Yum! Brands Inc. announced Tuesday plans to spin off its China business as an independent franchisee of the company by the end of next year, just as pressure from investors had been building following two years of significantly challenged sales in the fast-growing country.
The deal would separate the Chinese restaurant operations, where Yum runs restaurants and builds them at an extraordinary rate, from a company that otherwise franchises elsewhere in the world. The deal is expected to be complete by the end of next year.
“Over the past year, our management and board have thoroughly evaluated a range of value-creating opportunities that capitalize on our considerable strengths,” Greg Creed, CEO of Yum Brands, said in a statement. “Following the separation, each standalone company will be able to intensify focus on its distinct commercial priorities, allocate its own resources to meet the needs of its business, and pursue distinct capital structures and capital allocation strategies. This will provide a clear investment thesis and visibility to attract long-term investor base suited to each business.”
Creed will continue to lead Yum Brands after the separation. Micky Pant will continue to lead Yum China as CEO.
Pant was given that title in August following the retirement of Sam Su. And last week, Yum appointed the activist investor Keith Meister to its board of directors. Both moves appear to have been a preview of the separation. Meister, managing partner at Corvex Management, bought up nearly 5 percent of Yum stock and pushed for changes, including a separation.
Yum has grown to depend on its China operations for sales and profits for years after well over a decade of fast growth there. KFC was the first foreign restaurant chain to enter China, and has since established leadership in the fast growing market, with about 4,900 restaurants in more than 1,000 cities in the fast-growing economy.
Overall, Yum has nearly 6,900 of its 41,000 restaurants in China. But because those restaurants are mostly company owned, and Yum franchises its restaurants everywhere else, those Chinese operations account for more than half of the company’s sales and profits.
Investors have pushed Yum to separate the two because Yum stock trades based mostly on those Chinese operations, and not on its global franchise business. Yum operates KFC, Pizza Hut and Taco Bell, and outside of China each of those brands reported same-store sales growth in the third quarter.
Pressure on the company intensified earlier this month when the company reported slower-than-expected sales improvement in China, which brought down Yum earnings in the third quarter. The company blamed a sudden, sharp decline in sales at Pizza Hut there, which offset improving sales at KFC, recovering from a year-long sales slide after a 2014 food safety scare.
“Over the years, we built our company’s global structure outside of China based on a franchise model that generates stable earnings, high profit margins, low capital investment and strong cash flow conversion,” Yum’s executive chairman, David Novak, said in a statement. “At the same time, our China business, which has been predominantly equity-owned, generates substantial operating cash flow annually, with tremendous ability to invest in its own growth.”
He said the deal “will create two best-in-class independent companies” with a capital structure “that provides strong financial support for our business strategies and meaningful cash returns to shareholders.”
After the separation, Louisville, Ky.-based Yum Brands would become a “pure play franchisor,” meaning it franchises nearly all of its restaurants and depends mostly on royalties from franchisees for its revenues. Outside of China, Yum’s annual revenues in 2014 were $6.3 billion.
Yum China would operate under a franchise agreement with Yum Brands. That division generated annual revenue of $6.9 billion in 2014 and has no significant debt, enabling that business to continue adding restaurants at a rapid clip. Yum is expected to add 700 new locations in 2015 and believes there is room for more than 20,000 restaurants in the country in the future.
Analysts were largely positive on the expected move. Nomura Analyst Mark Kalinowski said that the separation “will get Yum Brands off the China roller coaster in a meaningful way and allow for better focus on enhancing non-China business lines.”
Wall Street accepted the move, too. The stock rose more than 4 percent in premarket trading on Tuesday.
Said Creed: “Yum Brands will have a more stable earnings stream typical of a franchise company powered by industry-leading brands, while also benefiting from the development of the China business as a unique growth engine.”
Contact Jonathan Maze at [email protected].
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