VC tackles China dining: Fast food, quicker expansion

Chinese smart phone manufacturer Xiaomi sources its handsets from Hon Hai Precision Industry, the company responsible for assembling the iPhone. Vancl, the country's largest online clothing retailer, sources apparel from workshops also used by Zara.

Both companies are heavily focused on design and user experience and they have featured in Qiming Venture Partners' portfolio since their early days. Now Hans Tung, the VC firm's Beijing managing partner, is looking to replicate this disruptive model offline in the food and beverage industry. The test case is YPX Cayman Holdings, owner and operator of Cloud 9, the mainland China licensee of a Taiwan casual dining chain.

"They don't have central kitchens - food preparation is done by high-quality outside vendors, using menus from Taiwan that the team has since tailored for China, and then delivered to the stores. YPX focuses on data analytics, customer service, food ingredient mix, and staff management" says Tung. "If you dig deep, it is a similar approach to what Xiaomi and Vancl have done for smart phones and apparel."

The approach is rooted in logic. By opting for a systematic outsourcing model underpinned by strong IT systems and logistics instead of central kitchens, YPX can expand rapidly at low cost. The company opened its first restaurant in 2010 and is on course to have 30 outlets by the end of the year. It wants to expand to 90 outlets within two years, with a particular focus on northeast China. Four in five restaurants will be located in shopping malls.

"Once YPX finds a location it can get operational in about two months, compared to 4-6 months for larger restaurants that need to bring in a lot of expertise and chefs from different areas," says Daniel Tseung, managing director of LionRock Capital.

Institutional investment

LionRock last week led an $11.5 million Series C round of funding for YPX, with existing investors Qiming and Ignition Capital also participating. The company received a further $4 million from investors in the Series B round last year who exercised warrants and then $2.5 million in debt financing from Silicon Valley-based lender Western Technology Investment.

The $15 million Series B round was led by Taiwan's Hotung International, with institutional commitments from Qiming and Mitsui Global Capital, as well as personal contributions from high net worth individuals.

For Qiming, the journey started before the company's China operations even existed. It was the sole participant in the Series A round, providing $5 million in green field investment. This came after the venture capital firm identified a restaurant chain that could be established in China and an entrepreneur to come in and run it.

"There are 50-plus listed dining chains in the US and 16 in Japan," says Tung. "There were about five in China and three of them have been bought out by other players. There are lots of restaurants around but why are none of them listed and scaling well?"

He concluded that most restaurant chains - typically small, family-run operations - made money because they weren't being run in a transparent fashion. If these chains met all of their tax and social security obligations in full, profit margins would be decimated unless rising costs were counterbalanced by improved efficiency.

Qiming targeted the casual dining market where the quality is lower but the prices are affordable and consumers are willing to pay a small premium for food safety, consistency and a pleasant restaurant environment. Other PE and VC investors have done the same.

Casual dining chains also fit well with the preferences of China's emerging middle class: there is a desire for out-of-home dining but a certain level of frugality remains.

Next came the CEO. Tung found his ideal candidate in Chris Tay, a Singaporean former tech entrepreneur who previously ran IT systems for the group that licensed Dairy Queen and Yoshinoya in China, before being hired by Taiwan food conglomerate Tingyi Holdings to run its China casual dining business, and finally moving to Yili Group, which wanted to start an ice cream parlor chain.

"Chris has worked for a Hong Kong family, a Taiwan family and a state-owned enterprise, restructuring portfolios and taking them to the next level," says Tung. "He has a scientific, data-driven approach to the fast casual restaurant business."

As for the restaurant chain, Tung and Tay spent six months scouting for possibilities before identifying Cloud 9, which has 67 franchised stores in Taiwan and claims to be the island's third-largest Wonton restaurant brand. The China operation has a separate ownership structure to its Taiwan affiliate.

Outside expertise

LionRock, which exclusively targets consumer-related assets, got involved largely because Tseung is a board member of Gourmet Master, a Taiwan-listed company that owns coffee shop and bakery chain 85°C. He supported the company's successful rollout in mainland China.

"Chris Tay asked me if I could help in a similar way on YPX," says Tseung. "There are similarities between the two. The 85°C offerings are not revolutionary - it is bread, cakes and teas but the strategy is executed very well, offering quality food at affordable prices for mass market Chinese consumers."

As for the VC investors' ultimate exit channel, Tung sees an IPO as the obvious option, but also sees the logic in a trade sale. And it all comes back to those 66 listed dining chains in the US and Japan. "China will be the biggest growth market for food and beverage over the next 10 years," he says. "If you have a company in China that has good corporate governance and does everything by the book, it would be an ideal partner."

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• Topics
• Greater China
• Consumer
• Venture
• China
• Consumer
• Qiming Venture Partners