New York-listed Yum China Holdings Inc.'s pursuit of a secondary float in Hong Kong will likely bring the fast-food operator a higher valuation and more firepower for acquisitions in the Chinese dining segment.
The operator of Kentucky Fried Chicken, Pizza Hut and Taco Bell in China has confidentially filed for an IPO in Hong Kong in a bid to raise up to $2 billion, Bloomberg News reported June 19. The move would help the chain emulate the success of local competitor Haidilao International Holding Ltd. and diversify its shareholder base at a time of heightened U.S.-China tensions.
A listing closer to its base might be prudent as China-centric investors may focus more on its performance in the country than on U.S.-China tensions, analysts said. Yum China will likely also benefit from investors who have greater familiarity with the business they are investing in.
The Hong Kong-listed stock of Yum's biggest competitor, Haidilao, has been an investor darling since it floated in October 2018. The traditional communal hotpot meals provider's shares have nearly doubled since its listing and its market capitalization exceeds Yum China's despite lagging in size.
"The investor base will be more familiar with [Yum China's] business model. [I]t will be easier for them to do channel checks just by looking at the color of the delivery rides on the road," said Bruce Pang, head of macro and strategy research at China Renaissance, in an interview. "For instance, every Chinese person believes that they are experts on Alibaba because they know the company's sales so well."
Yum China may not be as "hot" as the other homecoming tech stocks like Alibaba Group Holding Ltd., JD.com Inc. and NetEase Inc., but it should benefit from being a well-known restaurant operator in the market, noted Sumeet Singh, head of research at equity capital market consultancy firm Aequitas Research.
The Chinese restaurant sector, which has grown at a compound annual rate of about 10.9% to 4.7 trillion yuan in 2019 from 2.8 trillion yuan in 2014, presents a new opportunity for investors looking beyond the tech sector.
"There's only a handful of players you can invest [in]. Yum China can benefit from this consumption upgrade trend in China," Roger Xie, a former strategic investment expert from Fosun and HSBC, said in an interview.
Time is ripe for M&A
In recent years, Chinese casual dining restaurant chains like hotpot specialist Haidilao have risen in popularity with the growing affluence of Chinese consumers, whereas the novelty of fast food brands like McDonald's and Yum's KFC has faded. This has prompted the western chains to localize their menus and modernize their businesses through robust digital offerings.
Yum China's early ventures into Chinese food, however, have been less successful. The company launched Chinese fast-food concept East Dawning in 2004 and acquired hotpot franchise Little Sheep in 2012. But these restaurants, along with coffee chain COFFii & Joy and its delivery units, ran into an operating loss of $14 million in 2019, widening from a loss of $12 million in the prior-year period.
"They want to be strategic, to have a position on those. Even the coffee business that doesn't make money, they want to have a presence," said Xie.
Chinese dining remains a high-growth segment nonetheless and Chinese-style fast-food chains could be attractive targets for Yum China, analysts said.
The Chinese fast-food format is very quick to serve, can operate from a smaller store footprint and requires very limited store keeping units, Jack Chuang, partner at OC&C Strategy Consultants, said in an interview.
It is no surprise then that despite early setbacks, Yum China recently set up a Chinese dining business unit after closing a $185 million deal for simmer pot dining chain Huang Ji Huang in April.
COVID-19 has hit Chinese dining restaurants harder than the limited-service, or quick-service, and chain restaurants like the brands under Yum China, which are more resilient as delivery and takeaway consist of a larger proportion of their business.
"Besides, it is easier to practice social distancing in [limited service restaurants]," said Han Hu, an analyst at Euromonitor International.
Overall Chinese restaurant industry revenue fell 36.5% from January through May as fears around the coronavirus pandemic stopped consumers from dining out. In comparison, Yum China's revenue declined 24% in the first quarter, when the industry was the worst hit by lockdowns. During the quarter, digital orders accounted for 84% of sales at KFC and 65% of sales at Pizza Hut, an increase of 29 and 36 percentage points, respectively, year over year.
In 2020, the overall consumer food service sector in China is likely to decline by over 20%, Hu said in an interview. The chained restaurants, however, are expected to fare better with an estimated decline of about 15%, compared to independent restaurants, which may fall by nearly 22%, Hu said.
"With COVID-19, people have greater trust in chain restaurants, not just fast food specifically. In general, they have better standard operating procedures, more transparency in the kitchen that leads to a safer production process," Chuang said.
Additionally, the Chinese dining segment is fairly fragmented, making it ripe for consolidation. Haidilao, which is the leader in the Chinese casual dining category, has only 716 restaurants in China, compared to Yum China's over 9,000 stores.
With restaurant businesses still reeling from the effects of the pandemic, and a healthy $1.54 billion of cash on its balance sheet and potentially more to come from a capital offering in Hong Kong, Yum China should be on the market for an opportunistic acquisition in the high-growth segment, said Xie.
"The challenge is whether you can find the right assets. Now would be the interesting time," Chuang said.
