China GPs: The Centurium strategy

Luckin Coffee has become China’s second-largest coffee shop chain on the back of an aggressive store expansion program. Making this loss-making business sustainable means bringing costs under control: not only through economies of scale but also by leveraging technology to deliver supply chain efficiencies and customer insights.

This bold experiment in new retail – the progress of which can be tracked through the public markets, following an IPO last month – rests on the fusion of consumer and technology. David Li, founder of Centurium Capital, stresses how this was coded into Luckin’s DNA.

“In 2016, before they launched the first store, we worked with them on the infrastructure, integrating the customer interface, store operations, and supply chain management,” he explains. “Everything is automated, from pushing a button to get coffee to calculating the stock for breakfast. And then they know where the customers come from, so the store success rate is very high.”

Centurium led Luckin’s Series A round in July 2018 – this was the GP’s first investment – and re-upped in the Series B six months later. There have since been four more deals, three of which are also predicated on the application of technology to traditional business models. 

“We focus on transformation,” Li notes. “After decades of growth, Chinese companies face a lot of challenges. We were recently looking at a retail business that a family had built from scratch. We showed what we did with Luckin, provided a bespoke solution that addresses governance, the business model and generational transition, and they are letting us take control.”

Fast start

Li spent 14 years with Warburg Pincus, building the firm’s China franchise, before departing in early 2016 to form Centurium. Fund I launched in early 2018 with a target of $1 billion and had collected nearly all that by the first close. The hard cap was set at $1.5 billion and then increased to $1.98 billion. A final close is expected in the next few weeks, although the firm is said to have stopped marketing to investors at the start of the year. Centurium declined to comment on fundraising.

Li’s fellow managing directors are Joseph Chow, whose resume includes stints as China president of Moelis & Company and CFO of China Netcom, and Lei Lin, who founded automotive research business Sinotrust Market Research and subsequently sold it to Experian Group and WPP. There are approximately 20 investment professionals in total, including Eric Wang, the former China head of Alvarez & Marsal, who joined as an operating partner.

One LP, when asked what made Centurium stand out from other China firms, pointed to a relatively high GP commitment – it is $60 million, or 3%, with the same earmarked for Fund II – and a strong track record at Warburg Pincus. Centurium’s consumer and healthcare-focused mandate is consistent with deals previously led by Li. Three of them – China Biologic Products, China Auto Rental (CAR) and Ucar – have direct links to Centurium. The firm invested in China Biologic last August, while Luckin was founded by Jenny Qian, who served as COO of CAR and Ucar.

Luckin represents Centurium’s highest-profile bet. The company has been open in its ambition to supplant Starbucks as the market leader in China and its willingness to forgo near-term profit in the pursuit of scale. Luckin’s 2,370 stores incurred operating expenses of more than RMB1 billion ($145 million) for the most recent quarter, with store rental and marketing accounting for about 45%. Revenue came in at RMB478.5 million. 

Li notes that Starbucks and Luckin aren’t competing on the same terms. A Starbucks Grande Latte has a direct operating expense of RMB20-21, while the Luckin equivalent is RMB13.30. “Breakeven would be RMB12 and we believe we can drive down the cost below RMB10,” he says. Moreover, Luckin’s new customer acquisition costs have fallen more than 80% over the past 12 months. 

Some analysts are sold on the store format, pricing strategy and expansion capability story. Morgan Stanley expects the company to turn profitable by 2020, although it admits there is a high level of execution risk. Other industry participants note that Luckin shouldn’t be watching out for Starbucks – it is the countless convenience stores offering coffee at similarly affordable prices who pose the biggest threat. If this is true, then technology will make or break the company. 

Over 90% of Luckin stores are pick-up only locations with minimal staffing requirements. Customer engagement, from marketing to processing orders and payments, is via app. The company can accumulate information on user preferences and, for example, try to turn a regular coffee drinker into a consumer of other product categories through special offers.

Efficiency drive

Centurium believes that the automation of front-end and back-end processes can accelerate Luckin’s path to economic sustainability. Versions of this scenario are intended to play out in areas as diverse as eyewear, kindergartens, and trucking. 

Eyeglasses brand Loho won support from Centurium to pursue an automated supply chain model. On one hand, it reduces the time taken for a new design to go from conception to launch, which means the company responds to demand trends faster and takes less inventory risk. On the other, it reduces the size and complexity of the physical store. Customers to browse products online, come in for an eye test, and have the completed eyeglasses delivered to their home within a few days. 

In the case of Zhangtong Jiayuan (also known as Happy Kids Education) and Keking, the pain point being addressed is industry fragmentation. The former works with small-scale kindergarten operators, providing online platforms through which parents can monitor the daily activities of their children on video and communicate with teachers. The latter develops cloud-based software that is embedded in the systems of logistics businesses, helping them manage back-end functions and finances.

“We target industries that are fragmented and do not invest in technologies, and by using a B2B2C model facilitate consolidating the sector and engage with consumers,” Li adds. “The common factor is using technology to generate more efficiencies and reduce costs.”

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• Topics
• Greater China
• GPs
• Fundraising
• Buyouts
• Growth
• Technology
• China
• healthcare
• Consumer
• Centurium Capital