UPDATE 3-Danone to raise stake in top China dairy firm for $665 mln
* Danone raising stake in Mengniu Dairy Co Ltd to 9.9 pct
* Danone and COFCO Dairy Inv't to subscribe to share issue
* Shares to be issued at HK$42.5/shr
* Price is 15.3 pct above Mengniu's previous close
* Mengniu shares jump as much as 9.5 pct to record (Adds details, comments from Danone and analysts)
By Denny Thomas, Donny Kwok and Dominique Vidalon
HONG KONG/PARIS, Feb 12 (Reuters) - France's Danone is spending 486 million euros ($665 million) to lift its stake in China's top dairy firm, aiming to tap into booming local demand and secure greater control over supply quality in a region often hit by food safety scares.
The investment in China Mengniu Dairy Co Ltd by the world's biggest yoghurt maker, whose brands include Actimel, Activia and Shape, will boost its holding to 9.9 percent from 4 percent, making it the Chinese company's second-biggest shareholder after China's COFCO Dairy Investment.
"This will allows us to pursue our ambition to expand in the fresh dairy category in China and benefit from its great potential," a Danone spokeswoman said on Wednesday.
China is already an important market for Danone, accounting for around 6 percent of global sales of 20 billion euros. But fresh dairy products make up less than 3 percent of its sales to China and the spokeswoman noted China's annual per capita consumption of fresh dairy products is 1.1 kg, or just 3 percent of what it is in France.
Sales of dairy products in China are expected to nearly double from 2012 to 2017 to about $89 billion, according to projections by business consulting firm Frost & Sullivan.
China is also an important market for Danone's baby food division, which makes up 20 percent of group sales, making it the No. 2 contributor after dairy.
Danone's latest commitment to China comes after it suffered a series of setbacks last year, including being fined for anti-competitive practices after a probe into price-fixing. It also recalled infant formula products in Asia due to an unfounded health scare stemming from New Zealand-based supplier Fonterra Co-operative Group.
Such problems have eroded Danone's image with Chinese consumers, analysts have said, and closer ties with state-owned Mengniu could potentially help smooth relations with Chinese authorities and consumers.
Analyst Francis Pretre at brokerage CM-CIC Securities said the new deal would allow Danone to "pursue its expansion in Asia in a more serene way, securing its supplies in terms of volumes as well as quality".
Mengniu shares rose as much as 9.5 percent to an all-time high of HK$40.35, although the stock gave up much of those gains as traders locked in profit from the past year's rise of more than 65 percent.
"Danone's willingness to pay a premium for the stake suggests that they are bullish over the long-term prospects of China's dairy industry," said Alex Wong, a director at brokerage Ample Finance Group.
Mengniu stock trades at 24.8 times 12-month forward earnings, compared with an average of 19.6 times for Hong Kong-listed food products companies, according to data from StarMine. The average for the Asia-Pacific region is 18 times.
Booming Chinese demand for dairy products has sparked a raft of deals in the country's dairy sector. Food-safety scares have also boosted demand for foreign baby milk formula, pushing Chinese dairy firms to seek ties with foreign makers.
Danone, also maker of Bledina baby food and Volvic water, formed an alliance with Mengniu in May 2013, under which the companies agreed to produce and sell chilled yoghurt products in China, pooling assets to form a venture with 2012 proforma sales of 500 million euros and an estimated market share of around 21 percent.
Under the deal announced on Wednesday, Danone and COFCO Dairy Investment, a venture with China's state-owned COFCO, will subscribe to a reserved rights issue by Mengniu at HK$42.5 per share, a 15.3 percent premium to Mengniu's previous close.
COFCO, Danone and dairy cooperative Arla Foods, Mengniu's three core shareholders, will combine their stakes within COFCO Dairy Investments, Danone said in a statement. COFCO owns 16.3 percent of Mengniu and Arla owns 5.3 percent.
Danone has long aimed to establish a major presence in China. Its first joint venture with China's largest beverage company, Hangzhou Wahaha Group Co, fell apart in 2009 after 13 years.
China's dairy industry is dominated by local companies including Modern Dairy, China Huishan Dairy Ltd and YST Dairy. But foreign players have taken a significant role in niche markets such as milk powder after a 2008 food safety scandal.
Mengniu plans to use the proceeds to cut debt. Deutsche Bank advised China Mengniu, the Chinese company said.
To see the statement please click (link.reuters.com/wuq76v) ($1 = 7.7564 Hong Kong dollars) ($1 = 0.7312 euros) (Additional reporting by Dominique Vidalon in Paris, with Elzio Barreto and Nishant Kumar; Editing by Stephen Coates and David Holmes)
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