Yum! Brands (YUM, Financial) is in discussions with private equity groups including the U.S. private equity firm KKR to dispose a minority stake of its Chinese operations as part of its spinoff plan. The Wall Street Journal reported people familiar with the matter have said that the owner of Pizza Hut and KFC is looking to sell off 19.9% of its stake.
At the details
Yum! Brands’ China operations are valued at around $10 billion. As per reports, the company is planning to sell 19.9% of its China business to dodge a huge tax bill. Besides talking to KKR and Baring Private Equity, the company is in negotiations with several Chinese financial firms. These discussions are currently in the early stages.
Yum! Brands has close to 43,000 outlets across the globe of which more than 7,000 restaurants are in China. In the fourth quarter, the company opened 384 restaurants in China, which translates to an average of more than four outlets a day. Selling a part of the business at this juncture could be a win-win for all parties. Yum! Brands is expected to generate cash to the tune of $2 billion, while the investing private equity firm would get an established brand that could be improved through innovative menu and service upgrades. Yum! could use a part of the fund raised to finance debt and the remaining to expand its domestic business.
When asked about the matter, a Yum! spokesperson denied to comment but restated the company’s proposal to spin off its Chinese operation and get it listed. The person said, “We continue to make good progress since we announced the transaction separating Yum! and Yum! China into two powerful, independent, focused growth companies. We will provide updates on the transaction at appropriate times, and we won’t comment on rumors or speculation.”
Why Yum! has decided to spin off
Yum! was the first Western fast food operator that entered the Chinese market in 1987. It soon became a popular name among the Chinese population that saw incomes rise and the middle class expand. Yum! now derives around 45% of its bottom line from its operations in the mainland. However, an unwanted series of food safety scares massively affected its growth curve a couple of years back, and ever since the company has been struggling to revive its sales to the prescandal level.
Chinese operations, which were once considered to be Yum! Brands’ biggest growth engine in the future, became feeble after the company was accused of using chicken with inappropriate level of antibiotics. Yum! immediately severed ties with suppliers identified as supplying chicken with high antibiotic levels. Sales have picked up over the years but not the way Yum! had hoped.
Besides, change in customer preferences for healthier food options and increased competition have curbed the company’s appeal to the larger Chinese crowd. Yum! Brands’ position has also been impacted by the overall slowdown in China. The company's CEO, Greg Creed, said, “The pace of recovery in our China division is below our expectations." As a result of these headwinds, Yum! announced its plan to spin off its Chinese operation last October. The company said that post spin off it is expected to return around 15% annually to its shareholders by way of dividends and earnings growth.
It should be noted that spinning off the business does not signal Yum!’s intention of breaking ties in China. The company will mostly operate through franchisees in comparison to the current format of company-owned outlets.
Looking forward
Though sales haven’t recovered the way the company had hoped, China remains a big market for Yum! Brands. KFC’s sales have been improving in the past two years. Pizza Hut, in contrast, has witnessed soft sales in the past few quarters amid the sluggish economic condition in China. Several analysts remain skeptical about Yum! Brands’ prospects considering the changing consumer preference, rising labor cost and higher rents. In the latest quarter, Yum! Brands China division’s sales climbed 7%, led by 7% unit growth and same-store sales improvement of 2%.
Operations have become tough for Yum! Brands post the scandal, but China remains one of the most lucrative markets with tremendous growth opportunity. The company’s recovery has been steady in China, and there is substantial room for improvement.
