Yum! Brands Finally Caves – Will Spin Off China Business

Sometimes there is just no stopping an idea full of momentum. After years of a spinoff idea being tossed around and pushed by all parts of Wall Street (sell side and buy side), Yum! Brands (YUM) has finally decided to pull the trigger and will spin off its China business into a standalone entity. While resistance appeared to exist at the top levels as recently as three months ago, this month’s appointment of activist Keith Meister to the board of directors, an ardent YUM spinoff supporter, signaled pretty clearly that a change was coming.

The new Yum! China will have a Chinese leadership team led by new CEO Micky Pant. The company will be a franchisee and have exclusive rights to KFC, Pizza Hut and Taco Bell (which is not yet in China). Currently, Yum owns most of its restaurants in China, but post transaction, the new China company will pay the parent a percentage of sales creating a royalty stream to the parent. This also means the parent company, Yum! Brands, will become a more traditional franchiser business with steady cash flows and a focus on delivering shareholder value. As part of that plan, it will take on more debt like other franchisers.

The new company isn’t expected to begin life with a highly leveraged balance sheet so it should be able to continue expanding its footprint and growing. That will be necessary if the company plans on increasing its store count to 20K from the current 6.9k today. While the China story sounds nice and both optimism and enthusiasm fill the press releases, it’s worth remembering that the segment has had serious issues and numerous missteps. For example, there have been scandals over food quality and safety leading to dips in same store sales and profits. The recent quarterly report led to a massive decline in share price after missing some of these growth targets. In fact, management’s earlier comments on the spinoff idea wasn’t a rejection of its value, but that a fix of the business was needed prior to setting it free. The potential is certainly there, but the question remains whether or not the execution can come back.

The spinoff is expected to be completed by the end of 2016 so the current management team has some time to sort out the details and right the ship. Despite the apparent ‘handwriting on the wall’, YUM’s shares still jumped a bit on the news. Perhaps more change is coming on the horizon and Barron’s notes that a Taco Bell spinoff could also make sense. With new blood on the board taking bold action, nothing can be ruled out.

Disclosure: Author holds no position in any stock mentioned.