China backs dairy sector consolidation

The PRC is trying to speed up dairy industry consolidation -- both a risk and opportunity for PE.

The Chinese government has drafted plans to introduce measures to promote the consolidation of China’s troubled dairy industry, aiming to cultivate up to five market leaders in the baby formula sector within five years, according to local media reports.

The plans, which are expected to be officially revealed later this month, include offering subsidies and tax incentives to dairy-related businesses engaging in M&A activity within the sector.

Following the 2008 tainted milk scandal in China, where melamine-tainted milk caused deaths and hospitalisations, the country’s dairy industry has faced a public backlash and intense scrutiny from regulators, leading to low valuations in related businesses, particularly baby formula suppliers.

China's promised tax and subsidy incentives are likely to drive acquisitions by strategic buyers, who are already willing to pay handsomely for dairy industry assets, an industry source said. That can be good news for private equity exits through trade sales.

“Strategic acquirers are willing to pay a premium for milk companies,” an industry source told PEI. “We acquired a dairy industry company for 3x to 4x P/E and recently a strategic bought a similar company for 22x P/E.”

However, GPs could also face increasing deal competition from corporate acquirers.

Most recently, Beijing Sanyuan Foods and China Mengniu Dairy – the same business that bought Yashili from Carlyle and China Modern Dairy from KKR – revealed plans to sell a 6.6 percent stake in China Mengniu to Danone Group, a French dairy company, following its rapid expansion into the emerging market. 

Private equity has been attracted by the increasing demand for milk in China combined with low-priced dairy assets, some in dire need of international best practices and rebranding.

The latest bid for dairy assets came in February when Hong Kong-based RRJ Capital proposed a $252 million investment in China’s Bright Dairy.

If successful, the firm would join a lineup of names that have tapped the sector in recent years.

In June last year, The Carlyle Group and controlling shareholder Zhang International Investment sold Yashili to China Mengniu Dairy in a HK$12.5 billion (€1.2 billion; $1.6 billion) deal, having invested during 2009 and 2010, Private Equity International reported earlier.

In May, Kohlberg Kravis Roberts had success from its own milk investment, gaining 2.9x the money it invested in China Modern Dairy.

CDH Investments, Hopu Investments, Temasek Holdings and Affinity Equity Partners are other private equity investors to have invested in the sector.