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3 Questions for the Yum! China Spin-Off (i.e., KFC, Pizza Hut) Going Forward

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So Yum! China has been spun-off. A reasonable move that gave them increased owner/management focus. It also gave some activist hedge funds a nice return. And the new spun-off Yum! China entity has released its first 10-Q, which was some interesting reading.

But there are now some important challenges going forward. These are widely discussed – and include:

  • Dealing with slowing same store sales growth
  • Expanding into third tier cities and other areas
  • Dealing with changing consumer preferences (especially an increased focus by Chinese on healthy eating)
  • Lots of interesting stuff in digital and deliveries.

Going forward, I have three questions for Yum! China:

Question 1: Who is the new Sam Su?

Yum’s success in China was not just because of its franchise. KFC is certainly a great restaurant and the popularity of KFC fried chicken in China is pretty crazy. But there are hundreds of franchises, including other chicken ones (Popeye’s Chicken must be pretty frustrated). But the franchise and core menu doesn’t explain KFC’s stratospheric success in China. I argue their success was overwhelmingly because of three things: 1) their core menu is really popular in China, 2) they got to China early and were bold – and 3) they had particularly committed management.

That great management was former China CEO Sam Su (and his team). He is a native of Taiwan and was a veteran of Proctor & Gamble Taiwan prior. He also came to KFC China early in his career and committed for the long-term.

Warren Buffett is frequently asked about what he looks for in a manager. He usually answers by saying he likes family ownership and owner-managers. Basically you want people who’s entire future depends on the company’s success. And one thing he frequently criticizes in public companies is CEOs who are only in their positions for a few years. He wants long-term, committed management. I think Sam Su was an example of that.

So my question is who the new Sam Su? Who is the China expert who will revitalize and grow this company for the next 20 years? You want long-term, committed top-tier management. Current CEO Micky Pant is certainly running hard, so it’s not a criticism of him. In fact, you could argue he is the perfect guy for the spin-off period. But I am looking for the next 15-20 year leader of the company.

Question 2: Are they going to franchise the China outlets? How many and how soon?

Most of the Yum! China outlets are owned. Franchising new outlets would be a way to accelerate growth in the number of outlets. And while Yum’s +7,500 China outlets is a lot, it is not overwhelming for China. You could have a lot more. Franchising would get you there faster.

But franchising decreases operational control. That has big implications in general. And this is a particular concern in a country rife with food safety issues.

Another idea is to just franchise the existing outlets. That would really move the needle financially. It would free up a lot of capital, get employees off the payroll and spike the return on equity.

Note: This is exactly what 3G Capital has done since acquiring Burger King. They shifted the existing units to franchises and have more than doubled their earnings in a few years. However, I believe the China Burger King franchise is still under a master franchise agreement with Cartesian Capital in New York. So I think this is mostly a non-China Burger King phenomenon.

Question 3: How far are they going into digital, deliveries and “new retail”?

KFC has just tried out a “pay by smile” technology at one of their China outlets. You basically look at the screen (i.e., for facial recognition) to make payment. And Yum! China has been doing lots of interesting stuff like this in both digital and deliveries (which sort of ties together). I’m curious how deep into “new retail” they are planning to go. Are the +7,500 outlets just going to become nodes in a massive “supply chain + production + chicken delivery” network?

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Anyways, those are the three questions I am thinking about. I wouldn’t be surprised if activists bring up the franchising question more and more.

Thanks for reading. jeff

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I write and speak about “how rising Chinese consumers are disrupting global markets – with a special focus on digital China”.

Photo by David Bote Estrada, Creative Commons license link here.

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