China Resources takes a caffeine injection

China Resources Enterprise pays $42 million to buy a majority stake in Pacific Coffee from Chevalier Pacific, earning Chevalier a healthy return on its five-year investment.

China Resources Enterprise (CRE) has agreed to buy an 80% stake in Pacific Coffee from Hong Kong conglomerate Chevalier Pacific, the two companies said in a joint statement yesterday. Chevalier will retain a 20% holding in one of Hong Kong's favourite coffeehouse chains, but has a three-year option to sell its minority interest to CRE.

Pacific Coffee has built a strong brand in Hong Kong since opening its first café in 1992, and like its rival Starbucks, it has Seattle, USA, origins. It currently operates 90 outlets, of which 83 are in Hong Kong, three on the Chinese mainland and four in Singapore. An additional five franchised coffehouses are spread across Malaysia, Macau, Foshan and Shenzhen.

"Over the past five years, Chevalier Pacific has established Pacific Coffee as a leading coffeehouse chain which enjoys strong brand recognition. Coffee consumption is experiencing rapid growth in China, fuelled by a growing coffeehouse culture among Chinese consumers," said Chen Lang, managing director of CRE.

"Our acquisition of the 80% stake in Pacific Coffee will provide CRE with a strong foundation to capture this growth. Our goal is to build Pacific Coffee into the number one coffeehouse brand in China," he added. It faces stiff competition, however, from Starbucks and McCafe (owned by McDonalds), which have a bigger presence on the mainland.

Hong Kong-listed CRE, a state-backed Chinese company focusing on food & beverage and consumer retail businesses, will stump up HK$326.6 million ($42 million) for its controlling stake, and will appoint four of the five directors to the board of Pacific Coffee. Chevalier paid HK$205 million for 100% for Pacific Coffee back in 2005, suggesting it has virtually doubled its money excluding any subsequent capital injections. CRE was advised by UBS and Chevalier by Optima Capital. The deal should be completed by July 7.

According to both companies, CRE paid a price-to-earnings ratio in the mid-20s and a price-to-book multiple of around five times. Chevalier has a put option to sell its 20% stake to CRE at the higher of HK$81.7 million and 12.1 times Ebitda, which is about the same multiple as CRE will pay for its 80% holding.

But for the time being, at least, Chevalier views the new arrangement as a forward-looking partnership.

"This transaction is a major step in realising our plan to expand the coffeehouse network into China. And the 20% balance which we retain, [indicates] that we are in partnership with CRE in this development and shareholders of Chevalier will continue to benefit from the business growth of Pacific Coffee," a Chevalier spokesperson told FinanceAsia.

Meanwhile, Pacific Coffee will provide CRE with a new revenue stream, and a potential growth opportunity. According to Euromonitor, retail coffee consumption in China is expected to grow by more than 35% over the next four years, to about 45,900 tonnes by 2014.

CRE is confident that its network of around 2,900 retail stores in China will help drive Pacific Coffee's growth "by increasing foot traffic and revenue through co-location, creating a more sophisticated lifestyle experience for the customers when they shop at its stores". The coffeehouse chain will also have access to CRE's sourcing and logistical capabilities.

Oscar Chow, Chevalier's managing director said: "CRE is a clear leader in China's retail market. Through our partnership with CRE, Pacific Coffee will be in a strong position to strengthen its competitive edge, build consumer recognition, expand its retail network coverage in China and capture a bigger slice of the market more effectively. Shareholders of Chevalier Pacific will continue to benefit from the business growth of Pacific Coffee after the transaction."

Pacific Coffee posted a net profit of HK$17.6 million in the year to March 31, 2010, after a loss of HK$20.3 million in the previous year.

Chevalier's share price rose 3.3% yesterday, despite a fall in the benchmark Hang Seng Index. CRE's shares closed 2.4% lower after being down as much as 4.3% intraday.

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