Caffeinated returns: Private equity's coffee shop craving

China has turned from a nation of tea-drinkers to the world's fifth biggest consumer of coffee. Private equity investors tapped the trend early with H&Q Asia Pacific providing $10 million in capital when Starbucks opened its first store in Beijing in 1999. Over a seven-year holding period 59 more outlets opened and today Starbucks has 851 nationwide.

According to Euromonitor International, China's market for chain coffee shops - coffee-themed enterprises with a minimum of 10 branded outlets - breached the $1 billion mark last year. In Asia Pacific, the market is worth $10 billion, nearly double the level five years ago.

There have been several notable PEP deals in the segment in recent years.

This month IMM Private Equity's bought South Korea's Hollys Coffee for up to $100 million; last year, Japan-based Advantage Partners saw a 7x return on its exit of Komeda Coffee to MBK Partners; and in 2011, Malaysian sovereign fund Ekuinas committed $5.5 million to San Francisco Coffee. In India, numerous PE investors have partnered with Coffee Day in the last seven years.

The Korean example

Explaining the context for the popularity of coffee in Korea, Joseph Lee, partner and senior managing director at IMM, looks back to the teahouse culture and the need for space in a densely populated country. Since then, there have been three main trends.

"First, people have more disposable income and second, consumer tastes have changed - so they are looking at coffee as more accessible and desirable," he adds. "As a result, in the last five years we have seen a significant increase in per capita consumption."

Korea is Asia's second-largest coffee shop market by value and it grew by 33% last year. In the past five years the market has expanded more than three-fold - from $508 million to $1.8 billion - and now has more coffee outlets than any other Asian nation, at 7,105.

The third factor is the surge in number of Koreans looking to open their own coffee shops, mostly young people who want to start new businesses as franchisees. This approach fits in well with the Hollys strategy: real estate is expensive so the best way to expand is through franchises. The company is now the sixth-largest player in the market with a 6.2% share.

The franchise model is also found in Japan, Asia's largest coffee market but one in which growth has been relatively subdued compared to likes of China and South Korea. Last year it expanded by just 5.5%.

"Japan's coffee shop market is relatively stable, with most chains gaining market share from mom and pop shops," says one local GP. "Where elderly proprietors are retiring and closing their shops, there has been an opportunity for Komeda and others to expand - that is how the market is growing."

In addition, coffee chains need to work harder to differentiate themselves from competition in Japan to achieve the kind of growth PE investors require. Komeda, which was first invested by Advantage in 2008, is a good example. Unlike other chains, it shunned city-center locations, preferring instead to set up large out-of-town, roadside outlets with ample parking and encouraging customers to stay for longer.

Like Hollys, Komeda adopts the franchise model and saw business expand 15% last year.

Emerging markets

The two chains differ in that Komeda's growth strategy has been entirely domestic whereas Hollys wants to establish itself in emerging Asia, making inroads in China and Southeast Asia.

While the coffee market in Southeast Asia is still very small - worth just $774 million - annual growth has averaged nearly 16% since 2007.

"It is also not just about the coffee. It has almost become a socio-cultural evolution - the coffee culture is a ‘social lubricant,' providing a convenient and comfortable environment for gatherings," says Amil Izham Hamzah, senior director of investment at Ekuinas.

He cites rising standards of living and a more global outlook as the main drivers in Malaysia's market as consumers explore a wider range of food and beverage offerings. San Francisco commands the number four spot in the market with a 6.2% share, but Starbucks holds a much larger chunk than elsewhere in the region with 54%. However, there is room for new entrants.

"International franchise-type brands are expanding aggressively to open new stores or to refurbish the older outlets with new concept and decor," says Hamzah. "We also see new independent brands being born. These are high-end cafes selling artisan-type coffee."

Although certain countries have become crowded, Asia's coffee story still has some way to go. Earlier this year Starbucks entered Vietnam - one of two Asian nations where it has yet to become market leader (the other is India) - to compete with local incumbent Highlands Coffee.

While Vietnam represents the smallest portion of Asia coffee chain market - worth a mere $39 million last year - it is still the fastest growing after China. Just as China represented consumer sector frontier territory back in 1999, maybe the less penetrated markets of today present the biggest opportunity for private equity.

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• Topics
• Consumer
• Greater China
• Southeast Asia
• North Asia
• Expansion
• China
• South Korea
• Japan
• Southeast Asia
• Consumer
• Growth capital
• IMM Investment
• MBK Partners
• Advantage Partners