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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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China’s Big Banks: learn how they overprice & misallocate loans while treating borrowers like conmen

Leave a Comment / December 11, 2014

Chinese banking loan approval process

Do you have the financial acumen to run the lending department of one of China’s giant state-owned banks? Let’s see if you qualify. Price the following loan to a private sector Chinese company.  Your bank is paying depositors 0.5% interest so that’s your cost of capital. The company has been a bank customer for six years and now needs a loan of Rmb 50mn (USD$8 mn).  The audit shows it’s earning Rmb 60mn a year in net profits, and has cash flow of Rmb 85mn.

You ask the company to provide you with a first lien on collateral appraised at Rmb 75mn and require them to keep 20% or more of the loan in an account at your bank as a compensating deposit. Next up, you ask the owner to pledge all his personal assets worth Rmb 25mn, and on top, you insist on a guarantee from a loan-assurance company your bank regularly does business. The guarantee covers any failure to repay principal or interest. What annual interest rate would you charge for this loan?

If you answered 5% or lower,  you are thinking like a foreigner. American, Japanese or German maybe. If you said 13% a year, then you are ready to start your new career pricing and allocating credit in China. At 10% and up, inflation-adjusted loan spreads to private sector borrowers in China are among the highest in the world, particularly when you factor in the over-collaterallization, that third-party guarantee and fact the loan is one-year term and can’t be rolled over. As a result, the company will actually only have use of the money for about nine months but will pay interest for twelve. Little wonder Chinese banks have some of the fattest operating margins in the industry.

Chinese private businessmen are paying too much to borrow. It’s a deadweight further slowing China’s economy. We are quite keen, by the way,  on private debt investing in China.

The high cost of borrowing negatively impacts corporate growth and so overall gdp growth. It is also among the more obvious manifestations of an even more significant, though often well-hidden, problem in China’s economy: the fact that nobody trusts anybody.  This lack of trust acts like an enormous tax on business and consumers in China, making everything, not just bank credit, far more expensive than it should be.

Online payment systems, business contracts, visits to the doctor, buying luxury products or electronics like mobile phones or computers: all are made more costly, inefficient and frustrating for all in China because one side of a transaction doesn’t trust the other. One example: Alibaba’s online shopping site, Taobao, will facilitate well over USD$200bn in transactions this year. Most are paid for through Alipay, an escrow system part-owned and administered by Alibaba. Chinese shoppers are loathe to buy anything directly from an online merchant. They generally take it as a given that the seller will cheat them.

Most of the world’s computers and mobile phones are made in China. But, Chinese walk a minefield when buying these products in their own country. It’s routine for sellers to swap out the original high-quality parts, including processors, and replace them with low-grade counterfeits, then sell products as new. Chinese, when possible, will travel outside China, particularly to Hong Kong, to buy these electronics, as well as luxury goods like Gucci shoes and Chanel perfume. This is the most certain way to guarantee you are getting the genuine article.

In the banking sector, loans need to have multiple, seemingly excessive layers of collateral, as well as guarantees. Banks simply do not believe the borrower, the auditors, their own in-house credit analysts, or the capacity of the guarantee firms to pay up in the event of a problem.

Disbelief gets priced in. This is the reason for the huge loan spreads in China. Banks regard their own loan documentation as a work of fiction. It stands to reason that if a company’s collateral were solid and the third-party guarantee enforceable, then the cost to borrow money should be at most a few points above the bank’s real cost of capital. Instead, Chinese companies get the worst of all worlds: they have to tie up all their collateral to secure overpriced loans, while also paying an additional 2%-3% a year of loan value to the third-party credit guarantee company for a guarantee the bank requires but treats as basically worthless.

In the event a loan does go sour, the bank will often choose to sell it to a third party at discount to face value, rather than go to court to seize the collateral or get the guarantee company to pay up. The buyer is usually one of the state-owned asset recovery companies formed to take bad debts off bank balance sheets. Why, you ask, does the bank require the guarantee then fail to enforce it? One reason is that Chinese private loan-assurance companies, which usually work hand-in-glove with the banks,  are usually too undercapitalized to actually pay up if the borrower defaults. Going after them will force them into bankruptcy. That would cause more systemic problems in China’s banking system.

Instead, the bank unloads the loan and the asset recovery companies seize and sell the only collateral they believe has any value, the borrower’s real estate. The business may be left to rot. The asset management companies usually come out ahead, as do the loan guarantee companies, which collect an annual fee equal to 2% to 3% of the loan value, but rarely, if ever, need to indemnify a lender.

Don’t feel too sorry for the bank that made the loan. Assuming the borrower stayed current for a while on the high interest payments, the bank should get its money back, or even turn a profit on the deal. Everyone wins, except private sector borrowers, of course. Good and bad like, they are stuck paying some of the highest risk-adjusted interest costs in the world.

When foreign analysts look at Chinese banks, they spend most of their time trying to divine the real, as opposed to reported, level of bad debts, devising ratios and totting up unrealized losses. They don’t seem to know how the credit game is really played in China.

Most of the so-called bad debts, it should be said, come from loans made to SOEs and other organs of the state. Trust is not much of an issue. SOEs and local governments generally don’t need to pledge as much collateral or get third-party guarantees to borrow. A call from a local Party bigwig is often enough. The government has shown it will find ways to keep banks from losing money on loans to SOEs. The system protects its own.

Chinese banks should be understood as engaged in two unrelated lines of business: one is as part of a revolving credit system that channels money to and through different, often cash-rich, arms of the state. The other is to take in deposits and make loans to private customers.  In one, trust is absolute. In the other, it is wholly absent.

Many Chinese private companies do still thrive despite a banking system that treats them like con artists, rather than legitimate businesses with a legitimate need for credit. The end result: the Chinese economy, though often the envy of the world,  grows slower and is more frail than it otherwise would be. Everyone here in China is paying a steep price for the lack of trust, and the mispricing of credit.