Yum! – Not So Appetizing

CIC consortium out of bid race over concerns with unit’s slowing growth in recent years

Yum! Brands Inc. (NYSE: YUM), owner of the Pizza Hut, KFC, and Taco Bell fast-food chains, and the largest fast-food chain in China, has suffered a major setback in its plans to spin off its China business into a separate unit. The Company has lost a potential ally in a consortium backed by sovereign fund China Investment Corp. (CIC), which has exited from the bidding process for Yum’s offer of a 20% stake in its Chinese business.

Source: Company's Website
Source: Company’s Website

The consortium, which includes KKR & Co. (NYSE: KKR) and Baring Private Equity Asia, had valued Yum at about $8 billion, which is roughly 20% lesser than Yum’s asking price. That apart, the consortium was seeking a controlling stake in Yum’s China business, which Yum would not agree because of concerns over negative tax implications on the sale proceeds. More worrying for Yum is the fact that the CIC consortium decided to withdraw its bid after finding that Yum’s profit margins were under pressure in a highly competitive market, as per Reuters.

Yum looking to sell 20% stake in its China unit

Yum was looking to sell just 20% of its China unit, which includes 7,200 stores, and more of the unit’s shares through an IPO later this year in Hong Kong or New York. The entire China unit is valued between $8 billion-$11 billion, based on its core earnings of about $1 billion. Hence, CIC’s valuation of about $8 billion for its China unit did not seem to go down well with Yum.

Better focus on Asian markets

Back in October 2015, Yum had agreed to hive off its China business from its U.S. operations after giving in to pressure from activist-investor Keith Meister, founder of Corvex Management. Mr. Meister is also a member of Yum’s board of directors. Corvex was of the view that by separating the Chinese unit, Yum could be able to better focus on the Asian markets.

Yum’s board had decided that the sales proceeds from the China unit could be used to fund a dividend and share buyback program. More importantly, the divestment was core to Yum’s plan of gradually reducing exposure in a business with shrinking market share and move from owning restaurants towards pure franchising.

According to Greg Creed, Yum’s Chief Executive Officer, the company plans to have at least 95% of its restaurants world-wide owned and operated by franchisees by the end of 2017.

What ails Yum’s Chinese operations?

Yum’s 30-year-old China business, is its cash cow, and accounted for about 53% of the Company’s revenue in 2015, according to Bloomberg. However, in recent years, Yum has been facing a myriad of headwinds with its Chinese operations as a result of food-safety scares, cutthroat industry environment, and supply chain control. Despite remaining the market leader in China, Yum has witnessed a steady decline in market shares in the country to 24% in 2015 from 39% in 2010, as per Euromonitor International and as reported by Bloomberg. In a bid to regain its supremacy, Yum plans to add 600 outlets this year, based on the Company’s input.

Source: Bloomberg
Source: Bloomberg

McDonald’s snapping at the heels

Yum, which is still the largest fast-food chain in China, has been steadily ceding market shares to arch rival McDonald’s Corp. (NYSE: MCD). McDonald’s has announced on March 31st, 2016, that it is seeking franchise partners in mainland China, Hong Kong and South Korea. McDonald’s is also expanding its operations, and is looking to add more than 1,500 restaurants in those markets over the next five years. The Company currently operates 2,800 outlets, most of which are company-owned.

Despite the tight competition, KFC is the major revenue generator for Yum, accounting for three-quarters of the Company’s operating profit in China for 2015. That being said, KFC’s share of the Chinese fast-food market declined to 3.6% in 2015 from 5.2% in 2010, as per Euromonitor and as reported by Bloomberg.

Despite a dim picture, there are some positives for Yum, as China same-store sales rose 6% in Q1 FY16 led by a 12% growth at KFC, which was largely driven by bucket meals sales during the Chinese New Year holidays.

Other bidders in the race

With the exit of the CIC consortium, the two bidders for Yum’s 20% stake in its China unit are Singapore state fund, Temasek Holdings Pte, and Chinese investment firm, Primavera Capital Ltd. Hopu Investment Management Co., a Beijing-based private equity firm, led by dealmaker Fang Fenglei, is also eyeing a potential investment in Yum China, as per Reuters.

Yum! Brand Value…

In a fresh development on Friday, May 20th, 2016, Yum announced a $4.2 billion share buyback program and declared a quarterly dividend of $0.46 per share. This is part of the Company’s plans to give back $6.2 billion of capital to shareholders before its China unit separation.

With CIC exiting from the list of potential bidders, it remains to be seen whether Yum indeed garners a fair valuation for its major brands.

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