McDonald’s sells control of flagging China business

CITIC and CITIC Capital will have a controlling stake of 52%, while Carlyle and McDonald’s will have interests of 28% and 20%, respectively.

McDonald’s has struck a deal to sell a controlling stake in its struggling mainland China and Hong Kong business for $2.08 billion in cash and new shares.

The US fast-food chain worked hard to find a buyer who could put the business back on its feet and grow. However it was adamant it would not sell to a competitor nor a lone financial investor. 

It chose Chinese conglomerate CITIC and CITIC Capital, which will own the majority of the business with a stake of 52%, while Carlyle and McDonald’s will have 28% and 20%, respectively.

In a fiercely contested auction the partners beat competition from House of Fraser owner Sanpower; as well as a consortium comprising Bain Capital and GreenTree Hospitality. TPG also bid for the unit alongside convenience chain WuMart, according to people familiar with the transaction. 

McDonald’s is the latest foreign company to retreat from China in the face of fierce competition. Last year ride-hailing firm Uber Technologies agreed to sell its China business to Didi Chunxing. Yum Brands, the operator of KFC, is spinning-off its Chinese business.

Broadly, foreign companies are increasingly struggling to justify further investments in China as the renminbi depreciates or their plans hit regulatory roadblocks.

While the headline sale value of $2.08 billion looks like a rounding error compared to McDonald’s $109 billion market cap, the US firm hopes the consortium will be able to turn the business around and catch up with Yum. That will produce a steady stream of cash in the form of a franchise fee.  

The partnership will act as the master franchisee responsible for McDonald’s businesses in mainland China and Hong Kong for 20 years. The new company will become the largest McDonald’s franchisee outside the United States.

The aim is to accelerate growth in McDonald’s business through new restaurant openings, particularly in tier 3 and 4 cities.

The focus will be on key areas such as menu innovation, enhanced restaurant convenience, retail digital leadership and delivery. It intends to add over 1,500 restaurants in China and Hong Kong over the next five years.

The partners are riding a favourable tailwind. China’s consumer sector is growing rapidly, benefiting from continued urbanisation, an expanding middle class and increasing disposable household incomes.

China’s working population is larger than those of the US and Europe combined, yet spending levels of China’s middle class are a small fraction of those in more developed countries.

As disposable incomes rise, people will continue to spend more on leisure and dining out, particularly in smaller cities where there is great growth potential. As such, the market for Western quick service restaurants is expected to continue to grow rapidly.

Yichen Zhang, chairman and CEO of CITIC Capital, will serve as chairman of the board of the new company. X.D. Yang, co-head of Carlyle’s Asia buyout team, will serve as vice-chairman of the new company's board. Equity for this transaction will come from Carlyle Asia Partners IV.

Zhang and Yang have known each other for many years, which helped the consortium gel together and convince McDonald’s they can work together for the company.

It took many meetings and explanation to make McDonald’s comfortable, in terms transparency in the decision-making process, with the fact CITIC is controlled by the Chinese government. In the end the US deal team felt Beijing-headquartered CITIC’s heritage – as the conglomerate set up with the approval of late leader Deng Xiaoping to interact with the West – made it a reliable partner.   

As part of a turnaround plan announced in May of 2015, McDonald’s committed to refranchising 4,000 restaurants by the end of 2018, with the long-term goal of becoming 95% franchised.

As a result of this transaction, McDonald’s is refranchising more than 1,750 company-owned stores in China and Hong Kong.

McDonald’s operated and franchised over 2,400 restaurants in mainland China and more than 240 restaurants in Hong Kong as of December 31. Currently employing over 120,000 staff and serving over one billion customers annually in China, McDonald’s is the second largest fast-food chain on the mainland and the largest in Hong Kong.

McDonald’s existing management team will continue to lead the business.

For McDonald's internationally, the move represents another step towards becoming a less capital-intensive business. Analysts at Wells Fargo estimate the China sale could drive an 800 basis point increase in Ebidta and a 150bps increase in return on capital invested.

The deal is contingent upon relevant regulatory approvals and is expected to close in mid-2017. The deal team is confident McDonald’s track record in supply-chain management and food safety procedures will have a positive impact on quality control in China.

JP Morgan and CITIC Securities gave financial advise to the buyers. Kirkland & Ellis provided legal advice. Morgan Stanley advised McDonald's. 

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