INSIGHTS | Is noodle chain the new blue ocean for China tech VCs?​

Once focused on Chinese tech companies, venture-capital funds are pouring money into new noodle chain brands that sprung up in the country. Even tech giants like Tencent, the social and gaming behemoth, and an active investor, are doubling their bets on the sector. The capital inflow and media attention on a very specific food and beverage vertical highly resembles China’s coffee craze four years ago – and has many observers referencing the spectacular rise of Luckin Coffee.

Chinese-style noodle chain restaurants first became tech investor darlings in 2021 when the industry faced tightened regulation while the country’s consumers became increasingly willing to spend more on quality products and experiences. There were twelve noodle chain investment deals in the first half of that year, with a combined total of RMB 1 billion injected into the emerging area. The market scale of Chinese noodle restaurants is expected to be worth RMB 346 billion ($52 billion) by 2022, according to Chinese data analytics firm iiMedia Research.

So will China’s noodle chain market see the emergence of the “next Luckin”? Or, more importantly, will the market craze maintain its momentum?

Blurring boundaries between tech and consumption brands

Before its spectacular, highly controversial downfall after a financial fraud scandal, Luckin helped grow the popularity of coffee culture in a majority tea-drinking nation and fostered the growth of a trillion-dollar market in China. 

Coffee chains are not tech businesses, but Luckin borrowed a playbook from tech companies by building its ordering and delivery services around mobile apps while adopting online-first marketing and branding strategies typical of internet companies. It’s perhaps no surprise that Luckin adopted an internet-based approach to the coffee business, given the company shares the same founding team of car-sharing platform CAR, Inc. But it was nevertheless a fresh approach when Luckin first rose to stardom in 2018.

Luckin is still trying to recover from the aftermath of a shocking RMB 2.2 billion accounting fraud scandal. Still, the company’s approach to entering a traditional industry with heavy discounts and an online-first marketing strategy has been picked up by many companies and viewed by numerous investors as a proven business model.

This model has been partially tested in China’s milk tea industry, which has seen the rise of bubble tea giants like HeyTea and Nayuki attracting funds from tech majors. Tencent has invested in HeyTea and Canadian coffee chain Tim Hortons, while ByteDance has backed Shanghai-based coffee chain Manner.

Venture capital attention has since been turned to a slew of verticals in food and beverage. Hotpot brands (for example, Lanxiong Hotpot), Chinese pastry chains (such as Bao Shifu), and packed stewed snacks (including Tencent-backed Shining Taste) are also getting investor attention. But for many investors, noodles, one of China’s favorite staple foods, is the next break-out vertical to win over.

The race to be Luckin for noodles

Luckin’s approach has prevailed in China’s noodle market over the past year. Armed with funding, a host of noodle brands have targeted rapid offline expansion combined with online marketing campaigns to quickly capture market share. Here are a few rising players in China’s new noodle chain brands.

• Hefu Noodles: A top player in the field, this decade-old brand of Beijing-style noodles operates more than 380 stores across China as of February. It has so far secured six funding rounds totaling RMB 1.6 billion. The company’s most recent Series E booked RMB 800 million in July 2021 from investors, including CMC Capital, Tencent, ZWC Partners, and Longfor Capital. With a market valuation of RMB 7 billion, the company is gearing up for an overseas IPO this year.
• Chen Xianggui: This Lanzhou-style noodle chain restaurant has received more than $300 million in funding since its establishment in 2020. Investors include Source Code Capital, an investor in ByteDance and Meituan, and Huaxing Growth Capital, the tech and entertainment-focused venture capital arm of financial institution China Renaissance. The company’s valuation reached nearly RMB 1 billion, with the most recent RMB 200 million funds secured last November.
• Majiyong: Tencent invested in the operating body of Majiyong, an upstart beef noodle brand, in late January. Last May, the Shanghai-based food chain received an angel round from renowned tech investors, including Sequoia Capital, Gaorong Capital, and K2 Venture Capital, at a valuation of RMB 1 billion ($160 million).
• Yujian Noodles: The valuation of the Chongqing-style noodle chain reached RMB 3 billion after receiving RMB 100 million in funding in September last year. Investors include Country Garden Venture Capital, the investment arm of property developer Country Garden, and restaurant chain Xijiade. 

Noodles 2.0: standardize noodle-making 

Chinese have been cooking and eating noodles for thousands of years, creating many varieties and styles of noodle dishes, making the category a rich, busy place for competition. While traditional Chinese noodle joints have shabby storefronts and affordable pricing, the new noodle chains have chic dining settings and are often located in malls and business areas, offering a Chinese-style fast food alternative for urbanites. 

Such stores are usually accessible through various online food delivery platforms and offer streamlined membership services embedded in popular social media apps such as WeChat. The noodle newcomers also charge higher prices with better service and chic settings. For example, a typical bowl of tomato and beef noodles at Hefu Noodle costs RMB 38, much higher than similar items sold at below RMB 20 in traditional shops.

On top of that, the new breed of noodle chains save on operating costs by standardizing and streamlining food production at “central kitchens,” which are back-end facilities that pre-prepare frozen packages of noodle toppings for the restaurants. This model saves chains on the cost of hiring professional chefs for in-store cooking while making better use of storefront spaces for diners.

Will the Luckin recipe work?

For investors, capital flows to where it could make the biggest profit. Tech venture capitalists are shifting attention to new consumer consumption brands when China continues to clamp down on the tech sector. Combining that with a growing base of comfortable Chinese consumers looking for better dining and life experiences, investors see the food industry as a new, safer sector to chase potentially mouthwatering returns. 

There’s no doubt that capital support is an indispensable element in developing an emerging industry, but it’s not the only or even the most important factor for a successful business. Luckin’s ousted founder and chairman Lu Zhengyao (Charles Lu) was among the first to launch a new Chongqing-style noodle shop (called Quxiaomian) last year in an attempt to duplicate Luckin’s success. But the brand received a lukewarm reception from diners and was soon forced to downsize operations.

An excessive inflow of hot money can also harm the long-term development of a market. From subsidy-fueled market grabbing wars to skyrocketing valuations, China’s tech market has seen multiple “bubbles” burst over the past two decades. The latest case was the community group-buy industry, where even top players collapsed after the venture craze ebbed last year.

In addition, the noodle market is facing obstacles before it can really take off. As with any offline business in China at the moment, noodle chains are dealing with dropping foot traffic as China fights a new wave of Covid-19 outbreaks with strict lockdown measures, which seem unlikely to end any time soon. The new noodle chains are not only competing with their peers but also with traditional noodle stores, which better cater to the taste of more price-sensitive users and sometimes hold a rustic charm and human touch that the newcomers can’t replicate. 

However, with the inflow of capital and market attention, the new noodle chains are a sector worth following.