ENLARGE

Customers outside a McDonald’s outlet in downtown Shanghai in July. Photo: Reuters

McDonald’s Corp. Chief Executive Steve Easterbrook, aiming to slim down the Golden Arches and boost profit, has turned to the market where he can do something big, fast: China.

The Oak Brook, Ill., chain is looking to cut a deal to turn its 2,200-store empire in China—65% of which it owns and operates—into a cash machine through all-out franchising. The move, for which a partner could be determined before the end of the year, is expected to fetch between $1.5 billion and $2 billion up front from investors, people familiar with the matter said.

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McDonald’s would also rake in an estimated 5% to 7% of sales for the 20-year life of the deal. It would keep a minority stake in these far-flung stores, while slashing its operational costs and preserving capital.

The timing of the initiative also reflects the maturing of the fast-food business in China, where McDonald’s and Yum Brands Inc.—owner of Kentucky Fried Chicken and Pizza Hut—have operated for a quarter-century.

As big consumer chains move from the familiar streets of Beijing, Shanghai, Guangzhou and other metropolises to smaller cities, they need Chinese partners with knowledge of the country’s real estate and market demographics to know where to put new stores and how to supply them.

“In the lower-tier cities, we want to accelerate, and a local partner would have more local wisdom and more local resources,” Phyllis Cheung, chief executive of McDonald’s China, said in an interview. “The whole idea of franchising is that you have more flexibility and speed to market—and are more able to answer to consumer needs.”

There appears to be a healthy appetite for the deal. A clutch of at least six bidders has shown interest in a McDonald’s China franchising deal, including U.S. private-equity giants Carlyle Group LP, TPG and Bain Capital LLC, according to people familiar with the situation.

The three private-equity firms have teamed up with local Chinese partners, such as Citic Ltd. and Wumart Stores Inc., who know local market conditions. McDonald’s is also looking to cut a similar deal with outside investors for its South Korea stores.

In China and Hong Kong, McDonald’s is asking its potential partner to take over its more than 1,400 company-owned restaurants and build 1,300 new stores. It still has room to grow in China, the only major market where the number of Kentucky Fried Chicken stores—5,000 and counting—outstrips the number of McDonald’s stores.

The winner will operate in a country where the novelty of burgers, fries and shakes has long since faded. It will need to find new ways to satisfy Chinese consumers demanding healthier, more upscale and personalized alternatives.

Bessie Wang, 33 years old, began eating at McDonald’s in grade school soon after the fast-food chain entered China 26 years ago, becoming a fan of the company’s fried-chicken sandwiches.

On a recent weekday, Ms. Wang was dining on a spicy chicken sandwich at the McDonald’s on Beijing’s Wangfujing shopping street. But her visits have declined.

“Taste isn’t the issue; it’s health reasons,” said Ms. Wang, an office administrator. “I don’t need to go as often anymore because other restaurants offer fried-chicken dishes.”

Sales from established McDonald’s stores in China have bounced back from a supplier issue that led to shortages of hamburgers and chicken at some restaurants in 2014. Same-store McDonald’s sales in the country shrank for four consecutive quarters before they began recovering in the middle of last year, according to figures provided on the company’s earnings calls.

And competition is rising. Dicos, a Taiwanese-owned chain, for example, offers chicken sandwiches at more than 2,000 restaurants in China, matching the scale of McDonald’s. Another growing Chinese fast-food chain, known as Real Kung Fu, sports a Bruce Lee logo, offering bowls of Chinese noodles with beef and pork.

The growing competition, Ms. Cheung said, is one reason McDonald’s is looking for a Chinese partner with a “deep understanding” of China’s market, rather than one that can simply bankroll new stores.

Yum announced a similar move last year to spin off its KFC and Pizza Hut operations in China and maintain a foothold in the country through royalty payments.

For companies such as McDonald’s and Yum, moving toward a franchise-only model in China makes sense now because the market has matured to the point where there are more people with experience running fast-food chains and fast-casual restaurants, according to Ben Cavender, director at China Market Research Group.

“There’s a stronger talent pool, and they have the capability to operate a franchise and operate it well,” he said. “Brands are also clamoring to try to grow into new markets, and they might not be able to do it quickly by themselves, and they need help.”

Source: WSJ