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Yum! Brands Splits In Two: Will Spin Off China-Facing "Bad Yum"

When just days after Yum! Brands saw its biggest earnings disappointment in years sending its shares cratering following Chinese results which cames orders of magnitude below expectations and leading to a major guidance cut, it appointed Icahn protege, activist investor Keith Meister to its board, many speculated that some major spin-off, or split of the company's China facing assets, was just a matter of time. And so it was, less than a week to be precise. Moments ago Yum! Brands announced its intention to split into two companies creating a publicly traded Yum! China or ("Bad Yum") which will contain the ongoing Chinese weakness, while keepping legacy Yum! Brands.

From the press release:

Yum! Brands, Inc. (YUM) today announced that it intends to separate into two independent, publicly-traded companies, each with compelling and distinct strategies and investment characteristics. The transaction will create two powerful, best-in-class companies, each with a separate strategic focus:

  • Yum! China, a market leader with decades of accumulated consumer loyalty and world-class operations in China, will become a franchisee of Yum! Brands in Mainland China. It will have exclusive rights to three category-leading brands: KFC, China’s leading quick-service restaurant concept, and a favorite of Chinese consumers; Pizza Hut, by far the leading casual dining brand; and Taco Bell, which is expanding globally but is not yet in China, providing significant upside potential.

Yum! China will have an attractive investment profile and significant opportunity for growth. The Company is expected to have no significant debt, with substantial financial capacity to invest in its business. A favorite of China’s growing middle class, Yum! China has the potential to grow to 20,000 restaurants or more in the future from approximately 6,900 restaurants today. The business also has significant sales and profit growth potential in its existing restaurants, which the Company plans to capture over time by growing its core offerings and expanding further into new initiatives such as home delivery.

  • Yum! Brands, one of the world’s largest restaurant companies with three iconic brands, will focus on expanding the presence and performance of KFC, Pizza Hut and Taco Bell around the world. These are three of the top ten U.S. and global QSR concepts. The Company will have an extremely attractive business model, with stable earnings, high profit margins, low capital intensity, and strong cash flow conversion. Yum! Brands will become more of a “pure play” franchisor over time, and is targeting having at least 95% of its restaurants owned and operated by franchisees by the end of 2017. It currently has a global base of over 41,000 restaurants, with approximately 2,000 new units being opened each year.

Yum! Brands is committed to returning substantial capital to shareholders in conjunction with the separation. This will occur as the Company transitions to a non-investment grade credit rating with a balance sheet more consistent with highly leveraged peer restaurant franchise companies. Moreover, this will allow for an ongoing return of capital framework that will seek to optimize the Company's long-term growth rate on a per-share basis. Further details will be discussed at the Company’s Analyst/Investor Day on December 10, 2015.

The Company does not expect to have incremental ongoing operating costs associated with operating as two separate, publicly-traded companies.

The Board’s unanimous decision to create two independent companies follows a rigorous review of strategic options conducted over the past year by Yum! Brands’ Board of Directors and management team, with the assistance of independent financial and legal advisors. The transaction is expected to be completed by the end of 2016 and is intended to qualify as a tax-free reorganization for U.S. federal income tax purposes, with the legal structure and form to be announced at a later date.

Highlights of China Business after Separation

As an independent company, Yum! China will have a strong, predominantly Chinese leadership team and compelling growth profile in one of the world’s fastest-growing restaurant markets. The China business delivered annual revenue of $6.9 billion in 2014, and has a substantial free cash flow, with no significant debt, allowing it to focus and capitalize on the unparalleled growth opportunities ahead of it.

Headquartered in Shanghai, Yum! China is already the leading restaurant developer in China, with approximately 6,900 restaurants in over 1,000 cities. China’s consuming class is expected to double from 300 million in 2012 to more than 600 million people by 2020, providing a strong tailwind to the growth of Yum! China. The business remains on pace to open about 700 new locations in 2015 and is targeting expansion to over 20,000 restaurants in China in the future.

The China business is driven by strong brands that are integrated into the lives of Chinese customers:

KFC, the first quick-service restaurant chain to enter China, is today the number one foreign brand with approximately 4,900 restaurants in over 1,000 cities. The brand enjoys a footprint more than twice as large as its nearest competitor and is growing in Tier 1 to Tier 6 cities.

Pizza Hut Casual Dining, the first restaurant chain to introduce pizza and Western-style casual dining to China, is the number one Western casual dining brand locally with more than 1,400 restaurants in nearly 400 cities. The brand has been elevated with major menu revamps twice annually, and is supported by inventive marketing and digital technology, asset upgrades, and the introduction of breakfast, tea time snacking and late night.

Pizza Hut Home Service introduced pizza delivery to China in 2001 and now owns nearly 300 Pizza Hut Home Service units in 40 cities. While at an early stage, this business is a leader in the fast-expanding home meal replacement category and is positioned to accelerate development, while leveraging digital technology and third-party platforms.

Mr. Pant and his team will be focused on driving growth in the China business, and developing new strategies to address the Company’s business issues and opportunities. The team will build on significant competitive strengths, including an experienced local management team, a highly educated workforce, a dedicated real estate and development team, industry-leading media budgets, a country-wide distribution system, best-in-class operations, and dedication to innovation and product quality.

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As for the biggest winner from splitting one "junk" company into two "junk" companies (judging by the jump in the stock price, the sum is less than the parts), it is none other than Goldman Sachs of course:

"Goldman, Sachs & Co. is serving as financial advisor."

Expect many other companies, especially in the luxury goods space, to follow in Yum's footsteps, now that Chinese exposure has become a liability after years of being an asset.