Malaysia - Why JCorp’s buyout of KFC makes sense

NEVER failing to entertain the market, KFC Holdings (M) Bhd is serving up yet another mouth-watering prospect coming into this new year.

Soon after a buy-out proposal was made by Johor Corporation in partnership with a private equity fund late last year, the Malay Chamber of Commerce (MCCM) then said it was trying to cobble together a counter bid for the fried chicken retailer and its parent company, QSR Brands Bhd. A price tag of RM6.90 for each QSR share was even mentioned, 10 sen higher than the offer by JCorp and CVC Capital Partners Asia Pacific.

It is another story though, as to whether MCCM can actually put together a decent bid. (MCCM officials have said they are wooing local institutions to join them in their bid). Recall that in 2010, one company called Asas Serba Sdn Bhd had used the platform of the MCCM to put in a bid for PLUS Expressways Bhd but that deal didn't come to fruition.

More significantly, one needs to better understand the rationale of JCorp's buyout offer before labelling it a bad deal on the basis that the deal entails the flogging off of good local assets to foreign parties.

The most significant aspect of JCorp's plans to privatise KFC is so that JCorp can gain more from this asset, by making it a more efficiently run business. If and when that happens, JCorp will have access to all the free cash flows that KFC should be churning out, minus unnecessary costs and expenses. At the moment, KFC isn't run in the most efficient way and secondly, JCorp doesn't have direct access to the cash flows of KFC because of the layered shareholding structure its prized asset is mired in. (JCorp owns 53% of Kulim (M) Bhd, which in turn has a 57.5% stake in QSR. And QSR owns 50.6% of KFC.)

That then brings us to the question of what is CVC doing in the picture? How come this foreign private equity fund is getting a piece of the action? The answer is simple enough: established private equity funds like CVC are the best people in town to turn around businesses. That is the very essence of private equity: buying assets that can be re-shaped for the better and exiting those businesses at higher valuations when all the hard work is done. In a sense, this deal is akin to JCorp bringing in consultants to help shape up one of their prized assets that isn't reaching its full potential. The only difference is that CVC, instead of earning the usual consulting fee, is being paid via equity participation in the very asset it is hoping to turn around.

Is that a good or bad thing? That depends on what happens next. This model is an excellent one if changes are indeed made to the running of KFC that translates into healthier cash flows, which in turn raises KFC's valuation. With CVC having an equity stake, its fortunes are inextricably linked to the performance of this asset. This is better than merely paying a consultant to come in to change things for a fee. CVC's modus operandi is to exit this investment after that process of shaping up KFC and this is how all private equity firms operate. The exit could take the form of a public listing of KFC.

However, things could go awry if JCorp and CVC took a shorter-term view of the asset. For example, in the past, there have been cases where private equity players, after taking over an asset, have tended to load the same asset with debt and used the financing raised to pay themselves back handsome dividends. Or the buyers can opt to break up the asset and sell it piecemeal, making more money in the process.

Clearly though, JCorp and CVC aren't aiming to do this. JCorp is going through some positive changes, aimed at steering itself back into health after being saddled with huge crumbling debts. It now wants to focus on only a few areas of business, namely palm oil plantations, healthcare, property and the food industry. CVC on the other hand, is a global name in private equity, and has its reputation at stake. CVC is one of the world's leading private equity and investment advisory firms, managing over US$44bil (RM140bil) worth of funds. It has a proven track record in managing and growing food and beverage and other consumer-centric businesses.

Hence MCCM needs to realise that the price that JCorp and CVC are offering to buy QSR and KFC is not one plucked out of the air but one that has been arrived at after some serious number crunching and assumptions of how much more KFC will be worth after the buyers dive in and put in the hardwork of making this asset more productive.

If MCCM has a plan that can match that level of turnaround efforts and financial returns, then they should go for it.

Raison D'etre - Risen Jayaseelan

The Star

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