January 6, 2017

China Mengniu Dairy Company Limited is moving to secure 91 percent control of China Modern Dairy – the largest dairy farming company by herd size and the largest producer of raw milk in China, through two deals with a combined total value of just over $1 billion.

Already in control of a 25.4 percent stake in China Modern Dairy, Mengniu entered into a purchase and sales agreement with Success Dairy II – a joint venture between KKR China Growth Fund and CDH Fund IV, to acquire 965.47 million shares in China Modern Dairy for $241.5 million, lifting its stake in the company to 39.9 percent.

Subsequently, because Hong Kong corporate regulations require an entity holding more than 30 percent in a company to make an offer for the remaining shares, China Mengniu has offered to acquire all remaining shares at the same price of HK$1.94 per share, reflecting a seven percent premium on the stock’s closing price on January 4. This deal would result in Mengniu securing 91 percent of China Modern for an additional $826 million.

The remaining nine percent of China Modern will remain in the hands of select shareholders who are refusing to sell according to a recent filing, including company CEO, Lina Gao, and therefore will remain listed on the Hong Kong exchange.

In the Beginning

Following an initial investment in Modern Dairy in 2008, which was later sold out after being held for five years, KKR, CDH and Modern Dairy announced in 2013 the formation of a joint venture that committed an investment of $140 million to build two, 10,000-cow dairy farms over the next two years.

In the years between 2008 and 2013, Modern Dairy had grown from a herd of 24,000 head across three farms to a herd of approximately 180,000 head across 22 farms.

The investment came at a time when sentiment was running high for China’s dairy sector as sales in the country were expected to double to $89 million, driven by population growth and China’s growing middle class. Over the five years between 2008 and 2013 China’s total dairy consumption grew by 10 percent with premium dairy products increasing their share of the market from 10 percent to 19 percent according to Euromonitor.

“The management of Modern Dairy saw a need arising from increasing demand for safer and healthier milk,” said David Liu, Head of KKR China in a company statement at the time. “The solution was a large-scale dairy farm that incorporated global best practices. Today, food safety remains a top priority and this new investment helps increase the supply of premium raw milk in China.”

Raw Milk Required

This move by Mengniu, China’s second biggest dairy company, to acquire the country’s largest dairy herd is in line with its need to secure a safe and constant supply of raw milk.

After a rash of food safety scandals involving China’s dairy supply, Beijing moved to streamline the industry as a means to lift quality and gain greater control of the market. New regulations strictly curtailed the number of dairy companies allowed to sell their products, and required those remaining, including e-commerce retailers, to register with the China Food and Drug Administration (CFDA).

These tighter regulations, combined with changes to China’s international e-commerce tax laws severely narrowed the field of players in the Chinese dairy industry. Additionally, at the China D20 Dairy Summit held this past August, China’s Vice Premier Wang Yang instructed the country’s top tier dairy companies to look abroad to secure a safe dairy supply to meet growing domestic demand.

However, by acquiring the largest domestic supply of raw milk, Mengniu could put itself ahead of the field in regard to cost of production. China Modern’s farms have highly desirable geographic proximity to regions in the country that are traditionally major areas of high dairy consumption. Together with Modern Dairy’s extensive presence across China, the deal will enable Mengniu to become the undisputed market leader with integrated control of the entire value chain according to Dairy Reporter.