(Reuters) - KFC owner Yum Brands Inc (YUM.N) said it plans to spin off its dominant China business, which has been besieged by food scandals and marketing missteps, amid pressure from an activist shareholder who recently joined its board of directors.
Shares of the parent company of the KFC, Pizza Hut and Taco Bell chains rose about 5 percent to $75.22 in early trading, before retreating to $73.55 in the afternoon.
Yum's move on Tuesday is the latest sign of activist hedge funds' strengthening grip over Corporate America.
Keith Meister, CEO of hedge fund Corvex Management, in May disclosed a stake in Yum and unveiled his plan for a Yum China split at a major investment conference.
His arrival appeared to serve as a catalyst for the spin-off, which Yum spokesman Jonathan Blum said was the result of a "rigorous, year-long review."
Yum was already at "the 10-yard line" with regard to the China spin-off when Meister entered the picture, a person familiar with the transaction said, calling the relationship between Yum and activist Meister a "meeting of the minds."
Yum appointed Meister, a portage of billionaire activist investor Carl Icahn, to its board last week. Corvex owns nearly 5 percent of Yum.
The split will create two independent, publicly-traded companies: a higher-risk and potentially higher rewarding Yum China and a more stable, high-cash flow Yum Brands.
Yum's 6,900-restaurant China division is the core driver of its business, contributing 54 percent of overall operating profit in the latest quarter.
That largely debt-free business will be headquartered in Shanghai and run by China leader Micky Pant, who in August replaced Sam Su, who was instrumental in making Yum the biggest Western restaurant chain in that country.
It will become a franchisee of Yum Brands in mainland China, paying the parent a percentage of its sales for exclusive rights to the KFC, Pizza Hut and Taco Bell brands.
Yum's China business recently has become significantly more volatile as it grapples with the country's persistent food safety issues, increased local competition and a cool-down in what is still the world's fastest growing major economy.
Yum China's sales at established restaurants have swooned in four of the last five quarters.
When Yum cut its full-year profit forecast on Oct. 6, citing weakness in China and the drag from the strong U.S. dollar, its shares tumbled 19 percent.
"Yum Brands is being tainted by the China business, so Yum Brands will trade at a higher multiple because it's a better business now that it's not attached to Yum China," Hedgeye Risk Management analyst Howard Penney said.
The post-spin Yum Brands will focus on the more mature U.S. business as well as emerging markets such as India. It is expected to provide shareholders a steady stream of income from royalties while allowing Yum to take lease obligations off its balance sheet.
Yum Chief Executive Greg Creed, best known for leading the successful U.S. turnaround of Taco Bell, will head the new Yum Brands.
"The separation of these two businesses gives shareholders the choice to own a growing annuity-like franchise cash flow stream, as well as the leading restaurant concept in a country with the fastest-growing consumer class," Meister said in an email to Reuters.
Yum Brands entered China in 1987 through its KFC brand, making it one of the first U.S. fast-food chains to set up operations there.
For years, its KFC and Pizza Hut brands reaped the rewards of catering to China's growing middle class with restaurants that offered a higher level of service and perceived food safety better than local rivals.
But the business in China hit road blocks. Among other issues, Yum recently has battled a scandal at a minor meat supplier, bird flu outbreaks, disappointing promotions, competition from cut-price delivery services for Mom and Pop restaurants and increasingly sophisticated local chains.
Nevertheless, Yum said it plans to one day have 20,000 China restaurants serving the country's still growing consumer class.
The separation, which is expected to be completed by the end of 2016, is intended to be tax free to shareholders.
Goldman Sachs is financial adviser to Yum Brands, while Wachtell, Lipton, Rosen & Katz and Mayer Brown are its legal advisers. PJT Partners is as an independent financial adviser to Yum's board.
Additional reporting by Yashaswini Swamynathan, Siddharth Cavale in Bengaluru and Michael Flaherty in New York; Editing by Anil D'Silva, Sayantani Ghosh and Bernard Orr