Ever wondered why KFC, Taco Bell, and Pizza Hut parent Yum! Brands (NYSE:YUM) has never added the hamburger to its fast food portfolio? No need to wonder any longer as the giant restaurant operator and franchise licensee has now rounded out its lineup of American fare by putting in a bid for Southern California-based The Habit Restaurants (NASDAQ:HABT).
The regional better-burger chain is unlikely to become a fourth major pillar for Yum! any time soon, but the transaction has some implications for other companies in the industry, namely The Habit's regional rival Shake Shack (NYSE:SHAK) and exclusive Chinese KFC, Pizza Hut, and Taco Bell franchisee Yum China (NYSE:YUMC).
The deets of the deal
Yum! Brands will pay $375 million in cash to The Habit shareholders, good for a $14 per share payout. That's about a 33% premium over the stock's closing price prior to the announcement, although $14 per share is still nearly 70% less than the company's all-time high, which it hit shortly after its IPO in 2015. It's been a painful ride for shareholders as the market came down from its sky-high expectations for the small chain. While The Habit will continue to operate semi-autonomously from its California home, investors will be shut out of any further rebound if the deal goes through -- which is expected to occur by the end of the second quarter.
As for Yum! Brands, The Habit's nearly 270 locations -- most of which are located in California with a few dozen on the east coast and a small handful of franchise-owned stores in China -- won't make much of a dent in overall results. One of the largest restaurant companies around, Yum! has more than 49,000 stores around the globe, generating $1.34 billion in revenue during the third quarter of 2019. In fact, Yum! opens more net new restaurants every quarter than The Habit has in total.
Nevertheless, Yum! said The Habit will begin to add to the overall bottom line in 2021, and the hamburger chain could provide a boost to growth long-term. After all, this is Yum!'s first push into the burger industry, which has been growing relentlessly here in the U.S. and is a popular franchise option for international operators. Plugged into Yum! Brands' massive ecosystem, The Habit could really take off in the years ahead. According to Yum! CEO David Gibbs, "The transaction is a win-win, because it allows us to offer an exciting new investment to our franchisees and to expand an award-winning, trend-forward brand through the power of Yum!'s unmatched scale and strengths in franchising, purchasing, and brand-building."
A hat-tip to the better burger
And that is where things get interesting. Because The Habit already has a few franchised stores in Shanghai and one in Hangzhou, Yum!'s franchise partner in the country, Yum China, will undoubtedly be interested in making a deal. KFC's single largest market is China, and Pizza Hut's No. 2 market is there as well -- although it has struggled the last few years. Taco Bell only has a couple of test stores as "Mexican food" is relatively unknown across the Pacific. The hamburger, though, is a different story. A patty -- be it traditional ground beef or a chicken breast wedged between a bun -- is a greasy, delicious, and popular beacon of Americanism around the globe. I'm keen on what this deal will mean for Yum China going forward, as it could be a real growth driver for the restaurant operator looking to further tap into the country's massive middle class.
And then there's Shake Shack, The Habit's East Coast-based better-burger rival that is quickly expanding west. Over the last few years, it's Shake Shack that has been more successful in its expansion efforts. It had over 250 locations at the end of the third quarter, but there are another 40 slated to open in the U.S. in 2020 and another 20 to 25 internationally. If The Habit ups its game under the auspicious eye of Yum!, Shack could get a real run for its money.
However, as I've been proven wrong on the matter, there could be plenty of room for two better-burger chains. America's love of the better-burger has thus far been insatiable, and it's not like Shake Shack and The Habit are going to begin stepping on each other's toes internationally any time soon. As network effects go, if The Habit and Shake Shack together start opening up locations at a fast pace, it may not be a zero-sum game with one winner and one loser. Rather, two players spreading the higher-quality hamburger gospel could be good for the industry overall and float both boats.
And it's this second scenario that I see as more likely now that The Habit will get some help from Yum!. Investors in the fast-food giant have to be happy with the price tag the company is paying for an emerging fast-casual burger name to round out the portfolio, but my money is on Yum China and Shake Shack shareholders being the bigger beneficiaries going forward.