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China’s Mengniu Dairy Co. to Buy Modern Dairy Stake to Control Milk Quality

May 8, 2013
 
 

The acquisition will increase focus on quality of supplies amid safety concerns in China’s dairy industry.

May 8 -- China Mengniu Dairy Co., the country’s largest dairy producer, agreed to buy 26.9 percent of China Modern Dairy Holdings Ltd. for HK$3.18 billion ($409 million) to gain greater control of milk supplies amid food safety concerns in the country.

Mengniu Dairy will pay HK$2.45 a share for the Modern Dairy stake, the company said in a filing to Hong Kong’s stock exchange today. That’s 12 percent less than the stock’s closing price yesterday. The two sellers were companies controlled by KKR & Co. and CDH China Fund III LP, according to the statement.

Acquiring the shares in Modern Dairy will help Hohhot, Inner Mongolia-based Mengniu Dairy increase focus on quality of its supplies amid safety concerns in China’s dairy industry. Food-safety scandals in China ranging from toxic melamine in milk powder that killed six babies, to kitchen waste reprocessed into cooking oil and rat meat being sold as mutton has driven consumers to buy products overseas.

"Accelerating and expanding investments in quality farms will allow Mengniu to establish a safer and more stable value chain in the dairy sector," Mengniu Chief Executive Officer Sun Yiping said in a statement.

Modern Dairy plunged 6.5 percent to HK$2.61, the most since December 2011. It is still up 23 percent this year.

The two private equity funds bought the shares "at a much lower price and they’ve been holding onto the shares for a long time," Anson Chan, a Hong Kong-based analyst at KGI Asia Ltd., said by phone. "The sale reflected their urgency to realize the gains."

Discounted Price

Mengniu shares gained 0.2 percent to HK$21.80. The benchmark Hang Seng Index rose 0.9 percent.

"We believe Kohlberg Kravis Roberts wanted an earlier exit from China Modern Dairy rather than having to sit through the full investment term," Charles Yan, head of Greater China Consumer Research at Standard Chartered Plc, said in a note. "We believe KKR is focused more on building a long-term strategic relationship with COFCO."

Modern Dairy is the largest raw milk producer in China, as well as the largest dairy farming company in terms of herd size, Mengniu said in a statement.

Steve Okun, a spokesman for KKR, declined to comment on the pricing. KKR completed purchase of Modern Dairy shares in 2009, according to its statement.

Prior to the acquisition, state-owned COFCO held 20 percent of Mengniu, while New York-based private-equity firm KKR owned 24 percent of Modern Dairy, according to data compiled by Bloomberg. Today’s deal will give Mengniu preferential purchase rights to Modern Dairy’s milk supply, Mengniu said in a e-mailed reply to questions. Mengniu doesn’t plan to increase its stake in Modern Dairy in the near future, Esther Lau, an external spokeswoman for the company today.

Consumer Confidence

Mengniu’s operating profit last year shrank 16 percent to 1.45 billion yuan as sales fell 3.5 percent. Food quality and safety incidents affected consumer confidence and sales, it said in a March 27 statement. In 2011, Mengniu said moldy cattle feed led to excessive toxin levels in its milk.

Since then, the company has run marketing campaigns emphasizing product quality to draw consumers back, and also formed a strategic partnership with Danish dairy firm Arla Foods in 2012 to improve quality inspection techniques and explore further co-operation.

Market Share

Mengniu sells liquid milk products including UHT milk and yogurt under its namesake brand in the Asian nation. It also produces ice cream and other dairy products such as cheese and milk powder. The company has the biggest share in China’s drinking milk market, controlling more than 34 percent share in 2012, according to Euromonitor International. Inner Mongolia Yili Industrial Group Co. ranked second with 24.8 percent.

Sales of milk in China will rise 70 percent to 147.4 billion yuan ($24 billion) in 2017 from last year, according to data from Euromonitor International.

Modern Dairy, which first started operations in 2005 and is the largest raw milk supplier to Mengniu, runs 22 large-scale dairy farms in China.

Milk sales at Modern Dairy rose 49 percent to 1.09 billion yuan in the second half of last year, according to the company. About 87 percent of its total sales goes to Mengniu, according to data compiled by Bloomberg.

Food Scares

Food scares in China’s dairy industry have been common. In 2008, at least 22 companies were found to have sold dairy products containing melamine, a toxic chemical that can make diluted milk appear to have a higher protein content.

Chinese police detained in March a Eastern China-based milk distributor suspected of repackaging and selling milk powder made by Swiss dairy company Hero Group that wasn’t licensed for sale domestically, the official Xinhua News Agency said.

Chinese consumers’ distrust of local milk has been driving domestic companies to look overseas. Yili Industrial said in December it plans to invest NZ$214 million ($180 million) in a baby formula project in New Zealand.

Hangzhou Wahaha Group Co., the beverage maker owned by China’s richest man Zong Qinghou, is looking to Australia for better quality milk sources that China lacks, Zong said in March. Wahaha already sources its "Edison" baby formula from the Netherlands.

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