Yum! Brands (YUM) Gains as UBS Makes the Case for China Spin-Off

Yum! Brands (NYSE: YUM) is stronger Wednesday (+1.7%) following positive comments from UBS analyst Keith Siegner, who discussed a potential China spin-off and raised his price target to $116 (from $110).

Siegner said while a China recovery is underway, the potential separation of the unit is an important catalyst. "With activist investors likely to push strategic alternatives to unlock value, we view one of the most likely scenarios a China spin-off to create a heavily franchised global KFC/PH/TB business and a pure play China master franchisee.

He added, "While we believe a China recovery alone supports further upside to shares as AUVs/profits rebound, we see meaningful value creation opportunity in a potential spin-off of the China business. Separating China isolates investment thesis and risk, enables proper capitalization for each business, and allows investors to more cleanly value each company."

Siegner said spinning off China, isolates risks and creates an attractive large cap global franchisor. "Under our illustrative base case breakup scenario, we assume a spin-off of the China business ("Yum China") that pays a royalty (we est. 4%) to Louisville ("Yum Global")," he said. "Yum Global would then be at least 95% franchised by 2017 w/ the potential for even more. Similar to other heavily franchised peers, Yum Global could increase leverage to 5-6x and use proceeds for share repurchase. Yum China would represent a direct play on the middle-class Chinese consumer via a U.S. listed (maybe), western accounting standards investment, that is initially ~8% franchised. We est. go forward EPS growth of near low teens and high teens/low 20s for Yum Global & Yum China, respectively. ~20% of Yum Global EBITDA would come from China (vs. ~40% currently)."

The valuation arbitrage and leverage opportunity could represent more than 30% of upside, the analyst argues. "Using discounted 2017E EBITDA, our sum-of-the-parts implies $76/share for Yum Global and $40/share for YUM China, with upside potential to the combined ~$120 more likely from more optimistic op profit scenarios (especially Yum China) than higher multiples," he said. "For valuation compares, we believe i) Yum Global could narrow the valuation gap to 100% franchised peers and trade at 15-17x EBITDA and ii) Yum China could trade at a 14-16x multiple as a standalone China discretionary stock."

For an analyst ratings summary and ratings history on Yum! Brands click here. For more ratings news on Yum! Brands click here.

Shares of Yum! Brands closed at $90.08 yesterday.

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