Yum Brands Acquisition of Little Sheep: Company vs. Franchise Operations

| About: Yum! Brands, (YUM)

Yum Brands, Inc.'s (NYSE:YUM) announcement last week of the acquisition of the 415-unit Little Sheep hot pot chain was not a surprise. YUM had invested via a minority stake earlier, and its earnings model more and more depends on China feeding its operations.

The YUM acquisition is estimated at $585M (US$), or about 8.5X 2011 projected EBITDA. Little Sheep had doubled its EBITDA since 2008.
Little Sheep went public on the Hong Kong Exchange in June 2008, and we now have some unit level margins to examine. The 2009 year-end numbers, all converted to US $ (at the then RMB $ exchange rate) show an interesting cash flow pattern. Company store operations are more important to Little Sheep, and franchising less so, versus its US peers. This could indicate a long runway for growth.
Company Operated Economics Work in China (2009 results, in US $):
  • AUV app. $1.255M
  • Company stores profit: 16.4%, or $ 205K per unit, 88% of the Little Sheep pre-G&A total segments profit.
  • Supply chain profit of $19,800 per franchised unit, or about 5.3% of total supply chain revenue.
  • Franchising profit of $7900 per franchised unit, or a 47% franchising margin.
  • Total company EBITDA of 14.4%.
  • Average check per customer: $7.45, 2.5% down from prior year.
  • 2009 same store sales, plus 1.7%; 2008: plus 10.0%; 2007, 3.3%.
In the past, Little Sheep was helped strategically by PE firm 3i Capital’s involvement, and a consulting engagement from Ronald Berger, the niche strategy consulting firm headquartered in Germany. Little Sheep reversed its franchising strategy in the 2006/2007 period, investing in many more company operated units, centralization, standardization of management processes and dialing back on unrestrained franchise development.
North American Franchisee Organization
In 2009, Little Sheep divested its entire US franchising business stake to Wang Fang of XFY Inc., with 5 stores in the US (Los Angeles, San Diego, and San Francisco) and four units in Canada, for a minimal $345,000.
The first North American unit was opened in Toronto, in 2005. According to Fang, the US average ticket was running about $20, before alcohol. This likely represents a per party not per person average.
We visited the unit in San Diego, in a center strip mall location (in a majority Asian-American community) with app. 100 seats, a central demonstration pre-cooking chefs station. It is very much intended for large groups and families and has an alacarte “add-on” menu structure.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.