The PepsiCo Spinoff of Yum Brands: Twenty-Year Review

Back in the 1990s, Pepsi had its hand in every cookie jar. It not only had its beverage lineup led by Pepsi, Diet Pepsi, Mountain Dew, and (before later selling it off) Schweppes, but also had branched out into food as well. In addition to the well-known Frito-Lay acquisition that turned it into a colossal source of snack profits, PepsiCo shareholders also had an entrenched interest in the fast food business, having held full ownership of KFC, Pizza Hut, and Taco Bell.

In September of 1997, Pepsi’s Board of Directors decided that it would spinoff Tricon Global Brands (YUM’s original name) with each Pepsi shareholder receiving 1 share of Tricon for every 10 shares of Pepsi owned.

What has happened to those Pepsi and Yum shares over time?

Today, each share of Pepsi has become 1.6 PEP shares with dividends reinvested for a compounding rate of 7% annualized.

Each .1 of Yum Brands stock has become  1.29 YUM shares with dividends reinvested for a compounding rate of approximately 17% annualized.

If you owned 250 shares of Pepsi stock in 1997, which would have cost you around $7,500 using pricing that incorporates the stock splits, and dutifully reinvested, you would 400 shares of Pepsi worth $38,800 paying $1,484 in cash dividends and also 322 shares of YUM Brands worth $26,726 paying out $463 in annual dividends.

The original $7,500 investment grew into something worth more than $65,000.

Some people might look at the outperformance of YUM Brands over the past two decades and thinking that holding the smaller spin-off is always the correct decision. While it is right more often than not, as the shares are cheap because institutional investors aren’t usually drawn to them and the unproven track record and financial data often causes more cautious investors to flee, I have seen instances when spin-offs are a way for a company to package up junk and liabilities and clear the deck from the corporate coffers.

In fact, a particular spin-off was one of the reasons I got interested in investments in the first place. The mother of a friend had inherited shares of Peabody Energy stock from her father, which at the time had recently spun off Patriot Coal.

For someone, as barely a college a student, I was asked for advice. After disclaiming and trying to avoid the question–there is no “win” here because you’re blamed if your advice is wrong and you receive only an illusory benefit of correct–it eventually reached the point where I was asked directly, “If this were money that you had inherited from your dad, what would you do?”

I had looked at Patriot Coal’s balance sheet, and it was the worst thing I had ever studied. I passed along an entry in a finance textbook that warned of leverage that exceeded 10x of normalized profit, and Patriot Coal’s debts were more than doubled that. To the extent that an existing business can beg for bankruptcy, that is how Patriot Coal was positioned coming off the Peabody spinoff, and it did file for bankruptcy four years later.

To the extent that you can figure out the quality of a spin-off in real time, the balance sheet is usually available. If it is a cyclical company with an enormous debt load that could not be serviced if the previous recession were to appear, stay away.

In Tricon/Yum’s case, the KFC, Pizza Hut, and Taco Bell brands were experiencing modest-growth in the United States and were growing at 20% annual rates in China. That is very intriguing. For those who wanted some type of global holding that could be understood, Yum Brands was a great way to access the Chinese markets without making the mistake of buying something that you don’t really understand.

When other large companies engage in similar spinoffs, I think of it as a company deciding to splice its growth and stability portions. The parent organization, Pepsi, is likely choosing stability at the expense of growth (at the time of the spinoff, Pizza Hut was launching advertising campaigns that were not growing profits and proved distracting at Pepsi analyst meetings. YUM’s executive team handled this issue with aplomb by coming up with various corporate-speak iterations of: “Look how fast Taco Bell is growing and how much free cash flows KFC is throwing off.” The spin-off organization, in turn, is choosing growth but giving up the stability of vast resources of the parent organization.

Although I perform the preliminary gut-check for the debt load and general solvency of the spun-off, my preferred approach is to ignore spin-offs and let them pile up. It is not uncommon to see the spin off company deliver returns that just turn the initial investment into a complete compounding machine. Who would have that, when buying Pepsi in 1996 or early 1997, that you would receive a teeny-tiny spinoff worth only a tenth of your Pepsi stock which would go on and quadruple your wealth compared to the initial amount that you directed into the parent entity. You want to go through life with your family’s name on more and more stock certificates or, to put it more modernly, become the beneficiary holder of the shares that your brokerage account acquires on your behalf. Holding onto these odd-ball things like YUM Brands for twenty years can end up becoming the super-compounders of your business life.

Originally posted 2018-05-15 16:16:34.

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