Added ingredient

LBO-style debt adds zing to Yum Brands break-up

Junk food and junk debt make a heady combination. Yum Brands, the firm behind Kentucky Fried Chicken, will stuff shareholders with more than $6 billion of cash before spinning off its China arm. That will leave the remaining "New Yum" with sufficient debt to make it look rather like a self-administered leveraged buyout.

On December 10, Yum laid out more details of the separation it first announced in October. Yum will split into a debt-free, store-owning Chinese operation with big expansion plans, and a far less capital-hungry global business whose KFCs, Pizza Huts and Taco Bells are largely owned and operated by franchisees.

In the process, Yum pledges to distribute $6.2 billion in buybacks and dividends. That's a big bite for a business whose market value is currently about $31.6 billion. Leverage at the New Yum will soar to 5 times Ebitda from 1.8 times on a proforma basis. Hence, Standard & Poor's joined Moody's in cutting Yum's credit ratings below investment-grade. Under pressure from activists, Yum management have effectively staged a quasi-LBO, only without the need to bring in Burger King backer 3G Capital or any other buyout firm.

In truth there is a decent financial case for gorging on leverage. Debt costs have ticked up but remain, all told, pretty cheap: 10 to 15-year BB-rated US corporate bonds yield about 6.8 per cent, Merrill Lynch data shows. Plus, the franchise-focused New Yum will actually have higher margins, and more stable earnings and cash flow, S&P says, making it better equipped to service a large debt load. And the industry is no stranger to high leverage, as 3G has shown with Burger King parent Restaurant Brands.

All that said, these are hefty debt multiples for a major listed company, and make Yum a riskier proposition. The split has often been presented in terms of focus, separating investors in a thrills-and-spills Chinese growth business from those lured by a global household name. If it wasn't wholly clear before, the added ingredient in this recipe is now obvious: a big dollop of financial engineering.