Monday, March 12, 2007

Opportunity to buy Starbucks (SBUX) for its China growth potential

It may be a mistake when Starbucks opened its store in the Forbidden City, this issue has attracted media attention and Chinese citizen’s discontent ever since the shop opened in 2000. Last week this issue has reached a new height when Mr. Jiang Hongbin, a lawmaker representing Heilingjiang province submitted a motion to the National People's Congress to close the outlet immediately.

The Forbidden City was the Chinese imperial palace during the mid-Ming and the Qing Dynasties. The palace was "forbidden" in the sense that, apart from members of the imperial household no one could enter it without the Emperor's permission. Today it has transformed into a museum and a popular tourist spot attracting 7 million local Chinese and overseas visitors each year.

The discontent of the Chinese is a cultural issue, it’s about invasion of Chinese culture by western culture, and about how Starbucks doesn’t fit into the environment of the Forbidden City.

Starbucks obviously understand the importance of respecting local culture when doing business in China. In 2006 it has appointed Dr. Eden Woon as Vice President of Government Affairs, Public Relations & Corporate Social Responsibility for Greater China. Dr. Woon was previously CEO of the Hong Kong General Chamber of Commerce, which has played a key role in working on the closer integration of Hong Kong's economy with that of China. Prior to that he was Executive Director of the Washington State China Relations Council and has spent 22 years with the U.S. Government. I found this a very good move for Starbucks, it’s important to pick someone who can lobby the Chinese government and at the same time get the Chinese message back to corporate America.

Starbucks share price has recently reached its 52-week low, it’s not because of this Forbidden City issue, rather it’s due to its decreasing same-store sales growth figures and a recent Chairman memo.

China is a top priority for Starbucks for its future revenue growth as stated by its Chairman. Yum! Brand is operating 1822 KFC and 254 Pizza Hut in China, its China division has contributed ~18% of company profit in 2006. McDonald also has 764 restaurants in this fast growing country and is still rapidly expanding. If Starbucks plays the cultural game right, with its current 240 outlets already established in the country it is very likely that Mr. Howard Schultz’s Chinese dream will come true in a not too distant future.

If you haven’t got a chance to visit China, please don’t under-estimate the Chinese domestic spending power. I used to visit this Starbucks in Beijing daily for breakfast when I worked in the capital city, based on my observation I can tell you over 90% of its visitors are local Chinese and they spend almost the same amount of money for the same cup of coffee as that is charged in Seattle. That’s where the growth potential is coming from.

What’s the harm to shut down one store (out of the current 240) in the Forbidden City if the Chinese government would allow you to open another thousand in other Chinese locations? As an investor I only look at growth potential and I see the recent weakness as a good bargain potential.

Disclosure of interest: I am having a LONG position in SBUX.