Bill Murray famously derided the Asian practice of eating hotpot: “What kind of restaurant makes you cook your own food?”
David Novak would beg to differ with this assessment. The CEO of Yum Brands announced last week that he wanted to up his firm’s 27.2% stake in a Chinese hotpot chain, and obtain full ownership.
Little Sheep, a Hong Kong-listed restaurant group has a market capitalisation of around $660 million, according to the Wall Street Journal. That means the acquisition will likely cost Yum more than $500 million – an amount that indicates the firm’s seriousness about China.
For Yum, it’s all about China…
Yum’s share price touched an all-time high of $54.98 on April 21. The reason? The fast food giant – which owns the KFC, Pizza Hut and Taco Bell restaurant chains – had surprised investors with strong earnings in the first quarter, thanks almost entirely to punchy growth in China.
“People are not buying our stock because of the US, they are buying it because of China,” Novak, told reporters all the way back in 2005. That was prescient. Chinese sales rose 28% in the first quarter, accounting for an incredible 54% of Yum’s total profit.
Never heard of Little Sheep?
Then you’re clearly not a connoisseur of Mongolian hotpot.
Little Sheep, which has 480 restaurants around China but only a few dozen in North America, serves hotpot-style cuisine in sit-down outlets. The business model has benefits: one is that it is light on chefs as customers cook the ingredients themselves, usually in a pot of boiling broth that sits at their table (a typical meal would include thin slices of lamb, noodles and mushrooms).
The Baotou-headquartered firm is particularly famous for a fragrant soup base made from a supposedly secret mix of herbs and spices. And even though hotpot may seem a winter meal, Little Sheep’s restaurants are busy year-round. Last year the chain saw its revenues jump 23% to Rmb1.9 billion ($291 million) from 2009.
Yum Brands says it has now submitted a preliminary bid, although Little Sheep has declined to comment on the details of the ongoing negotiation. Analysts say the move signals that Yum is looking to diversify beyond its core pizza and fried chicken offering, in search of continued growth. Economic Information Daily reckons that buying Little Sheep makes sense as it will allow Yum to grow sales without cannibalising its existing Chinese businesses – that is, KFC and Pizza Hut – which have a stranglehold over much of the Western fast food market.
Another major attraction, says the Financial Times, is that Little Sheep is also a meat supplier. Its smiling lamb logo can be seen on packaged meat sold in Chinese supermarkets, and it was China’s first organically-certified mutton producer. In a time of increasing concerns over food safety, buying a company with such direct control over its supply chain is a big plus.
What is the wider significance of the deal?
“With the mooted purchase of Little Sheep, Yum’s reincarnation as an American company with increasingly Chinese characteristics reaches a new stage,” says the FT.
Yum has already travelled a long way from Louisville, Kentucky. But it appears determined to embrace the Chinese market in a bigger way. In addition to the acquisition of Little Sheep, it announced in January that it will sell its 1,630 Long John Silver’s and A&W franchises in the US to help fund expansion in China.
The fast food giant also launched a Chinese chain, East Dawning, in 2004. It hasn’t grown very fast, with 21 outlets in 4 cities. But the company has still done well enough out of its China experience to take some of the lessons learned there back home.
For example, in 2008 Yum introduced a roasted chicken menu to US customers because it had become so popular among Chinese consumers, who considered it a healthy alternative to fried chicken.
Yum’s senior executives in China, (and some now retired from the firm), have also become minor celebrities in their own right, often in demand to explain how the company has done so well.
The normal reply is that, since entering China in 1987, the fast food giant has focused on hiring Chinese managers (admittedly a few Taiwanese-born ones at first), as well as on building plenty of partnerships with local companies in its expansion drive.
Another core factor: Yum has spent time working out what the Chinese might actually want to eat (which sounds like it shouldn’t be revolutionary, but it seems to have been unusual at the time). It offered an array of regional dishes that appeal to domestic tastes (see WiC53 and 101).
KFC, for instance, has added a local twist to 40% of its dishes, such as red-hot Sichuan chicken and rice porridge with thousand-year egg for breakfast.
With 3,800 KFC and Pizza Hut restaurants, Yum now controls a 40% market share among fast food chains in China, compared with 16% for McDonald’s, which has 1,300 locations, according to market research firm Euromonitor. Its sales in China have been big enough for Yum to report earnings separately since 2005. By contrast, McDonald’s prefers to lump China revenues into the Asia-Pacific, Middle East and Africa category.
Industry observers now forecast that within four years, Yum will be dependent on China for more than half of its global revenues, says Warren Liu, a former Yum vice president. Currently the US market still makes up 59% of Yum’s sales.
Any clouds looming?
One worry is that Yum may be putting too many of its eggs in the China basket. “I worry about too much reliance on a single market no matter how financially attractive that market is,” says Liu.
Then there is the competition. McDonald’s, Yum’s closest rival but much slower off the mark originally, announced last week that it is planning its biggest expansion to date, opening 700 new stores by 2013 and hiring 50,000 new employees.
“McDonald’s is expanding faster in China than in any other market in the world,” says Kenneth Chan, chief executive of McDonald’s China.
Nor is the acquisition of Little Sheep a done deal, says the Southern Metropolis Daily. It will be subject to government approval, and the Chinese government is wary of budding local brands falling into non-Chinese hands. Beijing famously quashed Coca-Cola‘s $2.4 billion attempt to take over Huiyuan Juice in 2009 citing anti-monopoly concerns. Diageo, the British drinks giant, is still waiting for regulatory approval to gain control of Shui Jing Fang, one of China’s best known brands of white spirit (see WiC54).
Yum may be used to fast food and fast decisions. This deal may require a bit more patience…
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