Yum split offers value with chance of aftertaste

October 20, 2015

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

First comes the gratification, then the remorse. But does the cycle familiar to Yum Brands customers also apply to its investors? The U.S. owner of KFC has decided to split off its troubled China business, leaving two separately traded companies. The logical and potentially rewarding move comes with the chance of a less savoury aftertaste.

Yum will hive off its China unit entirely, according to a person familiar with the situation, listing it wherever garners most interest from investors. While that’s what activist investor Keith Meister wanted even before he was added to Yum’s board last week, it’s also a no-brainer. Yum’s own-and-operate model in China jars with its almost entirely franchise-based business elsewhere.

After the split, the two parts will have very different flavours. Suppose the China division can increase its number of stores by half to 10,000 and create $1.4 million a year in revenue from each one, as it did before food scares in the People’s Republic last year thwacked its sales. A Breakingviews analysis suggests the unit could be worth $27 billion on a debt-free basis, three-quarters of the whole Yum enterprise value.

The more mature Western-world business, meanwhile, could be slathered in debt. The owner of the KFC and Pizza Hut brands might be able to extract a 3 percent licence fee from its expanded China affiliate, giving it $420 million a year in mostly stable income. Add that to last year’s non-Chinese EBITDA of $1.1 billion, assume there’s room for borrowing worth three times EBITDA, and there’s scope for a one-off debt-funded payout to investors of more than $4 billion.

Despite this, the $32 billion Yum’s stock rose just 4 percent after the split was announced on Tuesday. That may be because any separation could be at least a year away. It may also reflect the China risk that will remain with the Western business. The U.S. unit will still depend on fees from the People’s Republic – increasingly so if growth plans there pan out. Yet it won’t be able to control them. Yum’s spinoff is sensible, but not a magic recipe.

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