Yum’s China split doesn’t look too tasty right now

May 23, 2016

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

Yum Brands’ split is not looking too tasty. With one of the most logical partners walking away from buying a pre-spinoff stake in its Chinese unit, it may be even longer before the KFC owner serves up some value.

Right now, the Yum break-up looks like a rather hollow victory for activist investors Corvex and Third Point. They won the argument that Yum’s global business – stable, slow-growing, mostly franchised, and thus able to bear lots of debt – should not have the same owners as a high-risk Chinese business that is a fast-growing but accident-prone market leader.

That insight hasn’t yet translated into better valuations. Last May Corvex’s Keith Meister, who now sits on Yum’s board, argued the whole company could be worth $130-plus a share. Since then, the stock has returned a negative 10 percent including dividends, versus a 32 percent advance at arch-rival McDonald’s. The performance might have been worse but for a big share buyback that is part of the reorganisation. Yum shares closed below $80 on May 20.

The problem is that after numerous setbacks at Yum China, investors are less willing to give it credit for future growth potential, even if a turnaround under new management is starting to show up in measures like improving same-store sales. Last year a Breakingviews calculator showed how the unit could be worth $27 billion if Yum China can expand its footprint in the People’s Republic by 50 percent. Reports from the current auction mention a valuation of $8 to $11 billion, for a business making $1 billion of EBITDA a year.

Now Reuters says China’s CIC, working with buyout group KKR, has quit the auction, having sought majority ownership rather than the minority stake on offer. That always sounded unrealistic, unless the duo was willing to pay up for control, and for the tax bill a sale would trigger.

Even so, their departure is not helpful. That is because the auction presumably has several goals: bring in some cash; reassure prospective public investors by introducing a big “anchor” at a decent valuation; and perhaps find a heavyweight local partner to help navigate future challenges in China.

Another unnamed buyout firm is still circling, as is Singapore’s Temasek. The latter certainly has the cash, but might now drive a harder bargain, and would be a less useful political ally. The split still makes sense, but has yet to cook up value.

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