On the Margin
Did Yum miss its spin-off opportunity?

Did Yum miss its spin-off opportunity?

This post is part of the On the Margin blog.

As I wrote earlier today, weak performance labeled by some as a “disaster” by Yum Brands in China is intensifying the pressure on the company to spin off that business to shareholders.

But the best time to do that might be long past.

Yum did a fabulous job and gets tons of credit for recognizing early the immense potential in China. The company has nearly 7,000 locations there. Its KFC brand is the undisputed leader there, and nobody else is particularly close.

Its growth there has been a boon to its stock. Nick Mazing, founder and portfolio manager at Ampera Capital, noted that Yum has had one of the best returns in the consumer space since 2003.

As China has grown in importance to Yum Brands, investors have increasingly ignored all other facets of Yum Brands — KFC, Pizza Hut and even Taco Bell. Currently, China accounts for more than half of Yum’s revenues and operating profit, even though only about 16 percent of the company’s units are there. Yum operates its restaurants in China, and franchises in most other countries.

The problem now is that Yum has been struggling in China for three years. Its KFC brand’s sales are returning more slowly than expected. And now Pizza Hut there is struggling with a sudden drop in sales. This is intensifying calls for a spinoff — particularly given the surprise executives expressed at the Pizza Hut drop-off.

But there are other issues in China, Mazing noted, with a new political regime that might be less friendly toward western companies and demographics turning less favorable. Other brands are struggling there, too.

As such, Mazing said, Yum “may have missed the window of opportunity for separating that business."

Investors do best when they sell an asset at a high price. This is true whether they are public company shareholders, private equity group investors or simple homeowners.

A good example of a company selling high came in 2006 when McDonald’s Corp. spun off Chipotle Mexican Grill. While many critics look back and oddly say that move was a mistake, at the time Chipotle was a hot, up-and-coming concept that received a celebratory welcome on Wall Street.

Of course, Yum could split its China business at any time, Mazing noted, and has many options for doing so. But, he said, the market wouldn’t likely give it the value it might have given Yum China a few years ago.

“In my view, given both the company trends and the overall investors’ attitude towards China, Yum has missed the window to get a good premium,” Mazing said.

To be sure, not everybody looks at China as the spinoff possibility. Nomura Analyst Mark Kalinowski suggests a spin-off of Taco Bell — which would be a sell-high type move.

Yet pressure is clearly on Yum to “spin off China, do something,” as Hedgeye Risk Management Analyst Howard Penney told Reuters today. Whether it will feel enough pressure that it does something with China before fixing the business remains to be seen.

Contact Jonathan Maze at [email protected].
Follow him on Twitter: @jonathanmaze

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