* China Mengniu to boost stake in Modern Dairy for $410
* Move designed to ensure quality milk supply
* U.S. private equity firm seen as biggest winner from deal
By Donny Kwok and Michael Flaherty
HONG KONG, May 8 China Mengniu Dairy Co Ltd's
deal to buy a $410 million stake in China's largest
unpasteurised milk producer is a strategic move to rebuild trust
after a series of scandals left local brands' reputations in
Mengniu, twice hit by accusations it sold tainted milk, said
on Wednesday it would buy 26.92 percent of China Modern Dairy
Holdings Ltd from private equity firms KKR & Co LP and
CDH Investments. The deal will lift Mengniu's stake in China
Modern to about 28 percent.
For Mengniu, whose liquid milk products rank first in China
by sales volume, the purchase is an attempt to ensure control
over its milk supplies and win confidence among consumers in a
market that is growing at about 20 percent a year.
For KKR, the storied New York private equity firm, the deal
is another lucrative transaction following its relatively late
arrival in Asia in 2007. After Modern Dairy's 2010 IPO and the
current deal, KKR will have almost tripled its original
investment, according to a person with direct knowledge of the
"It is a deal which benefits all parties, of which the
private equity funds are seen to be the biggest winner," Sunwah
Kingsway Group Research analyst Steve Chow said.
"Chinese dairy products makers are racing to secure reliable
and high-quality raw milk sources, in particular from overseas."
Mengniu's main competitor, Inner Mongolia Yili Industrial
Group, has gone overseas to secure quality milk. It
was granted approval to build an infant milk formula plant in
New Zealand last month.
Headquartered in China's eastern province of Anhui, Modern
Dairy sells almost all its raw milk products to Mengniu.
The HK$2.45 per share purchase price is a 12.1 percent
discount to Modern Dairy's previous closing price - a rarity in
M&A where acquisitions usually come with a roughly 25 percent
Modern Dairy's share price has soared since the end of last
year, from HK$2 to HK$2.79 at Tuesday's close. Speculation about
talks between Mengniu and Modern Dairy first surfaced in last
"The increase of Mengniu's stake in Modern Dairy is to
secure both quality and quantity of raw milk sources," Sun
Yiping, chief executive officer of Mengniu said in a press
Shares in Modern Dairy fell nearly 12 percent to HK$2.46 on
Wednesday, while Mengniu Dairy's stock rose 1.6 percent. The
Hang Seng index was 0.62 percent higher in intra-day trade.
Standard Chartered said in a research note that part of
KKR's rationale for accepting a discount was to build a
long-term relationship with COFCO, the state-owned enterprise
which is the top shareholder in China Mengniu.
In addition, KKR has already earned a "quite reasonable"
return on its investment, the bank added.
KKR and China-focused private equity firm CDH bought stakes
in Modern Dairy after the country's milk industry was battered
by a 2008 scandal involving chemical-laced products. KKR paid
$150 million in cash for a 34.5 percent stake, which it sold
down to 24 percent after Mengniu's 2010 IPO. CDH paid $50
million for its holding.
Mengniu was one of about 20 companies implicated in that
scandal, when the lacing of milk with the industrial chemical
melamine killed at least six children and sickened nearly
300,000 people. The company now says that enhancing the quality
of its milk supplies is a key focus for management.
Mengniu teamed up with Danish-Swedish dairy group Arla Foods
in June last year to develop dairy products in China,
in another bid to regain consumer confidence.
But late last year Mengniu apologised after a government
quality watchdog found that some of its products contained
aflatoxin, a substance produced by food fungus that can cause
severe liver damage, including liver cancer.
It is not alone in facing quality-control problems. China's
Bright Dairy & Food Co Ltd recalled batches of sour
milk in September last year after it received hundreds of
customer complaints, while Inner Mongolia Yili Industrial Group
recalled baby formula tainted with "unusual" levels of mercury
China's dairy market is still relatively young, with
consumption of dairy products growing at an annual compound rate
of 20 percent, a stark contrast to U.S. and European markets
where demand has been shrinking in the past decade.