Yesterday, YUM announced plans to de-risk the company from its China business by executing a major restructuring, including the spin-off of its China business (YUM CHINA). In addition, in a shift from their previous thought process, the company will lever-up its remaining predominately franchised business (YUM BRANDS).
We fully believe that this move will create significant shareholder value. The timing of the actual restructuring will be dependent on achieving final approvals and executing the necessary steps, but is expected to be completed by the end of 2016.
As more details become available, we believe the stock will trade higher over time. In the short run, holding things back will be the good bank/bad bank mentality.
Over the coming months, Yum! Brands (the good bank) is expected to execute a Leveraged recapitalization. In a complete shift from it’s current philosophy, YUM announced intentions for its franchised business to “become a non-investment grade credit rating with a balance sheet more consistent with highly-levered peers.” As a result, we believe that the new Yum! Brands will execute a $13-$15 per share leveraged recapitalization, bringing the new company to a debt-to-EBITDA ratio of 4.5x-5.0x. Upon this event we see the stock trading above $80 and the market capturing a majority of the leverage recap immediately.
Spin-off of Yum! China (bad bank for now) will likely be a better managed company as a stand-alone entity. It can also be argued that giving the public a direct way to play in the growth of KFC will boost consumer attachment to the brands - China KFC and Pizza Hut. While not specifically announced, we believe that YUM China will trade on the Hong Kong exchange, and will be the largest consumer company traded on that exchange. It also could be a must own equity for funds and indices in that region. We have long believed that the process of KFC China going public will act as a significant positive catalyst for the business as we have seen numerous times in the USA.
SHAK Chairman, Danny Meyer, said on CNBC last week that all the press about going public helped build brands awareness. KFC China will likely see that same benefit from months of substantial positive press. Lastly, looking at the Corvex plan the Yum! China business can also execute structural changes that can accelerate growth by selling stores and bringing in sub-franchisees.
Our new YUM model assumes that YUM China will pay YUM Brands a 4% royalty rate.
In the coming days we will be updating our sum-of–the-parts model for the combined entities.
Please call or e-mail with any questions.
Howard Penney
Managing Director
Shayne Laidlaw
Analyst
