna be amore volatile stock,

(01:34:24):
which is gonna giveyou more opportunities.
The shareholders of techcompanies and the underlying
businesses both tendto be more volatile.
It bounced around.
And so you can find NVIDIA a fewyears ago went down a ton as well.
In two thousand twenty two,
all the big seven techstocks went down a ton.
And I was pounding the tableon every single one of them,
but I specifically called outMeta as my favorite because the

(01:34:48):
others were down, I don'tknow, thirty to fifty percent,
and Meta was downseventy five percent.
I think that Meta has more I'll probablyregret saying this in the future,
but I think that Meta'sbusiness is fundamentally more
stable than something thatis a business to business.
I feel the same way about Apple.
Apple has so much of mycontent. I've got my music.
I've got my movies.

(01:35:09):
I've got all the textmessages I've ever sent.
They're all locked inApple's walled garden.
And so, therefore,
Apple has a much greaterlikelihood of having me as a
customer in another twentyyears than does Microsoft,
just to name one.
And Facebook is thesame way. Right?
I've got ten or fifteen yearsof my life on Facebook and
pictures of my familyand all these things.
So it's hard for me to imaginethat they would do something

(01:35:32):
foolish enough to lose the trustand appreciation of their customers.
Whereas something like NVIDIA,
I'm not saying NVIDIAis gonna go away.
I'm just saying that they haveto continue to produce at the
razor's edge of innovationto maintain their leadership.
Yes.
And their valuation is soextreme today that it that
there's a lot of roomfor for it to fall.

(01:35:52):
Even if the company does well,
it's gotta perform spectacularlywell to justify that valuation.
So you could end up with a stockthat's just flat for a while.
And I think that there arepower law winners that you and
I are able to analyzeand understand,
and then there's gonna be powerlaw winners that, frankly,
I'm definitely just notable to fully appreciate.

(01:36:13):
I cannot understand even nowwhat the hold that Nvidia
has over its customers is.
I can regurgitateit to you. Right?
But I do not understand it theway that I understand why I use
Meta, why I use McDonald's,why I use Apple.
And I think you if youdon't have a real appreciation for
what it is that binds the customerto the company in question,

(01:36:36):
it's much harder for you toinvest with real conviction.
There's a simple obvious answer,
which is they're providingthe chips for AI in
a massive land grab, andthey have the best chips and
greatest supplier, whatever.
The tricky part about NVIDIA,which is why I can't own it,
isn't just the valuation,
but there are millioncompetitors and the actual

(01:36:58):
purchasers, the theGoogles of the world,
the Amazons of the world,
are trying to developtheir own chips in house.
Those are pretty innovative,
deep pocketed companies thatdon't like paying a king of
transom to Nvidia every year.
So it's very hard for youto Game out. I'm with you.
Think about how many King'sransoms do end up being paid
for so long.
The entire tech infrastructurehas hated paying Qualcomm's

(01:37:20):
ransom sincenineteen ninety six.
Yeah. And they tried everythingin their power to stop it.
They tried legislation.
They tried controllingthe different, tech standards.
They tried defrauding Qualcomm,stealing the technology,
and yet Apple this year willstill spend billions paying
Qualcomm royaltiesfor its technology.

(01:37:40):
I'm not saying you'rewrong about NVIDIA at all.
I I don't know either, andthat's why, for me, I would
much rather say if I have tobuy a stock for the next ten
years and I'm not allowedto sell no matter what,
I'm comfortable making thatkind of a bet with McDonald's.
I'm not comfortable making thatkind of bet with NVIDIA. Yeah.
And I will admit that it's it's notunlikely that caution costs me money.

(01:38:03):
I'm really okay with that.
What I want as an investoris an acceptable return.
It's impossible to try topretend that I can make the
maximum return every timeI make an investment.
Right?
So it's interesting, Porter.
We're just talking about youmentioned the latest greatest
opportunity, the bottomof the COVID panic,
and I actually just pulled up.
We you were doing your poundthe table the previous Friday.

(01:38:27):
This was me on Monday,
and I actually gave tenstock recommendations.
And I broke them thoughinto two categories,
conservative and risky.
And so my five conservativestocks were Berkshire, Amazon,
Google, GeneralDynamics, and Altria.
My five risky stocks were werethe beaten down stuff that had
really gotten clobberedby by COVID, TripAdvisor,

(01:38:49):
Spirit Airlines, Capri,
Penn National Gaming, agambling company, and Howard
Hughes, a real estate company.
It was a group of stocks thatin a market that had fallen 35%
in six weeks, the blue chipswere down, you know, 30-odd%,
but the risky ones weredown eighty percent.
And here's what's interesting.
In the whole basket did well,but if you bifurcate it into

(01:39:12):
the conservative stocks ina period of time, the S&P,
since that day,
through this very momentthat we're recording here,
S&P is up 121%.
The conservativestocks are up a 126%.
Same as the S&P.
Exactly. A little bit. Andthat doesn't count dividends.
So it's actually a couple We'llcall it a couple percentage
points a year better thanthe S&P, which is nice.
That's great.
Yeah.

(01:39:32):
The aggressive stocks have onlygone up 29% in a hundred and
plus one twenty one.
But here's the thing,
if you measure it to the peak beforethey've come down, for example,
let's just give a simpleexample like a TripAdvisor.
We recommend it $19. Today,it's at $17, down 8%. Right?
It's dragged down the returnof the aggressive portfolio.
But it actually went from 19to 61 during the, pandemic

(01:39:55):
recovery that was thecore of our thesis.
In fact, if you take tothe peak of the five aggressive
stocks, which to as of todayare only up an average of 29%,
at their peak, theywere up an average of
358%. Yeah.
Because, for example,
Penn National Gaming wentup 9x before You know what?
I way back.
The moral of that story is thethings that are not power law

(01:40:19):
winners, you have to followa trailing stop with.
And the things thatare power law winners,
you have to not followa trailing stop with.
Yes.
And then you have to have thewisdom to know the difference.
Yes.
The idea that you're gonna sellMcDonald's because it has a bad
quarter and falls 25% Yes.
Nonsensical. Right.
The idea that you're gonna hold PennNational forever is nonsensical.

(01:40:41):
It does not have afundamental advantage.
It's a very competitivespace. Right.
And so let me give an exampleof the three monster winners I
mentioned earlier.
Meta up five x in thepast two and a half years.
Netflix at the bottom inOctober two thousand twelve up
ninety x in thenext eight years.
And McDonald's from nineteensixty five when it went public

(01:41:02):
to 1999, thirty four years.
McDonald's was one of the greatestgrowth stocks of all time.
It was one of the most widelyheld stocks in America,
peaked at forty eight dollars,
and in the next two and ahalf years or so, three years Clap.
It went to 12. Mhmm.
And I would I know becauseI was buying it that day at
twelve fifty a share.
And since then, it's up almost exactlytwenty x from thirteen to two sixty,

(01:41:24):
roughly speaking.
Here's what's interesting.
From their recent peaks,
how much did each of thosethree stocks decline?
McDonald's a yearearlier. That thing.
So McDonald's, I just told you,
went from forty eightto twelve, 75% decline.
How much had Meta gone down inthe previous year or so from
its recent peak to itsbottom in November k.
Twenty two? Of twenty two. Iwould guess 75%. 75%. Yeah.

(01:41:46):
How much had Netflix gone downwhen it bottomed in October?
Probably 75%.
75%. Yeah. Now here's the thing.
Those three stockswere we would both say,
those are your longterm compounders.
And they're gonnahave huge drawdowns.
We we would not haveused a stop loss,
and we would have hadto endure seventy five percent drawdowns.
And that's okay because we'regonna own ten of those stocks.

(01:42:07):
And if it were easy, anybodywould do it. Exactly. Exactly.
By the way, when you have apower law winner, you don't sell.
You do the opposite. Yes.
You buy every time it goesdown, there's ten points. Yes.
But here's the key.
You have to know what you're doingbecause You gotta know the difference.
There are so many stocks wherethey're down twenty percent.
You better have a stoploss in and get out.

(01:42:29):
Like, Penn Gaming, the biggestwinner from my March of
twenty twenty portfoliowent from fourteen Yeah.
To a 136. It was up 837%.
And where is it today?Back down to 19.
I wanna say one morething about all this.
The purpose of these podcastsis for us to do deep dives and
learn ourselves and share whatwe've learned with our audiences.

(01:42:52):
The other thing is to try to beready to buy these businesses
when the opportunity approaches.
And here's what's sofascinating about that.
That's not hard forme to do, Tilson.
I don't mind buyingstocks after big blowouts.
The the the market doesn'tscare me because I think I know
what the businesses are worth.
But what I do end up doing istrying to buy the one that's

(01:43:13):
fallen the most,
instead of simply justrecognizing that buying the
great business when you have theopportunity to is the way to go.
Let's say we wakeup tomorrow morning,
the stock market'sfalling fifty percent.
Who knows?
Russia rattles a saber,
and people think we're gonnahave nuclear war next week.
Stock market crashes.
You and I decide we're not gonnahave nuclear war next week.
We go to work.

(01:43:34):
And what we will do, Ibet, is we will look for
the marginal quality businessthat's now trading for nothing.
Because we are exactly rightthat over the next nine weeks,
the return in that stock willbe larger than the return in
McDonald's.
But what we forget is we willnot have the opportunity to buy

(01:43:56):
McDonald's at nine timesearnings in ninety days.
That opportunity will go.
And it's very hard to havethe discipline to actually buy the
highest quality compounderinstead of the thing that is
dirt, silly, cheap.
Right?
And look, I think the lesson,
of what happened with thoseten stocks I recommended,
the five conservative,five aggressive,

(01:44:17):
then March of 2020 is thatit was I'm glad I gave my
subscribers twotypes of stocks and a
reasonably diverse, you know,five of each, not just one.
But if you're gonna buythe more aggressive stuff,
you have to understand thatthis is more of a trade.
This is more just predicting thatthe world isn't gonna come to an end.

(01:44:39):
So you get a bigger pop,but you gotta sell those.
If you just wanna focus on therest of your life and whatever,
then just stickto the blue chips,
the long term compounders.
So if I were to start managingmoney again, I would look to
buy a ten stock portfolio thatI would make one trade a year.
I would swap out one stock.
My general bias would beto swap out one of the

(01:45:00):
underperforming onesbecause the again,
one of the keys is tolet your winners run.
The long term compoundingdoesn't work if you sell
something just after it doubles.
Then then you're never gonna geta five or a ten or a fifty bagger.
But here's the thing,in today's environment,
if somebody gave me xmillions of dollars and said,

(01:45:20):
I want you to manage this fund.I believe in you, Whitney.
If I were to get back into thatbusiness, I think off the bat,
I might only havetwo or three stocks,
and I'd have to bepatient and Right.
Yeah. Wait. And itmight take a few years.
It might take a market pullbackor a sector pullback or
something to happen toone of those, you know.
But I've got at least a hundred companiesin my head that fit that criteria.

(01:45:40):
You love to own,
but you're waiting for a pricewhere the compound returns will
be very attractive.
I'd like to wind up with onemore question for you. K.
Which is if you could bechairman and CEO of McDonald's
for a year Mhmm.
What would you do toturbocharge the business?
What would you do to double thevalue the intrinsic value of

(01:46:00):
that business in three tosix years or or maybe more?
Any ideas?
Not really.
Which is sort of why Idon't own the stock today.
And we it's an it's beenan open recommendation in
Stansberry's investment advisorydating back to
December of two thousand twelve.
Anyone who followed our adviceand has held it with dividends

(01:46:21):
has earned two hundredand 52% returns.
And I'm very comfortablecontinuing to hold it because
it's one of theselong term compounders,
and I don't think there's any caseof extreme overvaluation here.
You can buy one of the world's greatestbusinesses at a market multiple.
So I think you'll do a littlebit better in the S&P from here.
But if the stock isn'tobviously cheap or there aren't

(01:46:41):
some obvious things that they couldbe doing differently to unlock value,
then it's hard to get excitedabout buying more of it here
because I don't have an answerto that until I see an answer.
So let me contrastthis, by the way,
with when I was thinkingabout selling it.
I bought the stock from sixteendown to twelve in early two
thousand three, and thenthe stock had rallied.
It was up about thirtythree dollars a share,

(01:47:03):
and now it's it's tripled.
It's three years later.
A triple in three years ispretty good annualized result.
That's right.
And and being young and stupid atthe time, I was thinking, okay.
Don't wanna be greedy,which, of course,
is the exact opposite viewpoint you should have.
I now understand.
You must be greedy if you finda great company and you buy it

(01:47:24):
at an attractive price.
You need to make five, ten,
twenty times your moneyon stocks like that.
Doesn't appear so cheap anymore.
I bought it from sixteen down to twelvethinking it was worth twenty five.
Few years later,things had gone well,
so I had moved my estimateof intrinsic value up to,
let's just say, forty dollarsand stock was at thirty three.
Facts. Doesn't seemthat cheap. Yep.

(01:47:44):
No time to move on. I cansurely find something cheaper.
Nice.
And then Bill Ackman came along,
And he had so much convictionin this idea, in fact,
that he raised a specialpurpose vehicle for it and
raised a lot of,
money and came out witha big slide presentation.
It was a seventy nine slide presentationthat What was the date of that?

(01:48:05):
November I don't have ithere exactly what day,
but November two thousand five.
Five. K.
And he This is right in the middleof the Super Size Me controversy.
Well, yeah.
That had I mean,
one of the reasons the stockhad gotten cheap was this
foolishness that Americans wereall of a sudden gonna start
eating healthier and Weren'tgonna eat the bad food at
McDonald's. That'snot gonna happen.
That had beengoing on for years,

(01:48:25):
and that's part of the reasonthe stock had gotten down to
$12 a share.
But I was just looking backin my notes when I was buying
McDonald's intotwo thousand three,
one of the best buysof my early career.
One of the reasons McDonald'sgot into a bunch of trouble is
they had been usingaggressive accounting.
And if the underlying businessdoesn't really take off that
aggressive accounting, they comeback and bite you in the butt.

(01:48:48):
And that's one of thereasons McDonald's stock went down by
by seventy five percent whenit finally caught up with them.
But I had so much conviction inMcDonald's back in early 2003,
and I had done an interviewwith the McDonald's franchisee
that I thought was particularlyinsightful where he pounded the
table and told me what wasgoing on inside the company.
And keep in mind, he was afranchisee, not a corporate.
He wasn't passing me insideinformation because he didn't

(01:49:10):
even work for the company,
but he gave me his experienceas a franchisee and said the
new CEO, Jim Cantalupo, isfixing all the dumb things
prior management was doing andall that had caused the stock
to go down by 75%.
And I thought itwas so interesting.
Like the and and the like,buying the pizza shop and
Right.
At a manger.
Well well, the worst thing they'vedone is started a price war with Burger

(01:49:31):
King, and they were discounting theirpremium, you know, their Big Mac.
McDonald's has always had,you know, a little part of the
menu, the dollarmenu and so forth,
where they're targeting
family friendly place where youcould come and get good tasty
food, and it it never marketeditself as this is the place

(01:49:55):
with the cheapestfood you can find.
And though, in fact, itdid offer great value.
And so they had doneeverything wrong.
And they had failed to innovateand create new products,
etcetera, etcetera.
And the franchiseehad laid all this out,
what all the mistakes were,
and then told me how the newCEO who had just come in a few
months earlier was fixing itall and returning McDonald's to

(01:50:16):
its roots as a great company.
And I had so much convictionin one of the very few times,
and I can I could count onone hand the number of times in my
life that I haveactually written to Warren Buffett
telling him about a stock?
And this was one of them.
And he sure should havebought it at the time,
but he did actually I think theonly time or one of only two
times where he actuallywrote back to me,

(01:50:37):
and he had actually written hissecretary had printed it out
because he doesn't have email.
And he had written and andhad circled the comment I made
about the hidden value ofMcDonald's real estate.
And he simply pointed out thatthe McDonald's, yes, it it
owned valuable real estate,
but it wasn't gonna help muchif McDonald's mismanaged the
business and couldn't make ago of it with the McDonald's on

(01:50:57):
that piece of real estate.
It isn't like McDonald's couldthen turn around and sell it
for some high value forsome other use if McDonald's
couldn't make a go of it,which was a fair point,
but an irrelevant point, really.
That wasn't a majorpart of my thesis.
The of course, the major part of thethesis was an insanely great business
that had not gone south.
It was encounteringshort term problems,

(01:51:19):
mostly of its own creation,
and that a new CEO isalready in and fixing those problems.
And, therefore,
it two years later afterthis fabulous investment,
two and a half yearslater in late o five,
Bill came along and laidout in a seventy nine slide

(01:51:41):
presentation the thingsMcDonald's could do to unlock
all sorts of value.
And the key pillars of itwere he wanted to split the company
into two pieces, which the companydidn't end up doing, but he's like,
what people are missing hereis people are valuing this company
as if it is a restaurantoperating business,
a relatively capitalintensive low margin business.
It's blank.

(01:52:01):
Really is is the greatestbusiness in the world, which is
or just gets a royaltyon other the franchisees'
hard work and lowmargins and so forth,
relatively low margins.
And so McDonald's ended up itdid take his advice in terms of
the way it reported its numberssuch that investors could see
the two differentpieces of the business.

(01:52:23):
And therefore, over time,
its multiple importantthing that Bill pointed out.
And secondly, he said,
you don't need to own30% of your restaurants.
You can own five percent
percent of them.
And they took that adviceto us for refranchising.
Took about ten yearsfor them to Right.
Refranchising.
Implemented the Ackman planfrom 2005 to roughly 2015.
Mhmm.
And then they implemented thefinancial engineering piece of

(01:52:46):
it that we discussed earlierof buying back a ton of stocks,
taking a return on equityto infinity by taking equity
actually in thenegative territory,
and recognizing that the companycould safely carry more debt.
So they took on debtto implement this,
and that really tookthe stock up, you know,
another leg from hundred totwo hundred and fifty dollars a
share, which iswhere it is today.

(01:53:07):
So you asked me a question.What could McDonald's do today?
What would my seventy nineslide Ackman plan be for what
the company coulddo to unlock value?
And I don't seeany major levers.
I don't think management eitherin terms of the way it is
operating and growing thebusiness or in terms of what
they could do with their balancesheet and on the financial side.
I think they've, over thepast twenty plus years,

(01:53:30):
picked a lot of thatlow hanging fruit,
executed superbly.
And so now I think what you'relooking at is a business that
still has decentgrowth prospects,
should be able to growwith population plus opening new
restaurants, so call that five,six percent top line growth.
As they grow, should be ableto expand margins a little bit.
So now you're intohigh single digits.

(01:53:51):
They're buying backstock $4.5 billion.
So that's about two percentof shares outstanding,
little over two percent, andthey're paying a 2.6% dividend.
I think little over two percent,
and they're payinga 2.6% dividend.
I think in the next five years,
if they justcontinue to execute,
you've got a stock thatcompounds in a 5% S&P500.
This is a stock that's gonnacompound at seven to ten

(01:54:11):
percent with dividends,
and that's verysatisfactory if I owned it.
But in terms of if I werebuilding a new portfolio from
scratch, I'm waiting forsomething that shocks the stock
and gives me I'm not gonna waitfor down seventy five percent,
but down ten to fifteen percenttrading in a range for two and
a half years isn't the kind ofthing that gets me excited to

(01:54:33):
put new capital to work.
I'm buying it all day long atfifteen times trailing earnings
for when that day arrives.
Yes. It's a twentytwo times now.
So that would be assumingearnings don't change,
that's down thirtypercent from here.
And you you know, I haveseen if you're patient,
you get those opportunities.
I've I've seen Hersheyat that price before,
and I think you'll youwill get that opportunity.

(01:54:54):
If I could be the chairman andCEO of McDonald's for a year or
for, what, a couple years,
what I would wanna do isreinvest more in building
out our restaurant business.
And the way that I would dothat is I would look for any
brand in my space that Ithink is competitive or

(01:55:14):
could become verycompetitive with my backing.
Today, I thinkthat's Shake Shack,
and what I would do is I wouldborrow the money to buy Shake
Shack, so I'm making my businessa little bit more levered.
And then what I would do is Iwould give every single person
who's a McDonald's franchiseethe right to build a Shake
Shack as well.
So if you own one franchise,you can have one Shake Shack.

(01:55:35):
If you own 21franchises if you want,
you can build 21 ShakeShacks and partner with our
franchisees to build out aversion of our restaurant that
is essentially the samething, but much higher margin.
At McDonald's, restaurantoperations are fairly low margin.
I estimate the operatingmargin at most franchises is
between ten and twelve percent.
I think that with a Shake Shack,

(01:55:56):
you could probably getthat to 18% to 24%,
and that would be greatfor the franchisees.
They would get superexcited about that,
and the trade off is instead ofa five percent franchise fee,
I'm gonna get a sevenand a half percent fee,
and you've gotta pay me agood amount of money for the
franchise upfront.
And that, if you did that,you would light a fire under

(01:56:17):
the market's beliefin McDonald's as a
growth system.
We're not just gonna haveone burger franchise.
We're gonna have burgerfranchises at the entry level
price and at the premium price.
And maybe someday down the road,
why can't we builda Chipotle Killer?
We know that business.
Why can't we have ourfranchisees help us to build a
Chipotle killer?

(01:56:37):
Yeah.
And I just pulledup Shake Shack,
three point five billiondollar market cap,
three point eight billiondollar enterprise value.
Buy it with a sneeze. Right.
McDonald's has a$236 billion Yeah.
Market cap.
We could borrow the money tobuy that restaurant by next
Tuesday.
Right.
Assuming you pay apremium to get it,
call it $3.8 billion enterprisevalue, call it five billion, round it.

(01:56:59):
That's 2.5% of McDonald's, and they'vealready got $48 billion of debt.
They could borrowfive billion more,
but maybe they buy it for some stockas partly a stock or cash deal.
No stock. Yeah. Youdon't wanna dilute.
So we can borrow it easily,
and we can borrowit at a fair rate,
and our franchisees aregonna pay us the money back.
Yeah.
And it's and it wouldbe like, right now,

(01:57:21):
it's trading at twenty timesEBITDA, trailing EBITDA.
McDonald's at fifteen times,
but it's only trading atthree point six times revenue.
McDonald's trading atnine times revenue,
so you'd have to assumepart of a larger system.
What you'd have to do thoughis you'd have to make sure that
the what has made Shake Shackwork, that secret sauce,
which is gonna bedifferent than McDonald's.

(01:57:42):
So McDonald's isvalue, speed Right.
Cleanliness, familyfriendly. Yep.
That's what makesMcDonald's tick.
There's something about ShakeShack that makes it tick.
I don't know the businessmodel to tell you what it is.
But whatever that is, you gottacontinue to invest in that.
You cannot let ShakeShack become McDonald's.

(01:58:02):
It's gotta stay Shake Shack.
Right.
I would much rather McDonald'stake five billion dollars and
do that for the next ten years.
Build out Shake Shacknationally, internationally.
Home run. Right.
Now it's And then it alsoproves that McDonald's is a
growth system, not justa restaurant franchise.
We know it's already workedin 18 different countries.

(01:58:23):
That's proof of concept.
And you know that McDonald'shas global distribution,
global marketing,global legal, global HR?
Sourcing, supply. Okay. So howmuch do you say it's worth?
Today, it's three pointeight billion. Right.
Take the buy Buy buy. Buy.Buy. It's It'd be five million.
Buy it. And it's five hundredit's five hundred restaurants?
Okay. Well, we can take that.
We can go from five hundredrestaurants at Shake Shack
today to 5,000 restaurantsin the next seven years.

(01:58:46):
And that is worth a lot of moneyeven with McDonald's scope.
Anyways, if anyone out there is listeningand has connections at McDonald's,
I would love to have aconversation with McDonald's
chairman and CEOabout that idea.
I'd also love to talk to himabout the number of countries
where there arenot yet franchises
available, like atTanzania, for example.
There's a wholebusiness to be had, and,

(01:59:08):
being franchisees of McDonald'swhere they don't yet operate,
and I'm interested indoing that business myself.
Please ring us ifyou are listening,
mister chairman of McDonald's.
Okay, Tilson. It'stime to wrap up.
Do you have any anyparting thoughts for the listeners?
The most important thing inan environment like where markets
are near all time highs isis the surest way to get poor

(01:59:31):
quickly is to tryand get rich quickly.
And the reason we're talkingabout McDonald's is long term
wealth creation,
which involves patience and recognizingwhat kind of market you're in.
We're in a richly valuedmarket, and so don't rush out
the risk curve.
Stick to index funds, blue chipstocks, but with modest expectations.

(01:59:52):
Keep steadying companieslike McDonald's and,
but just be patient.
And don't worry about the lackof exciting things to do today
because that canchange tomorrow.
My parting shot is howbadly most Americans
need to understand therole that high quality
common stocks play in protecting

(02:00:15):
your savings.
We live in a veryinflation prone world.
We also live in a world wherethe government is making
everybody promises aboutsupporting them during their
retirement that they willnever be able to keep.
So it is more important thanever that you safely and
steadily learn how to compoundthe value of your savings

(02:00:36):
through common stocks.
The whole point of this podcastis for you and I to do these
really good deep dives tounderstand the whole business,
and especially to understandwhat the secret sauce is that
binds the customer to thatbrand, and then, therefore,
hopefully, to have some clarityabout its staying power.

(02:00:57):
So that when there is anotherbottom, which there will be
in our lifetimes,another March of '22,
another March of2009, another Black
Monday 1987, when you dohave these, about every
decade, an opportunity to buyjust about anything you want.
What I am hopeful that we willbe able to do, both in our own

(02:01:21):
portfolios and with oursubscribers listening is be ready.
Know what you're gonna buy.
Know why you're gonna buy it,
and then don't getshaken out of the trade.
Yeah. We'll look forward todoing this again next month.
I look forward to it. Thankyou very much, Tillson.
Thanks to the crew fortheir patience today.
We look forward to talkingwith you next month. Bye bye.

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