Consumer

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Tim Culpan is a technology columnist for Bloomberg Gadfly. He previously covered technology for Bloomberg News.

Private-equity firms must be licking their lips. Yum! Brands, owner of Pizza Hut and KFC, is looking to sell a stake in its China unit as part of plans to hive off the business into a separate publicly traded company, the Wall Street Journal reported.

Such a sale could spell a rare opportunity to turn around a company that, while having lost its star power, remains China's fast-food provider of choice.  KKR, Baring Private Equity and several Chinese funds are among those exploring the purchase of a possible 19.9 percent stake, the Journal said.

The $10 billion valuation cited for Yum China would price the business at eight times its 2017 Ebitda of $1.25 billion, Morgan Stanley estimates. That's a pretty tasty valuation. Yum Brands currently trades at a multiple of more than 11 times, based on enterprise value to estimated 2017 Ebitda, according to data compiled by Bloomberg.

For the uninitiated, Yum was China's first Western fast food operator, opening a KFC outlet just off Beijing's Tiananmen Square as far back as 1987. It carved out a bigger chunk of the market as incomes rose and the middle class grew, and now makes half of sales and about 45 percent of its profit from China. A series of food scandals, a shift in Chinese consumer tastes and stiffer competition (witness Hony Capital's buyout of British middle-class favorite Pizza Express) have combined recently to undermine the company's appeal.

Dominance Wanes
Yum's share of China's fast-food market has been falling but it's still the leader (%)
Source: Euromonitor

Yum said in October that it plans to spin off the China unit, and executives have discussed a plan to go public in New York at some point -- although such a sale, or investor appetite for it, isn't assured.

The challenge for the China division will be convincing investors that the days of food-safety scares are behind it. Yum China may also struggle with the orphan problem in New York: a lack of similar-sized peers in a market where most Chinese companies are startups or technology giants such as Alibaba. Multinationals with substantial China operations (Volkswagen, for instance) generally don't have them traded separately.

Declining Tastes
Revenue growth at Yum's China division has fallen sharply
Source: Bloomberg data

Still, things are looking up for Yum in China. The unit's operating margins, which have consistently lagged other divisions, have improved by more than some analysts expected, with lower food and labor costs setting up 2017 for  ``a strong earnings growth year,'' Morgan Stanley said in a note last month. With consumer spending set to triple in the next decade, Yum stands to benefit, the brokerage said.

Soft Margins
Yum's operating margins in China consistently lag other divisions
Source: Bloomberg data

Yum Brands has 7,176 of its 42,692 global stores in China and, despite its travails, hasn't pulled back. The company opened 384 outlets in the country in the fourth quarter, or an average of more than four per day.

For now, selling to private equity could benefit all parties. Yum would get an outside investor and some cash; the private equity firms a recognized brand that they can upgrade through innovations to menus and service delivery; and Yum's China division a partner (or partners) experienced in turnarounds.

The experience of Li Ning, the sportswear company named after an Olympic gymnast, shows that private equity firms can achieve business revivals in China. The company, part-owned by TPG Capital, posted an annual profit this month after three years of losses caused by competition from the likes of Nike and Gap. That's something for Yum China's potential investors to digest.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net
Tim Culpan in Taipei at tculpan1@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net