Mengniu Dairy Said to Hold Talks to Acquire Modern Dairy

China Mengniu Dairy Co. (2319), the country’s largest dairy producer, has held talks to acquire raw milk supplier China Modern Dairy Holdings Ltd. (1117), said two people with knowledge of the matter.

The companies’ largest shareholders, COFCO Corp. and KKR & Co., have been involved in the discussions, the people said, asking not to be identified because the information is private. State-owned COFCO holds 20 percent of Mengniu, while New York- based private-equity firm KKR owns 24 percent of Modern Dairy, according to data compiled by Bloomberg. Modern Dairy rose as much as 18 percent in Hong Kong trading today.

Buying Modern Dairy, China’s largest raw milk producer, would give Mengniu more control over its milk supply as concerns about safety in the nation’s dairy industry linger. Maanshan- based Modern Dairy generated almost all of its 735.6 million yuan ($116 million) of revenue for the six months through December from supplying Mengniu with unpasteurized milk.

“The proposed deal makes sense because it will speed up Mengniu’s upstream production and secure its raw milk source,” said Sunny Kwok, an analyst at Guotai Junan Hong Kong Ltd. in a phone interview. “If Mengniu decides to build its own farms, it will take at least five years before it can see any substantial contribution.”

Tainted Milk

The value of the potential acquisition hasn’t been determined, the people said. Talks between the two companies have stalled amid China’s political leadership transition, though a deal is still expected to happen, one person said. Modern Dairy has a market value of HK$9.65 billion ($1.24 billion), based on yesterday’s closing price in Hong Kong. Mengniu is valued at HK$40.5 billion.

Modern Dairy gained 10.5 percent to HK$2.22, after rising as high as HK$2.37 earlier today. Mengniu was unchanged at HK$22.85, and the city’s benchmark Hang Seng Index added 1.1 percent.

K.W. Wong, an investor relations manager at Modern Dairy, declined to comment on discussions with Mengniu. The company later said “there are no negotiations or agreements relating to intended acquisitions or realizations which are discloseable,” under listing rules, in a statement to the Hong Kong stock exchange.

Chris Kwok, a spokesman for Mengniu, wasn’t available to comment. Officials at COFCO weren’t immediately able to comment, while KKR declined to comment.

Mengniu blamed moldy feed given to cows for excessive toxins found in milk at one of the company’s warehouses in December. It later pledged to invest as much as 3.5 billion yuan in its own farms to improve milk quality. Modern Dairy said at the time that its products weren’t involved in the Mengniu contamination.

Rising Profit

The toxins were discovered by regulators three years after at least six infants were killed and 300,000 children sickened by melamine-tainted milk in China. Some suppliers had added the chemical used to make plastics to make the protein content of diluted milk appear higher than it was, the Chinese government said. Modern Dairy wasn’t implicated in that scandal.

Mengniu’s shares have fallen 13 percent since before the December toxin discovery, closing at HK$22.90 yesterday in Hong Kong. Modern Dairy has slumped 30 percent from its November 2010 IPO price.

Executives at Chinese state-controlled companies have refrained from making large acquisitions that could jeopardize their political aspirations as China nears its once-a-decade leadership transition, investment bankers have said.

Hohhot, Inner Mongolia-based Mengniu said in June that it plans to build eight to 12 ranches this year. At the end of December, Modern Dairy had 16 farms and four under construction.

KKR Investment

Demand for milk is rising in China as economic growth boosts incomes. Retail sales of milk will almost double to 147.4 billion yuan in 2017, from 76.1 billion yuan last year, according to data from Euromonitor International. Mengniu dominated the market with 34 percent of sales by value in 2011, followed by Inner Mongolia Yili Industrial Group Co.’s 24 percent and Bright Food Group Co.’s 7 percent, the data show.

Mengniu profit rose 28 percent to 1.59 billion yuan in 2011, as sales increased almost 24 percent to 37.4 billion yuan. Modern Dairy’s net income in the six months through December jumped 88 percent to 163 million yuan, as sales climbed 61 percent, the company said in February. Of that revenue, 98.5 percent came from sales to Mengniu.

KKR, which managed $61.5 billion in assets as of June, first invested in Modern Dairy in 2009 when the company was still called Ma Anshan Modern Farming Co., according to data compiled by Bloomberg. KKR initially invested $150 million in the company, people familiar with the matter said in June of that year. COFCO, a grains trader backed by China’s government, first acquired a $790 million stake in Mengniu with Hopu Investment Management Co. in July 2009, the data show.

Denmark’s Arla Foods amba announced in June that it bought a 6 percent stake in Mengniu. Mengniu will develop and market Arla Foods’ products in China and other countries, and was also selected to set up a China-Denmark milk technology center, according to the company.

To contact the reporter on this story: Cathy Chan in Hong Kong at kchan14@bloomberg.net

To contact the editor responsible for this story: Philip Lagerkranser at lagerkranser@bloomberg.net

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