Yum, and the art of the spin-off
Having recently researched Yum! Brands (which has KFC, Pizza Hut and Taco Bell as its major operations), I was reminded how well a spin-off can work out. In this situation a listed company has incubated a business until it’s ready to stand on its own feet as a separately listed group with its own management team and, perhaps most importantly, its own balance sheet.
The distinction between management and balance sheet cannot be stressed enough, as one is a much bigger consideration than the other. It’s a lot simpler to replace an underperforming management team than it is to fix a broken balance sheet.
A division or subsidiary of a listed company usually has a separate management team regardless of whether a spin-off is in the works. Admittedly, the team carries far less regulatory responsibility than executives of a listed company, but the operational pressures are the same.
The balance sheet is a different story, because a subsidiary or division can tap into the listed holding company for capital with ease. When separately listed, that flexibility is gone, as there are now numerous other public shareholders in the mix. Before a company can be set free as a separately listed entity, the balance sheet needs to be in great shape and the treasury function needs to be working properly.
Assuming that the balance sheet is strong enough and that the management team has sufficient depth of experience and ability, a spin-off can make sense when one part of a listed group doesn’t really belong with the rest.
This is a classic value-unlock strategy that gives investors a choice of where to invest. The theory is that the group is trading at a discount to the sum of the parts, as investors can’t get direct exposure to the assets that they truly want, so setting those assets free allows true price discovery in the market.
Chain of success
Back in 1997, PepsiCo gave a company called Tricon to its shareholders through a spin-off. It traded under the ticker $YUM and eventually adopted that name, along with an exclamation mark for good measure.
At that stage, Tricon held the three major chains that are part of Yum! Brands today and had about 29,000 restaurants in the system. This made it the largest restaurant group in the world by number of restaurants, and second only to McDonald’s in terms of revenue.
This allowed PepsiCo to focus on its core business, which is a soft drink and snacks empire. Though South Africans aren’t really Pepsi drinkers, we certainly know our way around a packet of Doritos or Lay’s at the braai. A strong argument can be made that the best part of PepsiCo’s business has nothing to do with the Pepsi brand.
The spin-off also unleashed the management team of the fast food business to build a successful group, something that was certainly achieved. In a recent earnings call the management team pointed out that Yum! has outperformed the S&P 500 by five times since its separate listing.
Over the past 10 years, Yum! has grown at a compound annual growth rate (CAGR) of 7.2%, its share price doubling over that decade. PepsiCo did better, growing at a CAGR of 8.7%. The gap is even bigger on a total return basis, as PepsiCo traded at a higher dividend yield than Yum! throughout that period (an average of 2.7% vs 1.8%).
Though the unbundled company didn’t outperform the parent company over the past decade, they have both pulled off highly presentable total returns in dollars. Even without the currency issue, that performance is well ahead of those of many large JSE companies.
Speaking of the JSE, recently spun-off (or unbundled) firm Zeda released a cracking set of numbers for its first update as a listed business.
In the quarter ended December, the mobility company grew revenue by 24% and earnings before interest, tax, depreciation and amortisation by 23%, with investors happy to see that margins were largely maintained.
Zeda, which holds the licence to Avis, isn’t just a generic car rental business. Yes, the car rental industry is synonymous with holidays, but 55% of rental revenue in Avis comes from contracted services like insurance. This gives a helpful revenue underpin to the business, alongside the fleet operations and the used car dealerships.
I’m hoping that Zeda picked up some balance sheet management skills from former parent company Barloworld, as that group is exceptional at navigating a crisis.
Regardless of which of the two groups will be the better performer, at least investors now have a choice.