Leading the Herd

In 2013, the management team at Guizhou Yonghong had a problem. Not with the business itself – the company, then nearing the end of its third decade, was one of the leaders in China’s crowded beef products market, and its Niutou brand of beef jerky was a regional favorite. But the three founders, who were all in their 60s, were looking to retire, and couldn’t find a suitable replacement to carry on the work after they left.

 

It was a classic succession dilemma, and a golden opportunity for Lunar Capital Management, which was considering entering China’s snack food sector. The firm’s representatives met with management numerous times over the course of a year, trying to convince them that Lunar was a different kind of PE investor: one that had plans for the company beyond making a quick buck.

 

“What we’re trying to do is to move away from this environment in China where everyone is simply looking for what’s hot now, which may or may not be hot three or four years from now,” says Derek Sulger, managing partner at Lunar. “We’re trying to look at where we can buy sustainable businesses that will outlast the generations. That’s what people are going to be looking to own and buy in China, from this point forward.”

 

The courting paid off in April 2013, when Lunar bought a 70% stake in Yonghong for $50 million. Now the GP is trying to show the truth of its words, through helping this well-known company grow even further through expansion into new regions and sales platforms. If Lunar can continue to boost Yonghong’s standing, the private equity firm will have a strong success story for future clients – and China will have a strong national brand that is poised to hook a new generation of consumers.

 

Well researched

Lunar’s interest in beef jerky was no random choice. The private equity firm looked at several criteria when deciding on a sector to target for its investment.

 

One of the most important was the opportunity to get involved in a strong consumer market segment. China’s snack food sector fit this bill. It has shown solid, if not spectacular growth over the past five years, and is projected to continue its steady rise in the future. But not all areas of the market are created equal, and Lunar knew it had to narrow its choices in order to find a segment in which a local company could have room to maneuver.

 

“For some of the niche sectors, like carbonated beverages, there’s a global foreign player, like Pepsi, and they basically set the rule for the whole industry,” says Jerry Mao, co-head of the PE firm’s investment and corporate finance team. “But there are still a lot of niche sectors, like beef jerky, nut-based snacks and others, where there’s no global leading player.”

 

The beef jerky market held additional appeal because of its high fragmentation. While there are regional leaders – including Yonghong, of course – with 500 brands of jerky being sold nationwide there is still plenty of competition and no one dominant player. This was welcome news to Lunar, since it meant there were consolidation opportunities by which its investee company could break out of the pack.

 

“We like to buy strong regional consumer brands that have reached a plateau for a couple of years, because that’s where we can help build on the founders’ success and leverage our ability to further grow the business outside of their core markets or expand into new distribution opportunities, such as modern trade or e-commerce,” says Y.R. Cheng, the Yonghong deal chairman and head of operations at Lunar. “That was very much the case with Yonghong as well.”

 

The story of Lunar’s involvement with Yonghong begins years before the investment. In 2011 the private equity firm undertook a survey of the snack food industry overall, highlighting promising segments. This first phase led the team to consider a beef jerky player.

 

The more focused second phase of the survey started in 2012, with a mapping out of the industry and the identification of several hundred players. From this group, Lunar shortlisted the top five candidates and visited each one. Yonghong stood out because of its long history and its focus on quality.

 

“In the past, a lot of people competed on cost, and on the price. Basically, whoever provided the lowest price in this industry would have the deal volume. But now people really focus more on the product quality,” says Mao. “Yonghong, over the past 30 years, has never had a quality problem before, which is quite rare in the snack food industry, especially in the beef jerky sector.”

 

The case for control

Key to the firm’s considerations was that the company needed to offer the chance to take a majority stake. Unlike many China-focused investors, Lunar sees control as a necessity to be able to effect the kind of changes a company needs. It also believes that having control over major decisions means it can avoid the risk that comes with sitting in the passenger seat while somebody else makes a company’s choices.

 

However, handing over control to a group of outsiders is not always palatable to an older generation of Chinese owners. To overcome the skepticism of the company’s founders, Lunar had to show that it understood the market and knew the challenges facing the company. This was when the long preparation paid off.

 

“It’s extremely hard to find these opportunities if you’re just looking at it as an investor,” says Sulger. “But if you’re deeply embedded in the industry, that’s how you know who the companies are, who owns them, what the dynamic is behind them. Our value proposition is quite simple; we get to know all these companies as industry peers, and we say to them, we’re a great partner to have if you want to professionalize your business, continue to grow your revenue, and become more profitable.”

 

Having taken control, Lunar set out to build the company into a true national brand. There were a few obstacles to achieving this goal; for one thing, the company’s primary brand Niutou, while beloved in China’s north and northeast, including Yonghong’s home province of Guizhou, had not made much of a splash in other areas. The flavor was considered too dry and too spicy for western and southern tastes.

 

Yonghong has addressed the taste issue by introducing new flavors, based on Taiwanese and Singaporean recipes. It has also added a jerky stick, in an attempt to appeal to younger consumers who want a quick bite after playing sports or a workout.

 

The flavor issue was relatively obvious, compared to concerns with the product’s packaging, which had remained relatively unchanged since the early 1990s. There was only one size and style available, a large bag with individually wrapped single servings inside. It was seen as old fashioned and inconvenient for individuals to buy for themselves. Lunar felt that more could be done to reposition the brand as a healthy source of protein, and not just a snack.

 

“The old packaging was tailored towards old consumers, and was not appealing to young consumers, a key consumer base for more healthy beef jerky products,” says Dragon Sun, a veteran of Mars and Budweiser in China who was hired by Lunar after the takeover to serve as CEO of Yonghong. “So we needed to strike a balance – to retain the packaging that appealed to legacy customers, while attracting consumers from the younger demographic.”

 

The company is innovating its packaging in a number of ways. Along with the jerky stick, it has introduced smaller packages for sale in convenience stores, and has also produced a special packaging style meant only for sale at airports and tourist destinations. This package features images of Guizhou province, promoting the product’s regional identity.

 

Yonghong has even introduced a new product meant only for online sales, in an attempt to separate its newly created online brand identity from its well-established offline presence. Lunar’s Cheng says that this is not meant to supplant the existing brand, but rather to avoid cannibalizing its offline sales and competing with itself on price.

 

“Expanding online allows us is to differentiate the product offering. You have to be very competitive when you sell online, with all sorts of promotions and pricing schemes,” he explains. “For a lot of companies this creates a challenge, because they often corrupt the offline pricing integrity and dump inventory. We encouraged the development of a completely different product line, with a different look and slightly different flavor, that allows us more flexibility to be price competitive on pricing.”

 

Yonghong has embraced a number of outreach efforts, including WeChat advertisements and online discounts. Its aggressive tactics have paid off; the company recently achieved the number one ranking in T-Mall’s snack food category recently, after clearing 30,000 units and generating more than RMB400,000 in sales over a three-day period. Bin Shen, Lunar’s snack food investment manager, says a modern company must be prepared to make an investment in order to see success in online sales.

 

“The key to getting successful e-commerce sales is to attract traffic, because it’s more expensive than in the past to attract customers,” he says. “I think the market research shows that right now, it takes about RMB40 to attract one online customer to your store. So you have to generate during the customer lifetime more than RMB40 of margin in order to break even.”

 

Lunar has been attentive to offline sales as well, working to build the brand’s awareness outside of its regional base. The key to this has been reaching out to modern retail channels, including hypermarkets such as Wal-Mart, Carrefour and RT Mart.

 

In the case of one national hypermarket chain, Lunar proved to be invaluable, thanks to an internal partner who helped to set up a strategic partnership between Yonghong and the chain. This allowed the company to sell its products directly to the store rather than going through the normal network of distributors.

 

In this space, again, the revamping efforts have paid off, with Yonghong’s sales to Wal-Mart increasing more than 200% in 2014. In eastern China, the company’s presence has increased as well, with sales increasing 150% year to date in 2015.

 

At the moment, Lunar is exploring bolt-on acquisitions for Yonghong. Obvious candidates would include another company in the highly fragmented beef jerky sector, but the PE firm is also considering acquiring companies in other segments, such as dried fruits and nuts. The possibilities for synergy in this space are considerable; although these foods obviously differ considerably on the supply side, the distribution pathways are very similar, allowing for consolidation opportunities.

 

“You are dealing with many of the same purchasing managers and distributors across many products, who can sell to other supermarkets,” says Shen. “In China the snack food category is very broad, but the distributor who’s doing snack food will also be doing beef jerky, chocolate, potato chips, all sorts of things.”

 

Exit options

While the firm is not working on an exit yet, there are, as always, considerations in play. One possibility is an IPO, either in Hong Kong or the mainland. Mao says the PE firm would want to make sure that wherever it is offered, the investors would understand the business. A trade sale is also possible. There are many in the market that have caught up to Lunar’s thinking and are eying snack food for its stability and growth prospects. Another PE firm, or a food and beverage conglomerate, could make a play.

 

Mao adds that Lunar is not worried about its ability to sell the company. The logic that led the PE firm to acquire the business will lead others to it as well.

 

“Strong consumer businesses, whether snack foods or others, never go out of style,” he explains. “There will be cyclicality that provides you the chance to acquire at certain times, knowing that there are always financial sponsors, global firms, domestic conglomerates and others keen to own sustainable strong brands.”