CITIC Capital, Carlyle join $2.1b deal for McDonald's China

A newly-formed company, Grand Foods Holdings, will pay up to $2.08 billion - including equity and debt - for the master franchise rights to McDonald's in mainland China and Hong Kong for a term of 20 years. CITIC will own a 32% interest in the company, with CITIC Capital and Carlyle holding 20% and 28%, respectively. McDonald's will retain the other 20%, which suggests it will realize an immediate $1.66 billion from the deal. The US company would also receive royalty payments over the course of the contract.

CITIC said in a filing that it is responsible for up to $665.6 million of the $2.08 billion total. On this basis, CITIC Capital would contribute $416 million with Carlyle putting in $582.4 million. These sums include debt but the two PE firms would likely offer a portion of the equity to LPs as co-investment. CITIC Capital is investing through CITIC Capital China Partners III, which is currently in the market targeting $1.5 billion, while Carlyle is using its fourth Asia buyout fund. That vehicle closed at $3.9 billion in 2014.

The partnership will use its combined expertise and resources to accelerate growth of the McDonald's business through new restaurant openings in China, particularly in tier-three and tier-four cities. The plan is to add more than 1,500 outlets in China and Hong Kong over the next five years.

Efforts will also be made to introduce more innovative menus, improve restaurant convenience and offer digitally-enabled services. Further details were not provided, but plans to revitalize the McDonald's business in the US include greater local and regional variation to menus, experimenting with self-service kiosks and table service, and mobile ordering and payment systems for food collection and delivery.

Another part of the fast food company's growth strategy is optimizing restaurant ownership. McDonald's said in 2015 that it would refranchise about 4,000 restaurants globally by 2018 - which would deliver estimated annual savings of $500 million - with the long-term goal of becoming 95% franchised. While the company is at least 80% franchised in its major developed markets, the figure is just 44% in its eight designated high-growth markets across Asia and Europe, which include China.

McDonald's currently has more than 2,400 restaurants in mainland China and 240 in Hong Kong, and it is said that 65% of the mainland China outlets are directly owned. As part of the new transaction, over 1,750 company-owned restaurants across the two markets will be refranchised.

"McDonald's core business proposition and potential in China is clear. We will work closely with the existing management team and partners, including Beijing Capital Agribusiness Group, to respond to local market expectations and continue to expand and improve the business to meet the needs of the Chinese consumer," Yichen Zhang, chairman and CEO of CITIC Capital, said in a statement.

McDonald's has more than 36,000 restaurants worldwide, including around 5,000 in its eight high-growth markets of China, Korea, Russia, Poland, Italy, Spain, the Netherlands and Switzerland, which are seen as having relatively higher restaurant expansion and franchising potential. Of McDonald's $25.4 billion in total revenue in 2015, these markets contributed $6.17 billion, of which just $731 million came from franchised outlets.

Most of the planned 400-500 new restaurant openings globally in 2016 were to be in China, but the company still faces challenges in the country. Both McDonald's and KFC struggled after it emerged in 2014 that suppliers had provided sub-quality meat to restaurants. They also compete for a share of China's growing quick service restaurant market with local chains as well as groups from Taiwan and Japan - hence the importance of local partners who can help secure and supply locations in lower-tier cities.

In November, Yum Brands, which owns KFC, Pizza Hut and Taco Bell, restructured its China business by spinning out the operation into a separate listed entity. Primavera Capital committed $410 million to the newly-created Yum China, while Ant Financial Services put in $50 million. The two firms could hold up to 10% of Yum China, conditional on the average trading price of the US-listed entity and their warrants being fully exercised.

Yum China has more than 7,300 restaurants, including 5,087 KFC outlets and 1,643 Pizza Hut stores, across 1,100 cities. In addition to the local licenses for KFC, Pizza Hut and Taco Bell, it owns the Little Sheep and East Dawning dining concepts outright. Starbucks has 2,171 outlets in China while Ajisen Ramen has approximately 660, according to a Yum China.

The McDonald's deal is contingent upon regulatory approvals and is expected to close in mid-2017. The existing McDonald's management team will continue to lead the business.

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• Topics
• Greater China
• Buyouts
• Consumer
• China
• CITIC Capital
• The Carlyle Group