McDonalds China was 80% sold (franchised really) to the Carlyle Group, Citic Capital and Citic Group. And the sale was shortly after the spin-off of Yum! China (i.e., KFC and Pizza Hut). But there is a big difference in ownership between the two. And my take is this should scare Yum! China.
Point 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 (and other things), both have moved from an “owned and controlled from the US” model to a more localized and franchised model.
This is pretty common for quick service restaurants (QSRs) in developing economies. As the market is initially emerging, the parent company 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. And 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! have moved to this model in China in different ways. More franchises, higher return on equity, faster growth, but less control.
Point 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.
Point 3: The sale of McDonalds China has moved them to a more aggressive PE-style management model.
The two factors I look at most in China restaurants are menu popularity (against constantly changing consumer preferences) and management performance, which has a lot to do with ownership and incentives. You don’t have big competitive barriers in restaurants. It’s not like you win and then can relax. 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 has a very different management / ownership model than Yum! China. It has a more aggressive and I think more effective model.
Despite the 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 majority controlled by Citic Capital / Citic Group and Carlyle Group. We can assume they are probably implementing the standard PE management playbook:
- Management with a big upside based on options against 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 in the near-term). 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, yes, KFC has always had an advantage in menu popularity in China. But McDonalds now might have a significant advantage in management performance. It is like Yum! China is driving a sedan and McDonalds has just upgraded to a Ferrari.
But we’ll see how it plays out.
Thanks for reading. Cheers, -jeff
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