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Yum's China spin-off puts new spotlight on risk
October 20, 2015 / 11:19 PM / 2 years ago

Yum's China spin-off puts new spotlight on risk

LOS ANGELES, Oct 20 (Reuters) - Yum Brands Inc’s move to spin off its China business will allow investors to choose how much risk they are willing to stomach in the fast-food company’s future.

The company said on Tuesday it would split into two independent, publicly held companies by the end of next year - one focused on its nearly 6,900 KFC and Pizza Hut restaurants in China and one devoted to its roughly 35,000 restaurants elsewhere in the world.

“It will get Yum Brands off the China roller coaster in a meaningful way and allow for better focus on enhancing the non-China business lines,” Nomura analyst Mark Kalinowski said in a client note.

Yum long has been a proxy for U.S. investment in China, and its business there still delivers more than half of the company’s overall operating profit. But the company has suffered from increasingly frequent stumbles in China, including last year’s scandal involving a minor supplier that allegedly was using meat past its expiration date.

More recently, Yum in China has been hit by slowing economic growth in the country, growing competition from local food companies and its own marketing blunders.

The company moved to spin off the jewel in its crown amid pressure from activist investor Corvex Management.

That move suggests that Yum expects its China business to get more challenging, said Arthur Dong, a professor of strategy and economics at Georgetown University’s McDonough School of Business.

“This is not an encouraging sign,” said Dong, who specializes in China. He admitted to having a “glass half empty” view on China, where fast-moving domestic restaurant competition is heating up as economic growth cools.

Yum’s KFC was a novelty when it debuted near Beijing’s Tiananmen Square in 1987 with a menu that included porridge and other local favorites. But times have changed.

A crop of well-run homegrown eateries have sprung up. They offer everything from knock-off fried chicken menus to regional fare, and are becoming daunting competitors to Yum and other foreign brands, Dong said.

“They’re the ones that are going to eat you alive,” said Dong.

Dong said franchising the China business would be one way for Yum to lower its risk. Right now, 93 percent of Yum’s China restaurants are company-owned, meaning the company does everything from paying to build restaurants to reaping all of the rewards and risks associated with the day-to-day operations.

Yum plans to reduce that ownership to 90 percent within the year and any future decisions about franchising in China will be made by the new company, spokesman Jonathan Blum said.

The post-spin Yum Brands will include the non-China operations of KFC, Pizza Hut and Taco Bell. Its struggling India division will be reabsorbed into the relevant brand segments.

Yum Brands will receive a royalty stream from Yum China, which Bernstein analyst Sara Senatore said may be slightly lower than the typical rate.

The more stable earnings stream will clear the way for the new Yum Brands to take on more debt, which would create opportunities for dividends, share buybacks or acquisitions that would benefit shareholders, Blum said.

The company currently has substantially less debt than direct rivals such as Wendy‘s, Domino’s Pizza, Dunkin’ Brands or Burger King parent Restaurant Brands International, analysts said.

Yum already has hinted that it plans to expand Taco Bell outside of its mostly U.S. base. That business had a third-quarter restaurant margin of 22.1 percent and was the only other Yum division to top Yum China’s 19.6 percent restaurant margin.

Although struggling in India, where sales at established restaurants tumbled 18 percent last quarter, it is in early days in countries such as Malaysia, Indonesia and South Korea, where young populations, wage growth and urbanization create opportunities, Morningstar analyst R.J. Hottovy said.

Reporting by Lisa Baertlein in Los Angeles; Editing by Michele Gershberg, Bernard Orr

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