BEIJING, Shanghai, Hong kong- Anti-monopoly regulators are turning the acquisition of a chain of Mongolian hot-pot restaurants by Yum! Brands Inc into the most profitable bet in China.
Little Sheep Group Ltd has tumbled after saying last week that China's Ministry of Commerce extended a review of Yum's HK$4.4 billion ($573 million) takeover by two months. Little Sheep, which rose to within 25 cents of Yum's HK$6.50-a-share bid, has now fallen 18 percent below that price, according to data compiled by Bloomberg.
Yum, the owner of the KFC fried chicken chain founded by Colonel Harland Sanders, is facing increased scrutiny from Chinese regulators as it attempts its biggest acquisition. While Little Sheep would extend Yum's lead among restaurant chains in China, independently owned eateries would still control more than 90 percent of sales.
That means the Ministry of Commerce, which has blocked only one of the more than 250 takeovers it has reviewed since China's anti-monopoly law began three years ago, is unlikely to reject Yum's bid, according to DBS Vickers Hong Kong Ltd.
"People are just too nervous," Alick Wong, an analyst at Louis Capital Markets in Hong Kong, said in an nterview. "If an American company wants to buy in China, it makes investors cautious. Any bad news will move the stock."
Wong expects the deal to close by March, which implies an annualized 69 percent return based on last week's closing price of HK$5.30, data compiled by Bloomberg show.
Jonathan Blum, a spokesman at Yum, didn't immediately respond to telephone or e-mail messages requesting comment on whether it expects the transaction to gain approval.
Zhang Zhanhai, chief operating officer at Little Sheep, declined to comment. The Ministry of Commerce, didn't respond to a faxed request for comment on Yum's bid for Little Sheep.
Founded in 1999, Little Sheep has more than 400 Mongolian hot-pot restaurants. The restaurant operator, whose Chinese name translates to Little Fat Sheep, agreed in May to an all-cash deal that would give Yum 93 percent of the company, according to Bloomberg data.
The acquisition would strengthen Yum's presence in China, where it generates more sales than in the US, by enabling the fast-food chain operator to offer a local specialty in the world's most populous nation.
Little Sheep has posted annual sales growth of more than 20 percent since 2006 and analysts project the company will extend that streak through at least 2013, according to data compiled by Bloomberg. Yum's sales haven't increased by more than 10 percent since 2002, the data show.
Little Sheep, which climbed as high as HK$6.26 after the announcement, plunged by the most in three years on Oct 26 after Yum notified the hot-pot chain of the 60-day extension by the ministry. The decision came four months after it first acknowledged the application. The regulator now has until December to decide on Yum's acquisition.
With the gap to the deal offer widening to HK$1.20 based on last week's closing price, buying shares of Little Sheep would translate into a 23 percent gain if the deal closes - without accounting of how long it will take to complete the transaction, data compiled by Bloomberg show.
That's a bigger potential windfall than any other takeover target based in China, according to the data.
While investors dumped shares of Little Sheep because of the possibility the deal will be blocked by antitrust regulators, the concern is unwarranted because China is dominated by independently owned eateries, said Titus Wu, a Hong Kong-based analyst at DBS Vickers.
Under China's anti-monopoly law, an acquisition that allows the companies involved to reach certain market share and sales levels needs the approval of the commerce ministry.
The ministry has reviewed 267 mergers under the anti- monopoly law and rejected only one - Coca-Cola Co's $2.3 billion bid for China Huiyuan Juice Group Ltd in 2009, said Marc Waha, Hong Kong-based partner at the law firm Norton Rose LLP.
The deal would have combined China's largest and third-largest makers of juice and given Coca-Cola a 17.5 percent share of the market that year, according to Euromonitor International.
In China's restaurant industry, independent operators garnered 92 percent of sales last year, while restaurant chains including Yum controlled just 8 percent, Euromonitor said.
Yum, which opened its first KFC outlet in China in 1987 and has more than 3,300 fried chicken outlets across the country, still accounted for less than a fifth of the sales within the smaller chain market. Little Sheep had a 2.1 percent share.