JPM Upgrades YUM Brands: China Spinoff Now A ‘Probability’

The YUM Brands (YUM) spinoff story continues to develop and it feels like a spin is becoming more a matter of ‘when’ vs. ‘if’. Breakup speculation has been rife for quite some time, but the recent ‘catalyst’ of activist funds Corvex Capital and Third Point taking sizable stakes seems to have kicked the frenzy into a new gear. Apparently they are starting to have some success getting the message through to management, leading JP Morgan analyst John Ivankoe to upgrade the name last week after attending a YUM China conference in Shanghai. The impetus for the upgrade was a feeling that management is no longer on the defensive against activist ideas and in fact, seems quite open to driving short and long term shareholder value. In his words, ‘a spin-off of China and corresponding levering up of the capital-light franchise business has moved from a “possibility” to a “probability”.

The spinoff would see YUM’s sizable China operations spun off into a standalone company that would pay royalties (~3%) to the parent. While the timing still remains unknown, the key value driver in this transaction is really financial engineering as it is expected that YUM would have a dramatically different balance sheet post-spin. Dramatically more debt, to be more specific, a stark contrast to its current, more conservative investment grade balance sheet. For an idea on the leverage front, JPM valued the name assuming 5x leverage on the ex-China/India YUM, along with 20+x EPS multiples.

The stock popped on the upgrade, much like it did after the activist investors unveiled their stakes. JPM slapped a price target of $108 on the name so there is still some upside, but it is starting to feel like a spinoff is already getting baked into the price. Although still unknown, that means the ‘when’ question could be more important than it seems.

Disclosure: Author holds no stake in any company mentioned