Meicai: Fostering the Next Tyson and Smithfield Foods – It's Not Sysco [2/2]

This article is part II of our analysis on Meicai – check out part I before you read. 

Intrinsic industry barriers

Even companies that are better at 'flash fights' like Meituan Dianping need to take things slowly in the B2B foodservice industry, where there is now a market with higher barriers to entry, at least in terms of capital investment. Meituan considers B2B food distribution, micro-loaning, car-hailing and Meituan Instashopping as important new initiatives –it reported CNY 20,409 million in revenues and 11.5% gross margin in the year ending on December 31, 2019. Industry insiders said that Meituan had lost an accumulative CNY 4 billion in the B2B food business in the previous three years. UBS research estimates a minus CNY 1,605 million operating loss for new initiatives in 2Q 2020, justifying an annual CNY 1 billion to CNY 2 billion – a fair number to believe. Further, doubling the loss sets the bar for the initial capital a startup needs to have up front, clearing out potential new and small entrants as well as weak ones. Songxiaocai, for instance, has been struggling to find its way amid the fiery competition between larger entities, switching from 'B2B transaction marketplace' to 'all in upstream.'

Meituan's Longzhu Capital, an active consumer investment institution, has made several fresh food deals to compete with Meicai – Guangzhou-based agricultural product distributor Lehe Food and group purchasing company Kangpinhui. 

It is not the right time to promote Meicai brands on a large scale, yet

Sysco increased its Sysco Brand case volume for U.S. Broadline, its largest division, to 38.46% in 4QFY20, which is unimaginable in today's China third-party food distributor ecosystem. But Liu expects to see a higher penetration of Meicai Brands originating from Meicai's platform in the future, due to the fact that: 1. Sysco faces a more concentrated upstream market than China, with names like Tyson and Smithfield Foods, dominant in chicken and pork categories – at the same time, there were barely category leaders in a niche. 2. Meicai aims to incubate more brands with partners in the future, and they can be financed independently and remain purely neutral in order to gain higher revenues. Taking the rice supply chain as an example, Meicai has successfully operated in crop auctions, rice processing and rice level grading, matching old rice with new rice, and logistics. The next step to unlock the rice brand here is to find a suitable partner to establish a new brand to compete with establishments, with the same quality of products but better prices. 

The general partnership will be similar to what Xiaomi, a phone maker that leverages the ecosystem it has built to become a strong IoT hardware player. MiOT Ecosystem – what Xiaomi calls its business – is a large network of smart devices that incubates well-known IPOs like Huami, among 89 startups operating in cellphone, smart home, security, healthcare, etc. "We've been studying from Xiaomi for a long time," said Liu, "different to Xiaomi's focus on tech hardware, that will see a dropping value as time goes by, Meicai's brand division will be a more stable one. We look to have 3,000 brands in the future."

On the other hand, Xiaomi usually holds minority interests, ranging from 30% to 40% in each brand company. Still, Meicai tends to have a controlling stake (50% or above) depending on how much resources it will put, and ask for voting power. 

Looking ahead, Meicai wishes to reach the critical mass in the coming six to seven years. In saying that, the scale gives it a decisive leadership in 2B. It will also replicate the model in 2B to 2C, restocking restaurants and households' warehouses upon their needs automatically, driven by technology.

Valuation

Meicai hardly discloses any operating data to the public. The effect is to keep the company mysterious and, more importantly, it avoids the possibility of data being captured and used by competitors. Liu spoke on GGV Evolving, saying Meicai expected to reach CNY 14 billion sales in 4Q2019. Later in another interview (link in Chinese), he said that the business had grown by 40% year-over-year in the same quarter. EqualOcean made our forecast based on these numbers and valued the company, benchmarking its US peers. Considering that Meicai is still in a relatively fast-growing stage vs. SYY, PFGC and USFD, and a higher recovery speed from coronavirus,  we give a premium to P/S and raise the multiple to 0.9, tripling the average multiple. In July,  China's catering business sales reached CNY 328 billion (link in Chinese), dropping 11% from over a year ago. From January to July, sales totaled CNY 17,891 million, a 29.6% growth. The valuation model shows that if Meicai can grow the business by 20%, it will be valued at USD 7.9 billion this year in our base case.