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Wall Street Journal - Why Yum’s China Deal Could Make KFC Great Again

Primavera Capital and Ant Financial are buying in, a promising development for current shareholders

 

By Jacky Wong

Sept. 2, 2016 7:34 a.m. ET

 

Yum Brands ’ deal in China should give shareholders a tasty meal.

 

The operator of KFC and Pizza Hut has secured two well-connected investors for its China unit ahead of the unit’s spinoff. Primavera Capital, run by former Goldman Sachs China Chairman Fred Hu, and Ant Financial, the financial affiliate of Chinese e-commerce giant Alibaba, will invest $460 million in Yum China, according to The Wall Street Journal.

 

With the transaction, Yum will gain a seasoned deal maker, Mr. Hu, and an influential businessman, Alibaba’s Jack Ma, on its side in the fiercely competitive China market.

 

In return, Yum’s current shareholders will endure a slight dilution, and give the two investors an 8% discount. But that discount will be figured after Yum China starts trading as a stand-alone entity later this year, by which time the price should reflect the benefit their investment brings.

 

The Chinese investors also enjoy upside if Yum China does well. They have warrants allowing them to buy an additional 2% of the company twice, first if its valuation reaches $12 billion and then if it hits $15 billion.

 

Yum’s China operations accounted for roughly half of the company’s revenue in the first half this year, but—because of a lower margin—only around a third of operating profits. Given Yum’s current market value of $35.4 billion, those warrants would be exercised only if Yum China trades at a higher earnings multiple—or significantly enlarges its business.

 

Yum Brands will no longer own Yum China after the spinoff, but will collect a 3% royalty. That appears low, but it doesn’t matter for current Yum shareholders. They will reap the benefits of the low fees by continuing to own the China offshoot.

 

An early entrant in China, Yum enjoyed great success, but sales have been stalling—a consequence of fading novelty value, food-safety scandals and rising competition. The new competitors include budding online food-delivery services backed by internet titans such as Baidu and Tencent—and Alibaba, which together with Ant sank $1.25 billion into one called Ele.me earlier this year.

 

Having Ant as a partner could give Yum China a leg up in this cash-burning battle.

 

Yum’s deal could make KFC in China great again.