July 27, 2018 / 7:11 AM / 10 months ago

Breakingviews - Yum China deserves more than a cheap takeout

A customer walks out of a KFC store in downtown Shanghai July 31, 2014. REUTERS/Carlos Barria

HONG KONG (Reuters Breakingviews) - Yum China deserves more than a cheap takeout. Hillhouse Capital is in talks to buy the operator of KFCs, Pizza Huts and Taco Bells in the People’s Republic, The Information news website reported on Thursday, after which the company’s shares rose 15 percent. If successful, the Beijing investment outfit gets a Chinese consumption play pre-packed with Western-style governance, and its technology knowhow could supersize the $14 billion company.

The target has strong cash flows and big ambitions, with plans to operate 20,000 locations in the longer term, nearly triple the number it had when it spun out from Yum Brands in 2016. It also offers investors a rare way to profit from rising Chinese consumption with the safeguards of a New York listing.

Still, Yum China trades at 9.4 times expected 2018 EBITDA, according to Eikon, while Starbucks, which is also expanding aggressively on the mainland, trades at 13.5 times. Although food scandals have plagued it in the past, and it’s a franchisee, not an owner, the valuation looks depressed.  

That makes it a ripe target for a buyout. Yum China had $1.6 billion in net cash in March, meaning Hillhouse could leverage up the business to boost returns. The secretive hedge fund-to-private equity group’s past deals also offer some clues for its ambitions. Founder Zhang Lei has turned $20 million of seed capital into a roughly $35 billion firm thanks to big wagers on Chinese internet companies including Tencent and JD.com. Now it uses its tech savvy to boost returns in takeovers.

Last year, the fund led a $7 billion buyout of Chinese shoe retailer Belle International. The company now uses online analytics to improve in-store sales. For instance, products are fitted with electronic tags to track the take-rate of people buying the shoes after trying them on.

Hillhouse’s knowhow in applying online analytics to bricks-and-mortar stores could be used to lure more customers to KFCs and Pizza Huts. But convincing Yum China’s management it should be taken private at a knock-down valuation, just two years after going public, could be a challenge.


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