Yum Brands to spin off struggling China business

Aamer Madhani | USA TODAY

Show Caption Hide Caption Yum plans to split its China business Yum! Brands Inc., whose restaurants have been selling crispy chicken in Beijing since 1987, plans to split its China business off into a separate publicly traded company following pressure from activist investorKeith Meister.

Facing pressure from activist investors, Yum Brands (YUM) announced Tuesday that it will spin off its China business.

The announcement comes after Yum Brands CEO Greg Creed told analysts earlier this month that the company would take "immediate action" and acknowledged its promised turnaround of its KFC and Pizza Hut brands in China has failed to take hold.

The possibility of a spinoff appeared all but a done deal last week after Yum announced that it had named activist investor Keith Meister to the company's board of directors. Meister, managing partner of Corvex Management, had been among the most vocal proponents of spinning off the China business. Meister has a 5% stake in Yum.

"Over the past year, our management and board have thoroughly evaluated a range of value-creating opportunities," Creed said in a statement. "Following the separation, each stand-alone company will be able to intensify focus on its distinct commercial priorities, allocate its own resources to meet the needs of its business, and pursue distinct capital structures and capital allocation strategies."

Shares in Yum closed at $73.03, up 1.8%.

The company operates about 6,900 restaurants in China, including KFC, Pizza Hut and the Little Sheep hot pot chain. As part of the transition, the new Yum China will have the opportunity to launch Taco Bell, Yum's strongest franchise in the USA, in China.

The transition is to be completed by the end of next year. The new China company is expected to have no significant debt, with substantial financial capacity to invest in its business, according to Yum.

The China businesses, which are about 93% company-owned, will pay a royalty fee to Yum Brands. Yum officials are still in the process of discussing with the regulators in China and the United States what the tax implications of the deal could mean. The China business generates about $1 billion in operating cash flow and has been growing at about 700 new restaurants per year.

Yum Brands will continue to be led by Creed, and Yum China will be led by Micky Pant, who was named CEO of the China unit in August. The company said it will divulge more about its China strategy at its scheduled investors day conference in December.

Meister on Tuesday said the move would "maximize shareholder value."

"Yum has two great, but distinct, business models embedded in one company — a highly attractive franchise business model everywhere in the world beyond China, and a leading company-owned restaurant model within China," Meister said in a statement. "The separation of these two businesses gives shareholders the choice to own a growing annuity-like franchise cash flow stream, as well as the leading restaurant concept in a country with the fastest-growing consumer class."

Yum in China has been dealing with the aftermath of a pair of food-safety scares in China since 2012, including one in which a supplier sold Yum and other chains expired meat. The average China restaurant generates about $1.2 million in revenue, down from about $1.7 before the food supplier incidents.

Company officials earlier this year predicted a turnaround in the second half in its China business. But Yum shocked investors when it reported its third-quarter earnings earlier this month that fell far below analysts' consensus estimate of 9.6% growth for the China segment.

Overall, Yum reported earnings of $1.00 per share, excluding special items, on $3.43 billion in revenue. Analysts surveyed by Thomson Reuters projected $1.07 a share on $3.68 billion in revenue for the company system wide.

It now appears that Yum's China turnaround is being stymied by a slowing economy in China. Despite its struggles, Creed called the China operations "self-sufficient and scalable." The company believes it can eventually grow its China operations to 20,000 restaurants.

China's GDP slowed to 6.9% in the third quarter, the weakest rate since the financial crisis. Still, Yum officials said they are bullish that the China business can grow.

Aamer Madhani on Twitter: @AamerISmad.