The Sale of McDonalds China Should Scare KFC (i.e., Yum! China)


So McDonalds China is being 80% sold (franchised really) to the Carlyle Group, Citic Capital and Citic Group. This sale is being compared with the recent spin-off of Yum! China (i.e., KFC and Pizza Hut).

My take is this sale should scare Yum! China. Here’s why:

#1: Both KFC and McDonalds have the same long-term strategy for China.

Both companies want growth in China – in market share, stores and return on equity. To achieve this, both are moving from an “owned and controlled from the US” model to a more hands-off, localized and franchised model.

This is pretty common for quick service restaurants (QSRs) in developing economies. As the market is emerging, they will often keep control, provide the capital and accept slower growth – in return for greater operational control. As the market matures, they franchise more, which has better economics and let’s you grow faster. Really, if you’re not franchising, you’re missing out on the best part of being a popular QSR chain.

So both McDonalds and Yum! are moving to this model in China. More franchises, higher return on equity, faster growth, but less control.

#2: Going forward, KFC will continue to have an advantage in terms of menu and consumer preferences.

Chinese consumers just like chicken a lot more than hamburgers. And KFC has always had an advantage in China in this regard. And while McDonalds has added lots of chicken items to their China menu, they will likely always lag KFC in popularity. There’s nothing wrong with that. You play the hand you are dealt. Note: Taco Bell has a much more difficult hand in this regard.


#3: The sale of McDonalds China has moved them to a more aggressive PE management model. This could imapct Yum! China.

The two factors I look at most for restaurants in China are menu popularity (against often rapidly changing consumer preferences) and management performance. Restaurants are businesses where you have to fight and re-win your market share every year. And management performance is critical in this.

The sale of McDonalds China means it will now have a very different management / ownership model than Yum!. It will have a more aggressive and I think more effective model.

Despite the recent spin-off, Yum! China has remained a public company with fairly diffuse ownership and traditional corporate management. The senior management has minimal equity ownership. The company has limited corporate debt. And the CEO and senior management probably have relatively short terms. Note: the average tenure for a public Fortune 500 company CEO is like 2-3 years.

In contrast, McDonalds China is now majority controlled by Citic Capital / Citic Group and Carlyle Group. We can assume they are probably implementing the PE management playbook:

  • Management with a big upside based on options against already specified performance metrics.
  • Increased corporate debt that basically places a sword at the neck of management.
  • A very focused 3-5 year plan that will significantly change the financials.

I suspect their plan is going to include opening lots of new stores quickly (probably in 2nd and 3rd tier cities – and by sub-franchising) and converting the currently-owned stores to franchises (which will free up capital and pop the ROE). That’s a guess but I think it is likely. Note; If you want to see this plan in action, look at the performance of Burger King since it was purchased by 3G capital in 2010.

So KFC has always had an advantage in menu popularity in China. But McDonalds now might have a significant advantage in management. It is like Yum! China is driving a sedan and McDonalds has just upgraded to a Ferrari. This should worry them.

Thanks for reading. Cheers, -j


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