The biggest challenge for Affinity Equity Partners in exiting Burger King Japan was getting buyers comfortable with a high-growth restaurant business in a relatively low-growth economy.

“When we spoke to potential advisors, they were perplexed as to what they could do with it. Same-store-sales growth of 5% is solid, and 7% is strong. If it’s double-digit, there’s not much more you can ask for. Over the last three years, EBITDA growth was 100%, 100%, and 75%. People hadn’t seen anything like that before,” said Charles Min, a partner at the private equity firm.

“Most financial sponsors and lending banks focus on cash flows. They want a steady business; they don’t need growth. They had to figure out how to fit it into a valuation framework and attach a multiple to it.”

Bidders who persevered were those who had been tracking the business for a couple of years. They included Goldman Sachs Alternatives, which ended up buying 100% of Burger King Japan for a reported JPY 78.5bn (USD 520m). The deal, which closed in late February, delivered a 5.8x return for Affinity.

It’s a strong outcome for a business that had previously tried and failed to scale in Japan, including a couple of occasions with financial sponsor backers. When Affinity assumed control of the country master franchise in 2017, there were about 70 outlets – minuscule compared to McDonald’s and Mos Burger on over 3,000 and 1,400, respectively. It was also badly run, but Min felt this could be addressed.

“They had missed on menu architecture, the balance between core, value, and premium items. There was way too much localisation. Every store had an open smoking section, so families were eating on one side and old men were smoking on the other. Restaurants weren’t clean enough, service was slow,” said Min. “While there were many negatives regarding the state of the operation, we felt we could fix them.”

The Korea manual

Affinity’s confidence was rooted in early advances made with Burger King Korea, which it had acquired over a year earlier. South Korea is notable for being the only meaningful market globally where Burger King arrived after McDonald’s and has overtaken its rival. Under Affinity’s tenure, the footprint has tripled in size and is now roughly 540 stores. This compares to approximately 400 McDonald’s outlets.

According to Min, there was a close correlation between the core competencies of quick service restaurants (QSR) in which Korea excels – restaurant development, menu architecture, operations – and the shortfalls in Japan. The plan was to bring that expertise to Japan.

Negotiations with the existing franchise holder, Korea’s Lotte Group, were protracted, so Affinity reached an agreement with Restaurant Brands International (RBI), owner of the Burger King, Tim Hortons and Popeyes brands, and entered on a greenfield basis. It opened eight restaurants. Another 90 or so were added when Lotte finally sold, but Affinity shuttered 26 to focus on the better performers.

The restaurants that remained were remodelled – which included removing smoking sections – and required to comply with a systematic operational manual. This manual was imported from Korea and Affinity drafted in personnel from that franchise to oversee training. While COVID-19 hit the business hard, it was also an opportunity to lean into upgrades.

“Korea’s QSR industry had encountered difficulties following a food safety issue, which saw sales drop 25%. We got through that and came out swinging because of the fixes made during the downturn,” said Min. “We took a similar approach in Japan. For example, we accelerated the remodelling and we greatly expanded delivery to the point where it is now 25% of revenue.”

In addition to bringing operational expertise – and menu items like the Spicy Shrimp Whopper – from Korea to Japan, Affinity sought to replicate a path towards digitalisation. Min recalls mapping out protocols for operations management, consumer-facing apps and kiosks, and data mining and marketing across three whiteboards. Burger King Japan’s digital sales went from zero to a market-leading 75%.

Notably, the franchise also played into its status as underdog to McDonald’s through guerrilla-style marketing. A Halloween short video depicting a zombie walking out of McDonald’s to buy a Whopper at Burger King was picked up by Japanese media. This happened again when one Burger King outlet posted across its windows a large-scale farewell letter to a neighbouring McDonald’s store that had recently closed.

“The letter said, ‘Goodbye old friend, you’ve been there so long, and it’s sad to see you go,’ but if you read the characters vertically, it said something along the lines of ‘We won.’ NHK thought it was cute and ran it on the 9pm news,” said Min. “At the same time, all our marketing and promotions activity was data driven. In the past, they relied on gut and feel. We took a differentiated approach.”

Exit options

Affinity’s original pitch to RBI when acquiring Burger King Korea was that it could build a wider Asian platform. Burger King master franchises in China and Southeast Asia were considered alongside Japan. When the private equity firm launched a sale process in 2H21, Japan and Korea – both portfolio companies in Fund IV, which closed on USD 3.8bn in 2014 – were bundled together.

The process was short-lived because the outbreak of war in Ukraine in early 2022 spooked potential buyers. First, RBI’s pledge to exit Russia in response to US sanctions created uncertainty about the strength of franchise agreements globally, even though Russia-related contracts ultimately remained in place. Second, the Burger King network sourced raw materials from Ukraine, and costs were going up.

Once conditions were settled enough to revisit exit options, the two franchises were on different paths. The Tim Hortons brand had been launched in Korea and needed time to bed down, while Burger King Japan had grown from an addendum to a business of scale with around 310 stores. Moreover, selling the two together was problematic when dealing with private equity buyers.

“Many financial sponsors have different teams for Korea and Japan within Asia. There would be internal competition – ‘Is this a Japan deal or a Korea deal?’” Min observed.

For Affinity, as a pan-Asian investor with a long history in Korea, there was always the option of investing in Japan as well, but until Burger King, it never followed through. Now, as global and regional GPs look to establish or grow Tokyo offices, fighting over a limited local talent pool, the market is likely to remain no more than an opportunistic target.

“It’s a market that fits very well with our focus on building strong relationships with partners and management teams and our focus on operations and value creation to improve fundamentals and unlock additional growth and efficiencies,” said Min.

“While you need a local presence, it’s not our style to go in there and make a senior hire. We would need to ensure that whoever joins us really fits with our DNA. That’s a key consideration.”