Month: November 2016

CICC eyes return to greatness — IFR Asia

Leave a Comment / August 11, 2020

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China International Capital Corp has unveiled its much-anticipated acquisition of unlisted China Investment Securities, in a move that may see the PRC’s oldest investment bank regain the top spot in the country’s securities industry.

CICC said on November 4 it planned to acquire 100% of Shenzhen-based CIS for Rmb16.7bn (US$2.47bn) through the issuance of 1.68bn domestic shares to current owner Central Huijin Investment at Rmb9.95 each. The issuance price represents a discount of 0.6% to CICC’s closing prior to the announcement of the proposed acquisition.

The move marks a significant shift in strategy for CICC, which has long flirted with the idea of setting up a retail brokerage unit as its share of business has dwindled, but has so far remained wedded to its institutional clients.

“If you look at CICC’s business model, it has a very strong institutional focus, but we all know China’s capital markets are primarily driven by retail investors,” said Benjamin Quinlan, chief executive officer and managing partner at Quinlan & Associates. “CIS has a strong retail franchise, so it seems to complement CICC’s existing business quite well.”

CICC made its reputation bringing some of China’s biggest state-owned enterprises and red chips to the equity and debt markets. This included the US$21.9bn IPO of Industrial and Commercial Bank of China in 2006 and the US$22bn IPO of Agricultural Bank of China four years later.

After being ranked the number one brokerage firm in China in 2010, it fell to number 23 last year, according to Securities Association of China data, as the flow of giant SOE listings dried up and other Chinese securities firms expanded rapidly, using their stronger capital bases and wider branch networks to build intermediary businesses, especially around margin trading.

Bi Mingjian, appointed CEO of CICC last December, has made expanding the bank’s brokerage and asset management units a key part of his overall strategy and has sought to reduce reliance on institutional and wealthy clients.

CICC has only 20 branches in the PRC versus the 200 of CIS, according to its website. CICC’s small retail footprint has affected its earning capacity from retail investors, who account for most of the trading in the onshore capital markets.

“CICC was originally founded to be China’s one ready-for-Wall Street, global investment bank, but that strategy is no longer perfectly aligned with the profits and priorities of China’s banking industry,” said Peter Fuhrman, chairman and CEO at China First Capital.

“Instead of trying to compete with Goldman Sachs and Morgan Stanley, CICC will now be matched against a group of domestic competitors. This is ideal as investment banking fees within China, both for IPOs and the secondary market, are high and not that troublesome to earn.”

ADVISORY BUSINESS

Most analysts consider the acquisition, at around 1.1 times forward book value, as good value and a good strategic fit that should help propel CICC up the league tables.

“If you aggregate the market share of both firms across the equity and debt capital markets and M&A advisory, the combined entity could come out as number one in all three rankings,” said Quinlan.

“This might not be the case, but we expect CICC to be at least a top-five player in ECM and DCM, following the acquisition, and most probably top three for M&A advisory.”

The proposed acquisition will boost CICC’s balance sheet. CICC ranked 24 in terms of total assets in 2015 with Rmb63bn, while CIS was 18th with Rmb92bn. Their ranking would advance to 13 after the integration, still far short of the industry leader Citic Securities with total assets of Rmb484bn.

CICC ranked 23 among China’s 125 securities firms in 2015 in revenue terms, while CIS ranked 17, according to the Securities Association of China.

Some questions have been raised about the potential cultural mismatch between the two firms and there have also been suggestions that the Chinese government may be directing the acquisition as it seeks to improve the sector’s reputation for probity.

China’s securities sector has expanded at a considerable pace in the last few years with the combined asset base of the 125 securities companies operating there increasing fourfold between 2011 and 2015 to Rmb6.4trn and there are few signs that the pace of growth is likely to abate.

“It could be a win-win situation for the two firms, because their business models are very complementary,” said an analyst.

“However, it is also a big challenge for CICC on whether it can generate the synergies it expects, by applying its strengths in high-end services to the huge customer base and network of CIS,” said the analyst.

Following the acquisition, CIS will become a wholly owned subsidiary of CICC, while Huijin’s stake in CICC will increase to 58.7% from 28.6%.

CICC and ABC International are financial advisers for the transaction. The deal requires approval from shareholders and regulators.

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Bill Gross, America’s “Mr. Unicorn”, Plots A Future in Asia

Leave a Comment / November 18, 2016

 

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Few technology entrepreneurs start one unicorn, a tech company with a market valuation of over $1 billion. Elon Musk has started three. Xiaomi’s Lei Jun two. Bill Gross has started and exited from seven, and has another two in his active porfolio.

Gross is the founder and chairman of Idealab, one of America’s oldest and probably still most successful technology incubators. Idealab was established in 1996. Gross was 38 years old then. He had already started and sold two software companies. He decided to take some of that money, as well as some from investors he knew, and start his own incubator.

From the beginning, Idealab has pursued a unique path among technology investors in California. Unlike most other incubators and VC funds, Gross himself comes up with most of the ideas for the new Idealab companies. Idealab then provides the first round of capital for each new company, hires a CEO and Gross takes on the role as non-executive chairman. Idealab has a full-time team to manage the back office work like HR and accounting for new companies during their early stages.  Idealab headquarters is in an old brick warehouse in the California city of Pasadena, near Los Angeles, and close to Caltech, where Gross went to school.

In the last 20 years, Gross has started 150 businesses. Of these, 45 have had successful exits, either through IPOs or M&A. A similar number are still in the Idealab portfolio.

The unicorns Gross created include some of the most successful early successes in e-commerce and online advertising. The companies are: eToys, Overture, Tickets.com, Netzero, Centra, Shopping.com and  Citysearch. Two other Idealab companies have recently merged with other tech startups. These merged companies, Twilio and Taboola, also now have valuations above $1 billion. Over the years, Gross also started and sold companies to Google, eBay, AOL, AirBNB. Along with internet companies, Gross has also started companies in solar and renewable energy, robotics, online education, wireless networking, 3D printing machinery, home medical care.

Gross long ago stopped raising money from outside investors. Idealab is a corporation, not a fund. Gross has the kind of freedom most tech entrepreneurs can only dream of – the imagination and drive to start new technology companies, a few new ones every year, and the capital to help them grow. Idealab’s capital contribution into each new company is about $250,000. If a company begins to grow according to plan, Idealab then raises outside money from VC firms, mainly the large ones based in Silicon Valley. Idealab’s return on invested capital up to now: 13.5 times.

Gross was born in Japan, but moved to California as a boy and got his start as an entrepreneur while in middle school. For 20 years, he has seen technology business opportunities earlier than most people. Anyone interested in where technology is headed, the important problems it may solve, how to incubate successful startups, and how China and East Asia may become more deeply integrated into California’s innovation ecosystem should listen to what Gross has to say.

 

Venture capital investing and incubators have grown very large in the last few years, both in the US and also elsewhere including China. There’s still a lot of capital looking for good ideas. Let’s dissect please how you look at the world. What are the key “metatrends” you see that will impact the shape and size of the global economy over the next 35 years?

Let me take you through those quickly. Start with population growth. The projections are there will be 9.7 billion people on the planet by 2050, up from 7.4 billion today. Larger population means lots of possibly negative impacts and so areas where technology needs to come up with new solutions. What are the major challenges in the future? I think mostly about six. I’m an engineer, so let me give you a list:

  1. climate change;
  2. how to the meet the need to provide better, more affordable healthcare and prevention against global epidemics
  3. food security, having enough safe food available across the world
  4. the growing technological divide between people living with the benefits of modern technologies and those who are left behind
  5. the workforce of the future, how to make sure people have the right skills to find productive jobs
  6. the future of the internet, how to provide security and privacy to everyone using it.

 

The people working to solve these problems probably hope to win Nobel Prizes, not become technology entrepreneurs.  So, where do you see the concrete business opportunities, where there’s both a future market and a potential for some kind of new technology breakthrough?

Of course, you wouldn’t expect me to hand over the keys to my kingdom, to give you the exact business areas we are now working on. But, I can share the industries where I think there’s lots of opportunity worldwide and where we’re actively coming up with new business ideas and looking to start new companies. Again, if you don’t mind, let me give it to you as a list.

  1. Autonomous cars and drones
  2. Clean water and clean energy
  3. New education models, including MOOCs
  4. Agriculture technology, including urban farming, growing food closer to population centers
  5. Advanced machine-meaning and deep neural networks to provide better, smarter data and decision-making
  6. 3D Printing, using metal, new materials
  7. IoT consumer and business
  8. Home automation
  9. Virtual reality and human-computer interaction
  10. New forms of transportation, including hyperloop and perhaps even flying cars
  11. Space, inexpensive launches, to space mining and microsatellites
  12. Software and information security systems to manage each of these

While it’s still possible to start successful companies with limited capital and get to market quickly as we’ve been doing for the last 20 years, some of the newer business opportunities I like will need much larger amounts of money and a longer incubation period. But, the rewards for success will be larger than anything we’ve seen up to now.

 

Up to now, you’ve focused only on building breakthrough tech companies in California to serve to US market. There are other places in the world with money and markets for good technology.

Yes, I definitely see a fusion of powerful and positive forces taking place in Asia that could allow Greater China to emerge as an important constituent in globally-important innovation, both as a market and as a base of ideas and manufacturing. This will be good for China, good for Asia, good for the US, good for the world.

I’m an inventor, and so have always looked to China. I have huge respect for the ingenuity, diligence and entrepreneurship of the Chinese people. Look at the example of China’s greatest inventor, Lu Ban, who lived almost 2,500 years before America’s Thomas Edison. He came up with ideas for flying machines and all kinds of advanced wooden implements .

 

So what role can you envision China playing as one of the world’s centers of technology innovation?

China, like the US, is a place where a large domestic market, manufacturing strength, capital and entrepreneurial culture all come together.

A few years ago, I gave myself a challenge, to come up with one new business idea every day.  I’ve mainly been able to keep up that pace. We could start even more companies, but there’s often one big constraint. We can’t find enough great people to run each new company. Greater China is blessed with having a large number of talented managers and engineers. That’s a huge and valuable resource. On the downside, intellectual property protection in China isn’t nearly as robust as it needs to be.

 

All of Idealab’s billion dollar exits happened during the early years of the internet, with IPOs for companies including eToys, Citysearch, Tickets.com and the sale of online-advertising business Overture to Yahoo. Have big exits become harder?

IPOs have certainly slowed down. The total number of annual IPOs in the US has been falling since we got started 20 years ago. It used to be over 300 companies on average IPOd every year in the US. It’s now below 100. This year is looking like one of the slowest for US IPOs. A big reason is the cost and regulatory burden of being a public company in the US. Our exits now come from M&A.  We continue to do pretty well.

Let me quickly go over our three of our most recent M&A exits. The three are all in different industries — mobile phone security, solar energy and robotics. We started Authy to provide simple but more effective mobile phone data and transaction security. We merged it last year with Twilio, which IPOd this summer on the New York Stock Exchange and now has a market cap of over $4 billion.

RayTracker is a company we started to improve the performance and energy production from solar panels by getting them to track the movement of the sun across the sky. This has been a passion of mine since high-school, to make solar energy more affordable and efficient. We sold RayTracker to First Solar, a Nasdaq-listed company. Today ground mounted trackers like RayTracker invented account for more than 90% of all solar installations in the US and First Solar is a leader the field.

The other recent exit is a little bittersweet, because we may have come to market a little too early with a product consumers originally didn’t really understand. They do now. Being too early with an idea can lead to failure just as quickly as being too late.  Our company was Evolution Robotics, which was probably the first company to design hardware and software for a home robot to clean floors. We had to come up with substantial new technology in vision recognition and spatial mapping, including our own proprietary indoor GPS system using infrared. We sold our company to a competitor, iRobot, which is now by far the largest company in this industry.

 

Can we have a peek inside the current Idealab portfolio? Talk to us about companies you think have the potential to grow into billion dollar businesses within the next few years?

I mentioned already my lifelong passion for clean energy and making solar energy cheaper and more efficient. We have two companies now, Edisun and Cool Energy, that have unique solutions that are finding a lot of market acceptance. Edisun both generates and stores solar energy, so it can be delivered to the grid when it’s needed. Cool Energy uses a Stirling Engine to capture low temperature waste heat, like from machines in a large factory, and turn it into clean electricity.  It can also make electricity from waste cold, like the huge refrigeration vessels used for LNG storage.

Mark Andreesen, the guy who invented the first commercial web browser and is now a successful venture capital investor, has said that “software is eating the world”. He means that just about every product and service is going to need more and better software in the future. I agree. The problem is, where are all those new software engineers going to come from? We’ve started two companies to teach kids how to write software, CodeSpark and Ucode. We’re noticing CodeSpark has more and more kids in China using it to learn to write software. We need to come up with a Chinese version, as well as Japanese, Korean.

One other area where we see huge potential is capturing and analyzing more and better mobile data, then using it for more efficient advertising. This could be as big a future market as “Pay-per-click” online advertising that earns so much money for Google and Baidu. I have a longer history in this area than most people. Overture, a company I started and sold to Yahoo for $1.6 billion in 2003, was an early successful pioneer of online advertising.

 

In the last 20 years, you’ve started 150 businesses, and had ideas for hundreds of others. Few people anywhere at any time have done that much business creation. What you have you learned about the reasons why start-ups succeed and fail?

I believe that the startup organization is one of the greatest forms to make the world a better place. If you take a group of people with the right equity incentives and organize them in a startup, you can unlock human potential in a way never before possible. You get them to achieve unbelievable things.  But if the startup organization is so great, why do so many fail?

This matters to me as an investor and entrepreneur. I’ve started more failed companies than probably just about anyone else. They all looked promising at the beginning, had money and people in place, but ended up dying. Each time a company fails it’s heartbreaking for the entrepreneur. So, trying to get some usable analysis on this process may end up reducing the failure rate for me and I hope many others too.

I tried to look across what factors accounted the most for company success and failure. So I looked at the five key factors — the idea, the team, the execution, the business model and the timing. It accounted for 42 percent of the difference between success and failure. Team and execution came in second, and the idea, the differentiability of the idea, the uniqueness of the idea, actually came in third.

 

After 20 years at Idealab, and twenty years before that starting and running your own start-ups, aren’t you getting tired of this, the pressure, the risk, the uncertainty of starting new companies? There’s got to be an easier way to earn a living.

I think we are in a very exciting time where technology and innovation permeates everything we do, and every company.  If the previous 20 years of my life were devoted to fostering entrepreneurship, I would love my next 20 to be about pushing new technological boundaries to make the world a better place. To happen, it’s going to need Asia and California to push together.

 

Version as published by Nikkei Asian Review

Chinese version as published by Caijing Magazine (财经杂志中文版）

Bill Gross’s TED Talk on why startups succeed

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The Big Sort — The Economist

Leave a Comment / August 11, 2020

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“THE vultures all start circling, they’re whispering, ‘You’re out of time’…but I still rise!” Those lyrics, from a song by Katy Perry, an American pop star, sounded often at Hillary Clinton’s campaign rallies but will shortly ring out over a less serious event: a late-night party in Shenzhen to kick off “Singles’ Day”, an online shopping extravaganza that takes place in China on November 11th every year.

The event was not dreamt up by Alibaba, but the e-commerce giant dominates it. Shoppers spent $14.3bn through its portals during last year’s event. That figure, a rise of 60% on a year earlier, was over double the sales racked up on America’s two main retail dates, Black Friday and Cyber Monday, put together. Chinese consumers are still confident, so sales on this Singles’ Day should again break records.

It points to an intriguing question: how will all of those purchases get to consumers? Around 540m delivery orders were generated during the 24-hour spree last year. That is nearly ten times the average daily volume, but even a slow shopping day in China generates an enormous number. By the reckoning of the State Post Bureau, 21bn parcels were delivered during the first three quarters of this year.

The country’s express-delivery sector, accordingly, is doing well. In spite of a cooling economy, revenues rose by 43% year on year in the first eight months of 2016, to 234bn yuan ($36bn). And although the state’s grip on China’s economy is tightening, the private sector’s share of this market is actually growing. The state-run postal carrier once had a monopoly on all post and parcels. Now far more parcels are delivered than letters, and the share of the market that is commanded by the country’s private express-delivery firms far exceeds that of Express Mail Service, the state-owned courier.

China’s very biggest couriers have been rushing to go public on the back of the strong growth. Most of them started life as scrappy startups, and are privately held. But because of regulatory delays, which mean a big backlog of initial public offerings, many companies have resorted to other means. Last month, two of them, YTO Express and STO Express, used “reverse mergers”, in which a private company goes public by combining with a listed shell company, to list on local exchanges. In what looks to be the largest public flotation in America so far this year, another, ZTO Express, raised $1.4bn in New York on October 27th. Yet another, SF Express, China’s biggest courier, recently won approval to use a reverse merger too.

But investors could be in for a rocky ride. Shares in ZTO, for example, have plunged sharply since its flotation. That is because the breakneck growth of courier companies masks structural problems. For now, the industry is highly fragmented, with some 8,000 domestic competitors, and it is inefficient.

One reason is that regulation, inspired by a sort of regional protectionism, obliges delivery firms to maintain multiple local licences and offices. Cargoes are unpacked and repacked numerous times as they cross the country to satisfy local regulations. Firms therefore find it hard to build up national networks with scale and pricing power. All the competition has led to prices falling by over a third since 2011. The average freight rate for two-day ground delivery between distant cities in America is roughly $15 per kg, whereas in China it is a measly 60 cents, according to research by Peter Fuhrman of China First Capital, an advisory firm.

A handful of the biggest companies now aim to modernise the industry. Some are spending on advanced technology: SF Express’s new package-handling hub in Shanghai is thought to have greatly increased efficiency by replacing labour with expensive European sorting equipment. A semi-automated warehouse in nearby Suzhou run by Alog, a smaller courier in which Alibaba has a stake, seems behind by comparison but in fact Alog is a partner in Alibaba’s logistics coalition, which is known as Cainiao. The e-commerce firm has helped member companies to co-ordinate routes and to improve efficiency through big data.

Other investments are also under way. Yu Weijiao, the chairman of YTO, recalls visiting FedEx, a giant American courier, in Memphis at its so-called “aerotropolis” (an urban centre around an airport) in 2007. He was awed by the firm’s embrace of advanced technology. He returned to China and sought advice from IBM on how his company could follow suit. YTO is using the proceeds of its recent reverse merger to expand its fleet of aircraft, buy automatic parcel-sorting kit and introduce heavy-logistics capabilities for packages over 50kg.

There is as yet little sign that China’s regions will begin allowing packages to move freely, so regulation will remain a brake on the industry. More ominously, labour costs are rising. There are fewer migrant labourers today who are willing to work for a pittance delivering parcels. This week China Daily, a state-owned newspaper, reported that ahead of Singles’ Day, courier firms were offering salaries on the level of university graduates.

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http://www.economist.com/news/business/21710004-chinas-express-delivery-sector-needs-consolidation-and-modernisation-big-sort

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China Inc.’s Investment Bank Dives Into Troubled Retail Market — Bloomberg

Leave a Comment / August 11, 2020

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China International Capital Corp., the investment bank ex-Premier Zhu Rongji set up two decades ago to help restructure the Chinese economy, is again taking on a role that fits with the government’s agenda.

CICC’s $2.5 billion acquisition of China Investment Securities Corp. will plunge the firm into the retail investor market, a segment it had long shunned because of thin margins and a traditional focus on institutional clients. The deal is part of Chief Executive Officer Bi Mingjian’s push to lessen dependence on volatile investment banking fees.

Yet the transaction also ties in with a key objective of the government, which will become CICC’s largest shareholder as a result of the purchase. Having used CICC to take some of the largest state companies public since the late 1990s, China is now looking for assistance in its quest to reform a retail-driven equities market that’s prone to speculative booms and busts.

In the wake of the latest such episode, a stock market meltdown last year, the government launched an unprecedented crackdown on the securities industry and arrested several high-ranking executives.

“CICC will once again play this civilizing and globalizing role, only with the more far-reaching aim of helping to professionalize the often-shambolic Chinese stock market,” said Peter Fuhrman, chairman of China First Capital, a Shenzhen-based advisory firm. “Its reputation is still unsullied in China, unlike other banks whose leaders have been marched out in handcuffs and whose market practices are widely blamed for the rampant speculative fever that often afflicts China’s domestic capital markets.”

Reforming Role

In announcing the takeover on Friday, CICC hinted at a reforming role by saying the two firms will “work together to improve the quality and efficiency of mass market services” through training and by upgrading technology systems at China Investment Securities’ 192 branches across the country that serve retail clients.

CICC is buying China Investment Securities from state-owned Central Huijin Investment Ltd. It will issue shares to Central Huijin, more than doubling the entity’s stake in CICC to 58.7 percent. CICC had to get a waiver from the Hong Kong Stock Exchange for the transaction, so that Central Huijin’s controlling stake wouldn’t be classified as a reverse takeover.

An additional rationale for the deal is Huijin’s push to consolidate the securities industry by combining institutional and retail brokerage businesses, said Zhang Chunxin, an analyst at CMB International Capital Holdings Corp. She cautioned that “the reform process will be long and gradual.”

China Investment Securities ranked 17th among Chinese securities firms by revenue last year, while CICC was 23rd, according to official data. Bi’s overhaul has the support of the firm’s foreign shareholders, who had already been pushing CICC to diversify into areas such as asset and wealth management, a person with knowledge of the matter said.

Sherry Tan, spokeswoman at CICC, declined to comment.

Shareholder Backing

The combined stakes of CICC’s main foreign backers — private equity firms TPG Capital and KKR & Co., and Singapore sovereign wealth fund GIC Pte — will drop to 15.3 percent as a result of the takeover. However, the foreign firms may buy additional stakes from Central Huijin in future, people familiar with the matter said.

When former premier Zhu Rongji created CICC in 1995, China was launching a shakeup of its state-run industrial sector, leading to the closure of some 60,000 firms and loss of 40 million jobs. Since then, CICC has worked on some of the biggest listings of state enterprises, such as China Construction Bank Corp. and China Mobile Ltd. It was the top adviser on mergers involving Chinese companies in 2014, 2015 and so far this year.

Buying China Investment Securities is a departure from former CEO Levin Zhu’s strategy. The son of the former premier, who ran the firm until two years ago, had long resisted expanding into retail broking, fearing it would erode margins and its differentiation from other Chinese securities firms, according to people familiar with the matter.

Last year’s leverage-fueled equities rally and the subsequent implosion brought worldwide attention to the shortcomings of China’s markets. The government responded with an effort that included enlisting securities firms in supporting the stock market as well as jailing senior brokerage executives for alleged wrongdoing. CICC wasn’t among the firms that took part in the stock-market rescue, but China Investment Securities was.

Market Manias

China’s 114 million individual investors account for the bulk of equities trading. That makes them a hard-to-ignore segment, but also one that tends to be susceptible to market manias. Critics contend that the government’s efforts to restore market calm last year only served to hurt investor confidence further.

The Shanghai Composite Index remains 39 percent below its June 2015 peak. Xiao Gang, who was removed from his post as chairman of China’s securities regulator this year, in January acknowledged loopholes and ineptitude within the regulatory system.

Some analysts aren’t convinced the deal is in CICC’s best interest. The stock fell 2.1 percent on Monday after a trading halt was lifted.

The transaction makes the firm “more like a state-owned company, which could compromise CICC’s corporate governance, operational autonomy” and its ability to retain top talent, said Fred Hu, Goldman Sachs Group Inc.’s former Greater China chairman.

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http://www.bloomberg.com/news/articles/2016-11-07/china-inc-s-investment-bank-dives-into-troubled-retail-market

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Has Yum Worked Out How Fast-Food Firms Can Crack China? — Bloomberg

Leave a Comment / August 11, 2020

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Global consumer companies trying to find a business model for China’s burgeoning domestic market will be watching closely as one of the oldest Western brands in the country starts a new strategy.

Yum! Brands Inc., which opened its first KFC restaurant in China in 1987 and also operates Pizza Hut outlets, has been losing market share thanks to a food-safety scare, changing tastes, increasing local competition and a host of other challenges that foreign companies face in China. It carved out its China operations into a separate company, Yum China Holdings Inc., which begins trading today in New York.

Ring-fencing the business, the largest independent restaurant company in China with 7,000 outlets and more than $900 million cash on hand, offers Yum a number of advantages in dealing with a fast-changing market. Yum’s example could provide a road map for other global consumer brands in the world’s most populous nation.

Yum China has issued 386 million shares at $24.36, which puts its valuation at around $9 billion, according to New Jersey-based research firm Edge Consulting Group LLC. The stock rose about 2 percent to $24.85 as of 9:59 a.m. in New York, while Yum Brands gained 0.7 percent to $62.49.

“When their China operations get so big and are clearly catering just to the China market, splitting off could unlock a lot of value for shareholders,” said Shaun Rein, Shanghai-based managing director of China Market Research Group. “If I were an activist hedge fund investor, I would be looking at carving out brands within large conglomerates that are China plays.”

Doing so allows Yum’s management of the China business to tailor its operations and products more swiftly to changing local conditions, such as the menu preferences of diners in different parts of the country, mobile-based payments systems, hiring and other factors.

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It also helps tap Chinese investors willing to pay high premiums for a stake of an international brand’s China operations. Yum sold a combined $460 million stake in its Chinese business to Primavera Capital Group and an Alibaba Group Holding Ltd. affiliate, Ant Financial Services Group, in September.

In recent years, Yum has ceded market share to local competitors because it was slow to react to market changes, said Rein.

“They didn’t make corporate decisions quickly enough, such as in adopting mobile payments, or adapting to consumers wanting more premium offerings,” Rein said. “Their ability to deal with the more complex environment here was held back by the lack of knowledge, the slowness of the U.S.”

Localization of offerings at KFC and Pizza Hut outlets in China will be an important component of the firm’s strategy for the country, Yum China Chief Executive Officer Micky Pant said at a briefing Tuesday in Shanghai. The company plans to increase investment in new outlets across its brands and does not plan to raise more capital, he said.

An activist hedge fund investor upset with the company’s handling of its China business is how Yum China came into being.

After a food-safety scandal in 2014 and cheaper local competition torpedoed Yum’s sales and profit in China, Corvex Management founder Keith Meister in mid-2015 urged the company to split off its Chinese operations — which contribute about half the group sales — saying that the move could generate an additional $16 a share in value for the Louisville, Kentucky-based company.

Yum’s total share of China’s market for fast-food chains dropped to 30 percent last year, from 40 percent in 2012, according to data from Euromonitor International. While sales have been growing again in China in the mid-single digits since late last year, the company has suffered from consumers shifting to healthier options and domestic chains sprouting up with more variety.


Volatility Reduction

Unlike Yum’s U.S. operations, where most of its restaurants are run by franchisees, Yum China directly operates over 90 percent of its outlets and plans to triple the number to more than 20,000 in the long term.

Yum’s spinoff would reduce volatility for its remaining business, while “giving investors with a higher risk tolerance access to a more pure-play China growth story,” said Jonathan Morgan, an analyst for Edge Consulting. “China’s economic slowdown could induce other U.S.-listed restaurant stocks to spin off their China businesses, to protect their core businesses.”

So far, companies with China consumer arms have often chosen instead to sell the division to a local competitor and take a stake in that business instead.

Wal-Mart Stores Inc. in June sold its e-commerce platform Yihaodian to China’s second-largest e-commerce company, JD.com Inc., for a 5 percent stake in JD. In August, Uber Technologies Inc. surrendered after a year-and-a-half battle with Didi Chuxing and agreed to sell its business in China. It departed the country in exchange for $1 billion in cash and a 17.7 percent stake in Didi.

McDonald’s Corp., meanwhile, is seeking to sell its 20-year mass franchise rights for China and Hong Kong for a reported $2 billion.

Starbucks Corp. is the only other major U.S.-listed food and beverage chain in China beside Yum, which owns and operates its outlets, numbering 2,400 stores across 110 cities.

China, Starbucks’ largest international market, represents the most significant opportunity for the company, said a company representative. The company has no intention to change its operation model in the market, according to the spokesperson.

Jackpot Valuations

“What we’ve seen across various industries is that foreign players eventually pull out or find a local partner,” said Hong Kong-based S&P Global Ratings’ restaurant and retail analyst Shalynn Teo. “It’s the local market knowledge and local relationships that determine which foreign businesses survive in China, and local players will always have an edge.”

With Chinese investors paying a premium for market share, such deals can prove attractive, said Peter Fuhrman, CEO of Shenzhen-based investment bank and advisory firm China First Capital. “As long as Chinese investors are offering jackpot valuations,

Those that don’t face the need to tailor their businesses to China’s widely diverse and morphing consumer market. Only from March this year did KFCs in China began accepting WeChat Pay; they started accepting Alipay mobile payments in July last year. Yet the country leads the world in the use of such transactions, with four out of 10 Chinese consumers using mobile payments at physical stores, research firm EMarketer estimated.

Starbucks stores in China still do not accept Alipay or WeChat, only Apple Pay, a decision which costs them 5 to 10 percent of sales, estimates China Market Research Group’s Rein.

Starbucks launched its own mobile payment system in China in July, allowing customers to pay with preloaded Starbucks Gift Cards via their mobile devices, according to the company.

As China’s consumer market continues to grow, more overseas companies may consider following Yum down the path of segregation.

“Four out of 10 spinoffs do not generate a return in the first year of separation,” said Edge Consulting’s Morgan. “How Yum China performs will help U.S.-listed companies evaluate their strategic options in China.”

 

http://www.bloomberg.com/news/articles/2016-10-31/yum-s-spinoff-offers-roadmap-for-western-brands-in-china-market

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