Yum Increases Exposure To China's Expanding Market

| About: Yum! Brands, (YUM)

By Jason Jenkins

Yum! Brands, Inc. (NYSE: YUM), known for its KFC and Pizza Hut fast-food chains, won approval by China’s Ministry of Commerce to buy Mongolian “hot pot” seller Little Sheep Group Ltd.

Little Sheep Group Ltd is the Chinese operator or franchisor of 480 Little Sheep hot pot restaurants. This will extend Yum!’s lead as the nation’s biggest restaurant operator. Little Sheep’s shares surged to a record high in Hong Kong trading Tuesday. The stock jumped 15 percent to HK$6.37 at the close, the highest level since its initial share sale in June 2008.

Once the deal has been finalized, Yum! will own over 93 percent of Little Sheep. The purchase will enable Yum! to grow its full-service presence in China. The remaining 6.8-percent stake in Little Sheep will belong to the chain’s founders, Zhang Gang and Chen Hongkai.

What This Does for Yum!

Yum! currently has 4,100 locations in China where the company brings in more sales than it does in the United States. Most of these locations are in the quick-service sector. As of the end of its third quarter, the company had 3,475 KFC units and 127 Pizza Hut Home Service locations in China, compared with 564 Pizza Hut casual-dining restaurants.

The Little Sheep acquisition costs about $566 million and gives the company around 460 outlets across China and 22 units outside that country offering a local cuisine. Before the merger, Yum! didn’t have an Asian or Chinese full- service operation and authentic Chinese food is still much more vast market than that for Western food.

Little Sheep specializes in Mongolian hot pot, a dish in which customers dip raw meat or vegetables into a communal pot of boiling broth. These types of independent eateries account for more than 90 percent of restaurant sales in China.

Sara Senatore, restaurant industry analyst with Bernstein Research, wrote in a research note that Yum!’s interest in Little Sheep “reflects its intent to be the leading brand in every significant category among restaurants in China.”

“We believe the decision to increase its stake reflects Yum!’s intent to be a leading brand in the ‘significant categories’ of Asian quick service and Asian full service,” she wrote. “Yum! dominates the Western Quick Service and Full Service Restaurant segments with KFC and Pizza Hut, but is largely absent from the Asian corollaries, which are dramatically larger markets.”

The Colonel Would Be Proud

I think the Colonel would be proud of this deal. It’s a win/win for both companies, so definitely take a long position on both. Yum!’s muscle behind the Little Sheep brand will also help the hot pot brand grow on the global stage. It’s a big win for Little Sheep Group to leverage Yum!’s seasoned international expertise and resources.

And as Jing-Shyh Sam Su, Chairman and Chief Executive of Yum! Restaurants China states, “This is another important step in executing our strategy of being Rooted in China, Part of China.” Yum! Brands is another one of the huge multinationals seeing a great deal of their profits coming from China – and they’re looking to grow there.

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