BEIJING—Yum Brands Inc.'s preliminary offer to take full control of Little Sheep Group Ltd., the operator of a popular hot-pot chain in China, has signaled a new growth strategy for Yum's largest market.
Analysts said the move indicates that Yum, which has 3,800 KFC and Pizza Hut outlets in China, is looking beyond pizza and chicken to establish its own presence in the rapidly growing market for Chinese casual dining.
Yum bought a 20% stake in Little Sheep in 2009 and increased its stake to 27.2% last year.Yum said after the close of Hong Kong trading Tuesday that the company had submitted a preliminary proposal to buy all of Little Sheep's outstanding shares, apart from a minority stake to be owned by the chairman and other founders. Little Sheep Chairman Zhang Gang owns 2.4% of the company. Possible Way International Ltd., which is based in Hong Kong, owns 29.9% of Little Sheep's shares.
Yum, based in Louisville, Ky., declined to release details of its proposal and said there is no assurance the company will make a formal offer. Yum said any formal offer would depend on regulatory approvals.
Shares in Little Sheep, which has a market capitalization of about US$660 million, rose 0.8% in Hong Kong trading Wednesday.
Little Sheep operates about 480 restaurants serving Mongolian hot pot, a cuisine in which patrons themselves cook meats and vegetables in broth on their tables. The company says its revenue jumped 23% to 1.9 billion yuan (US$291 million) last year from 2009. Profit increased 26%.
China accounted for 54% of Yum's overall profit of $264 million in the first quarter of this year. Yum has grown in popularity with Chinese consumers by adding Chinese-style items, such as fried shrimp and seafood-topped pizza, to its menus.
But Charles Yan, an analyst at Taiwan-based Yuanta Securities Investment Consulting, said such localization has its limits. "To grow without cannibalizing itself, the company needs to buy into the Chinese market," he said. "This will be the most effective approach for expansion."
Mr. Yan said that by tapping into Little Sheep's supplier network, Yum would be able to expand into other kinds of Chinese cuisines and other Asian cuisines, such as Korean barbecue, which is popular in China.
China's restaurant business is booming as personal incomes increase. The market for fast-food and casual dining rose 16% last year from 2009 to reach $340 billion, according to consulting firm AlixPartners, of Southfield, Mich. That compares with 1% growth for the U.S. industry, where sales reached $570 billion.
"The U.S. is dead. Europe is dead. China is the growth market," Mr. Yan said.
Hot pot's popularity is spreading rapidly among office workers in Beijing and other Chinese cities.
Private-equity firm Actis LLP invested $50 million in 2008 for a majority stake in Xiabu Xiabu Catering Management Co. The hot-pot restaurant operator has 160 restaurants in China and plans to open another 80 this year, said Lim Meng Ann, Actis's regional head.
China's chain restaurants typically have higher profit margins than U.S. restaurants do, despite rising labor, rental and food costs, according to AlixPartners. On average, Chinese restaurants increased sales 14% in the first half of last year.
Mr. Paul, the AlixPartners analyst, said it is likely the Yum's proposal will pass regulatory muster but that anything can happen in China, where the government is protective of Chinese brands. Beijing quashed Coca-Cola Co.'s $2.4 billion attempt to take over China Huiyuan Juice Group Ltd. in 2009.
