July 24, 2015 / 5:00 AM / 3 years ago

UPDATE 1-Danone swaps Dumex China unit for deeper ties with domestic dairy giant

* Plans to sell Dumex business to part-owned Yashili

* Dumex sales had plunged after series of food scares

* French firm to raise 9.9 pct stake in dairy giant Mengniu

* Competition rising in China’s $20 bln formula market (Recasts, adds Danone statement)

By Donny Kwok and Adam Jourdan

HONG KONG/SHANGHAI, July 24 (Reuters) - France’s Danone SA is pulling the plug on efforts to revive its flagship Dumex infant formula unit in China on its own, swapping a business ravaged by food scares for a bigger stake in a domestic dairy giant as competition heats up in the world’s biggest market for formula milk.

The French food supplier said on Friday it has struck a “preliminary agreement” to sell its Dumex unit, once its top formula brand in China, to Yashili International Holdings Ltd . In return Danone will deepen ties with one of the country’s biggest dairy firms, raising its 9.9 percent stake in China Mengniu Dairy Co Ltd, Yashili’s indirect parent.

The move reflects a growing challenge for international firms in China’s fiercely competitive $20 billion infant formula market. Dumex saw its sales plunge after a series of scares in the last few years.

“That had a strong impact on consumers’ trust in the brand. It really damaged them in terms of reputation and sales. This sort of marks Danone getting out,” said James Roy, Shanghai-based associate principal at China Market Research.

Danone didn’t disclose a value for the Dumex business, and didn’t say by how much it will raise its holding in Mengniu, worth nearly $10 billion by market value. The French firm, which reports first-half earnings later on Friday, spent $665 million to up its stake in Mengniu last year, and paid $550 million more for a 25 percent stake in Yashili itself.

While Yashili is its main formula business, Mengniu has operations in yoghurt, liquid milk and ice cream - which could help Danone expand its China business outside infant formula.

In February, Danone’s Chief Executive Officer Emmanuel Faber said the firm was “reshaping the future of Danone in China” around its alliance with Mengniu. Dumex wasn’t likely to contribute much to China growth in 2015, he said.

Danone is the number three player with 8.1 percent share of China’s milk formula market, where it has other formula brands including Nutrilon. The overall market is set to double in size by 2020, market research firm Euromonitor said.

Beijing is putting pressure on firms to increase domestic production, creating an incentive to tie-up with local partners, one industry executive said recently. Abbott Laboratories has a new formula plant near Shanghai while New Zealand dairy giant Fonterra has invested in China farms.

The deal will also help Yashili boost its reputation with domestic consumers who see international ties as a mark of quality and safety. Danone and Yashili will collaborate on a manufacturing facility in New Zealand, the Chinese firm said. ($1 = 6.2096 Chinese yuan renminbi) (Editing by Kenneth Maxwell)

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