Dec. 2 (Bloomberg) -- KKR & Co. LP., the private equity company of Henry Kravis and George Roberts, will invest $100 million in a Chinese raw milk supplier, betting the $18 billion market will recover from a contamination scandal, two people familiar with the plan said.

KKR will buy a minority stake in the Anhui province-based Modern Farm, controlled by former managers of China Mengniu Dairy Co., the nation’s biggest liquid milk producer, the two people said, asking not to be identified because it’s a private investment.

KKR is investing as China’s milk producers, the world’s third-largest, are pushed to meet higher standards by the government after a lack of quality control led to a chemical taint that killed at least six infants. India today extended a ban on Chinese milk products by six months.

“Valuations in the industry were lowered quite a bit as a result of the milk-powder tainting,” Sophie Fan, an analyst at CSC Securities HK Ltd., said. “So now is probably a good time for private equity to enter the market, and expectations of this may be relatively high at the moment.”

Mengniu Dairy dropped 4.6 percent to HK$8.30 in Hong Kong trading, after rising as much as 19 percent. Bright Dairy & Food Co. jumped 7.8 percent and Inner Mongolia Yili Industrial Group rose 8.3 percent in Shanghai trading.

Industry Crackdown

Melamine, an industrial chemical used to make plastics and tan leather, was found in infant milk powder and other Chinese dairy products in September. Some suppliers had added the chemical to diluted milk to make the protein content appear higher than it is, the Chinese government had said.

China’s Ministry of Industry and Information Technology will lead an industrywide crackdown in the next six months, forcing dairy businesses without proper quality assurance to close, while giving the better-managed companies discounted financing, the government said Nov. 19.

The government is also raising the requirement for dairy farms, forcing them to meet more stringent hygiene standard, it said then. China’s dairy exports plunged 92 percent in October on the melamine scandal, China Daily said today, citing customs.

Improve Standards

KKR’s investment may help Modern Farm improve its technology to meet higher quality standards. Mengniu Dairy holds a small stake in Modern Farm, the people said. David Liu, head of Greater China and a partner at KKR, led Morgan Stanley’s investment in China Mengniu Dairy when he worked at the bank’s private equity arm.

Modern Farm’s officials couldn’t be reached immediately for comment. Richard Barton, who handles media enquiries for New York-based KKR in Asia, declined to comment.

Rising incomes in China, the world’s third-largest milk producer, have boosted the value of dairy consumption to $18 billion last year, according to Euromonitor International Plc. Demand was expected to rise to $20 billion before the scandal, according to the research company.

The investment was reported earlier by the Financial Times.

To contact the reporters on this story: Cathy Chan in Hong Kong at kchan14@bloomberg.net; Lee Spears in Beijing at lspears2@bloomberg.net.

Last Updated: December 2, 2008 03:19 EST