Japanese wary of McDonald's share offer

Bloomberg News Service

TOKYO — Yoshio Inamura still remembers when he was a 17-year-old standing in line at Japan's Ginza shopping district to try a hamburger for the first time.

McDonald's Tokyo-based unit hopes to triple its number of burger outlets, to 10,000, by 2010, using an initial share offering this summer to help pay for the move. Bloomberg News Service

"The company has already run up its growth," said Inamura, who doesn't plan to add the stock to his 40 billion yen ($320 million) fund. "McDonald's Japan is running a time-machine-like management by copying business practices which were successful in the U.S. 20 to 30 years ago."

Inamura's concern, shared by other investors, is that profit growth has peaked as hamburgers have lost the novelty of 30 years ago, when the Japanese diet was mostly fish and rice. Rivals Yoshinoya D&C Co. and Matsuya Foods Co. now serve up beef, chicken, and even salmon with rice just as fast as McDonalds.

While McDonald's has responded by undercutting rivals on price, a weakening yen may increase costs and undermine that strategy. Its burgers may be cheaper but its shares won't be. They will be sold at 31 times estimated earnings, higher than Yoshinoya's 21 times and its U.S. parent's 19 times. Inamura says he would buy the stock at 20 times profit.

Investors say the company needs to expand into new food businesses similar to the U.S., where the parent company operates restaurant chains that serve pizza, chicken and Mexican food.

"If they stick with hamburgers for a long time, the company may not be able to cope with Japan's growing aged society," said Kazuyuki Katsushima, a retail analyst at UFJ Partners Asset Management Co., which manages 1.4 trillion yen in assets.

Aging society a problem

People in their twenties visited McDonald's 15 times a year, while people above their forties, like Inamura, visited only twice, according to the company's latest survey.

The company and its shareholders will sell 26.2 million shares to raise as much as 92 billion yen, Japan's largest initial public offering this year, according to share sale documents. That would be double the size of this year's nearest IPO by Usen Corp., an Internet access provider.

The company will use share proceeds to open 400 more shops, buy land for outlets and may even start new food businesses, said president Den Fujita. While he didn't say what sort of business may be started, Fujita admitted: "Noodles are still my favorite food because that's what I ate when I was 12 years old."

Daiwa Securities Group, Morgan Stanley Dean Witter & Co., Nikko Salomon Smith Barney Ltd., Mizuho Securities Corp. and 25 other securities firms are arranging the sale. The final price will be set on July 17.

The share sale will give the company a market value of about 465 billion yen, making it the second largest stock on the over-the-counter market after Internet directory Yahoo! Japan Corp.

To tempt investors, the shares will be sold at about 3,500 yen, 30 percent lower than the original plan of 5,000 yen, bankers involved in the sale said. To attract individuals frustrated with bank interest rates close to zero, the company will sell shares in 100-share lots costing 350,000 yen ($2,800), instead of the traditional 1,000-share lot.

Even that may not be enough, investors said.

The shares will be sold at 31 times estimated earnings, based on the price indicated in share sale documents. That compares with 14 times for rival Mos Burger. While McDonald's Japan boasts sales 5 times bigger, its size also means rapid sales growth will be harder to come by.

The stock is more expensive than Fast Retailing Co., for example, even though the operator of discount casual clothing stores called Uniqlo doubled sales last year.

Winning with deflation

The only saving grace for McDonald's may be Japan's high unemployment and bankruptcies, which have turned people away from more expensive restaurants.

Some investors, especially individuals, are more optimistic that Japanese will continue to buy 200-yen ($1.60) Big Macs and other cheap burgers as the economy heads for recession.

McDonald's Japan, which sells two out of every three hamburgers in Japan, increased sales by offering food at a third the price of rivals.

A strong yen over the past two years made imports of potatoes and beef cheaper, helping it to become the most profitable overseas unit of McDonald's Corp.

The company has dominated Japan's hamburger market by selling burgers at 85 yen during weekdays, one-third the price Mos Burger charges and half the price at Lotteria Co., Japan's third-largest hamburger seller.

"McDonald's is one of a few winners in Japan's deflationary economy," said Naohiko Sasaki, who helps manage 360 billion yen in Japanese equities at Kokusai Asset Management Co. "It managed to turn around a tough business environment to a favorable one."

Waning profits

The company benefited from its parent's distribution network and managed to keep prices low by importing more than 20 percent of the food it uses at favorable exchange rates.

Net income for the year ended December 2000 rose 6 percent to a record 16.8 billion yen from a year earlier. Sales in the same year increased 9 percent to 357.9 billion yen. The Japanese company contributes a tenth of the parent's total revenue.

There are already signs that profit is waning. The company expects pretax profit to decline 8 percent for the year ending December because of a 7 billion yen increase in royalty payments to its parent and rising investment costs. Pretax profit fell 6.7 percent in the previous year.

For the next fiscal year, the weak yen is likely to increase the cost of imported materials. The company set a currency rate of 94 yen to the dollar for this fiscal year. The yen has dropped 8 percent this year to about 124 to the dollar.

"It is about time for them to try something different, but chances are they'll face more severe competition," said Inamura.