Analysts weigh in on benefits of Yum! Brands’ China split

A KFC store in Shenzhen, China | Wikimedia Commons

A KFC store in Shenzhen, China | Wikimedia Commons

Louisville-based Yum! Brands announced on Tuesday that it will turn its China division into a publicly traded company by the end of 2016. The move is expected to boost the company’s value by several billion dollars.

According to a statement from the company, Yum! China will become a franchisee with exclusive franchise rights to KFC, Pizza Hut and Taco Bell brands. Currently there are 6,900 KFC, Pizza Hut and Little Sheep hot pot restaurants in China. (The company has not introduced Taco Bell to the market.)

Though hedge fund manager Keith Meister is widely credited with forcing Yum’s hand on the spinoff, the fast-food company has faced pressure for change from analysts and other shareholders for nearly two years. Meister’s fund, Corvex Management, does own a 5 percent share of Yum! Brands and it gained a seat on its board last Friday.

For more than a decade, Yum! China has been Yum! Brands’ cash cow, responsible for generating nearly half of its profits. But a protracted sales downturn there tied to a questionable food supplier and the overall softening of the Chinese economy has yielded investor cries to sell the China division to reduce the American company’s market exposure. Currently, 93 percent of Yum! China’s stores are company owned.

The move also is in step with Yum’s ongoing company store ownership reduction worldwide.

“Yum! Brands will become more of a ‘pure play’ franchisor over time, and is targeting having at least 95 percent of its restaurants owned and operated by franchisees by the end of 2017,” the company said in a statement. The net result, it added, is to create “an extremely attractive business model, with stable earnings, high profit margins, low capital intensity, and strong cash flow conversion.”

Yum!_Brands_Logo.svgDarren Tristano, executive vice president of restaurant industry research firm Technomic, says Yum’s China spinoff reflects an overall difficulty in owning and operating chain restaurants abroad.

“As chains in the U.S. continue to re-franchise company stores, capex expenditures and risk continue to be reduced,” Tristano says.

Despite the incredible growth opportunities that remain in China, Tristano warns that restaurant operators eyeing the market should proceed cautiously. “Chains that feel that they can operate in the market should consider licensing and franchising before attempting to own and operate.”

Former KFC owner John Y. Brown Jr. tells IL the company’s amazing success in China since cracking the market in 1987 proves that the free enterprise system can work even in a communist country. But he acknowledges that China’s governmental control over such businesses makes operating there tricky.

“This company is operating in a marketplace that’s truly unpredictable,” says Brown, who bought Kentucky Fried Chicken from Col. Harland Sanders in 1964. He also was Kentucky’s governor from 1979 to 1983. “China still is a communist country, and you can bet that that nation’s leaders are still uncomfortable with a foreign company doing so well there. … Still, Yum has done tremendously well going into China and becoming one of that nation’s most successful retailers.”

Brown calls the spinoff “a pretty smart move” that relieves the company of the costly operational side of ownership. “It’s difficult to run a company that large in a foreign country under one umbrella. But they’ve had excellent leadership over there, too. They’ve done really well.”

While it’s clear the public offering of its China assets will elevate the U.S. company’s value by several billion dollars (estimates range from $3 billion to $7 billion), what’s not clear is whether the sale will impact performance at Yum’s 18,000 U.S. units.

Of its trio of domestic concepts, Taco Bell remains its leader, turning in an uninterrupted streak of strong positive year-over-year sales increases. KFC has exhibited modest improvement in the past year, but its sales comparisons are on negative to flat numbers in the recent past. And despite a significant menu overhaul late last year, Pizza Hut sales remain flat to negative.

So will Yum! Brands invest any of its proceeds from the China offering into improving its domestic system? Not likely, according to Jonathan Maze, senior finance editor at Nation’s Restaurant News, a trade publication covering the U.S. restaurant industry.

“No, they won’t,” Maze says. “It’s a shareholder (benefit).”

As well as a corporate benefit that will enable the company to focus on fewer moving parts in its massive system.

“This will enable (Yum! CEO) Greg Creed and his management team to worry less about China,” Maze said. “That’s going to make it a more focused organization, and you can make the argument that restaurant companies perform better when they are more focused.”

He says it also will enable shareholders to benefit directly from the upside provided by Taco Bell’s strong U.S. performance.

“Yum trades almost entirely on what China does, so the idea that Yum! Brands can be free from that burden is a good one,” he says.