JCorp/KFC/QSR

KFC is one of JCorp’s better assets with growing operating cash flow and dividend payouts to shareholders. It generates more than rm300 million in gross operating cash f low per year.

So it is easy to see why JCorp, with some rm3.2 billion of debts to pay off in 2012, wants to bring KFC closer to the mother ship.

The Johor state government is teaming up with CVC Capital Partners via a special purpose vehicles called Massive Equity Sdn Bhd to carry out the exercise.

It will cost Massive Equity some rm2.2 billion of its bids to acquire the assets and liabilities of QSR is successful. The bid will also trigger a general offer in KFC as QSR has more than a 50% stake in the former. The success of the general offer in KFC will cost Massive Equity a further rm3.2 billion.

The exercise will add to JCorp’s debt burden considering that it holds 51% equity interest in Massive Equity. JCorp has yet to strengthen balance sheet and firm up plans to meet its rm3.2 billion debt obligation. Will this exercise the help JCorp with the debt restructuring in anyway? Should not the group focus on asset disposal and resolving the rm3.2 billion bond issue instead of taking on more debt?

However, officials from Massive Equity say the exercise to streamline the structure will add value to the JCorp group of companies as whole. JCorp could have partnered any local funds, such as the EPF, to take over QSR and KFC. However, JCorp preferred CVC Capital Partners because of the value proposition that it brings to the business and there will something left on the table for JCorp to take back after paying the cost of acquiring the assets and liabilities of QSR.

But naysayers believe otherwise. They say the growth in KFC’s business cannot outpace the cost of carrying out the transaction. The growth will no doubt come from KFC’s chains as Pizza Hut and Ayamas chains are not generating the kind of growth that would motivate a private equity firm to undertake a privatization.

The deal values the assets and liabilities of QSR and KFC at rm5.5 billion. Assume that the outlay of the deal is rm5 billion after stripping the cash from the companies. If the amount is divided on a 30% equity and 70% debt basis, the equity portion would come up to rm1.5 billion to be shared by JCorp and CVC. This means JCorp’s portion would be rm750 million. The debt which probably be financed by a local bank, would be r,3.5 billion.

At a conservative interest rate of 7% it would cost the JV almost rm250 million per annum. KFC’s gross operating cash flow in FY2010 ended Dec 31 was rm318 million. But after stripping out of the cash flow for operations, the amount left would probably be just enough to service the debts. It would not be much left on the table for JCORP even if KFC improves its operations and stops the leakages to improve cash flow.

The upside will come in the next few years when both companies (QSR and KFC) are re listed, probably as one entity. And then JCorp would certainly continue to have a majority stake in QSR and KFC. But would it need to fork out a hefty amount to buy back CVC Capital? Would CVC Capital exit post listing?

In the immediate term, the bigger concern is if the deal will go through.

The offer for KFC still seems to be on the low side. At r,4.00 for the shares and rm1 for the warrants, it is lower than its all time high price of rm.4.11. The offer values KFC at more than 22 times earnings in FY2013 ended Dec 31 and more than 20 times earnings for the current year of operations ending Dec 2012. The offer for QSR is almost 17 times its earnings for the current year of operations.

While the valuations for QSR is generous, KFC is different and minorities may demand a higher valuation.

What happens when minorities do not approve the KFC offer but accept deal for QSR. Then the deal will not happen as the takeover of the assets and liabilities of QSR is subject to the KFC transaction going past the shareholders.

There has been speculation that other parties will come into Massive Equity at a larger stage. This is on the basis of JCorp not having the financial muscle to undertake the exercise at this juncture.

Some of the names being bandied about include businessmen with extensive interests in Johor and strong links with the state and the palace. However, Massive Equity denies such a notion.

Massive Equity is a venture between JCorp and CVC Capital Partners. Where CVC Capital gets its money is unknown. But JCorp holds the majority stake in the venture, and its is something that will add value for the longer term.