Deal Mechanic: Modern Dairy, KKR

In 2006, Modern Dairy built its first farm in the eastern Chinese province of An’hui, with the intention of raising dairy cows and selling raw milk to branded dairy companies for processing into various dairy products.

China’s demand for dairy consumption had been growing rapidly for the previous two decades, but an underdeveloped raw milk supply chain – which was comprised of millions of individual farmers – had led to milk safety issues and quality risks. This culminated in the huge tainted milk scandal of July 2008, when six babies were killed and a further 294,000 reportedly taken ill. The cause was proved to be contamination by the industrial chemical melamine, which was eventually traced back to former Chinese dairy products company Sanlu.

So there was clearly substantial demand for a large-scale dairy operation to provide safe, high-quality milk – but a lot of operational challenges to overcome too. This was the context in which Kohlberg Kravis Roberts chose to enter the Chinese dairy sector: between 2008 and 2009, the firm invested a total of about $150 million of equity in Modern Dairy.

The results have been impressive. Today, it’s the largest dairy farming facility in China, both in terms of herd size and (according to the China Dairy Association) raw milk production, churning out 1.8 million tonnes of milk per year. Between 2008 and 2011, top line revenue at the Chinese dairy farming company grew 393 percent to RMB 1.4 billion (€172 million; $222 million), while EBITDA rose 520 percent to RMB 459 million. More recently, the company reported that net profits for the 12-month period ending 30 June 2012 were RMB 396 million, a 77 percent increase.

What’s more, this bottom line growth hasn’t come from cutting costs and shrinking employee numbers, as in many big buyouts; under KKR’s ownership, Modern Dairy has seen employee headcount more than double, from 1500 at the time of investment to roughly 3250.

While KKR has yet to fully realise its investment in Modern Dairy, the firm looks poised to generate a very healthy return. In 2010, KKR took the company public on the Hong Kong Stock Exchange alongside China-focused CDH Investments, raising $448 million. The firm sold 222 million shares in the IPO, roughly one third of its original investment, and received $79 million in proceeds.

Much of Modern Dairy’s growth is directly related to operational changes spearheaded by KKR Capstone, KKR’s in-house team dedicated to improving the operations of portfolio companies. The group spent 16 months working intensively alongside Modern Dairy’s management team. It then dialled down its involvement slightly for a period, to somewhere between nine and 13 days per month – but since July 2012 it has been back with the company full time, spending somewhere between 14 and 19 days per month with management.  So what have been their key initiatives?

1. Building out management


One of the first things KKR did to spur growth at Modern Dairy was to help the company recruit key organisational positions it needed to improve operations. 

“KKR’s partnering with the founders of Modern Dairy to enhance management capability and build a sustainable managerial platform to drive operational improvement were the bedrock to having Modern Dairy become the business it has become,” says Julian Wolhardt, KKR’s regional leader of China, who was named non-executive chairman of Modern Dairy in September.

In fact, this amounted to a substantial overhaul of the management team. “This included enhancing the already solid management team of Modern Dairy by helping them find a chief operations officer, chief nutritional advisor, head of purchasing, and head of breeding, among other positions,” he tells PEI. KKR also worked with management to implement training and succession plans for important functions such as farm heads and functional center heads, to improve the sharing of knowledge. 

Along with the expanded management team, KKR also established a more robust and numbers-driven management system: they worked to identify the key performance indicators that highlighted the most valuable operating metrics, and established a process by which they would be reviewed on a monthly basis. They also revamped the company’s budget review and reporting system, which is linked to the compensation and incentive plans of all members of the management team.

“The system has transformed how Modern Dairy manages its business and has fundamentally improved management effectiveness across the board,” says Wolhardt.

2. Improving best practice

While enhancing business performance using tried and tested methods of operational improvement is something all private equity firms with operations teams strive to accomplish, few have had to deal with the unique set of challenges that come with having to use live cows to produce their core product.

In order to address the company’s health and safety risks – which, not surprisingly, was a hot topic in the wake of the tainted milk scandal – KKR helped Modern Dairy set up an outside advisory board and implemented stricter standard operating procedures for disease prevention and food safety. This has had tangible effects: it helped Modern Dairy reduce milk bacteria count by 80 percent, to approximately 0.5 percent of the China national standard.  

KKR Capstone and Modern Dairy also developed standard operating procedures for all aspects of dairy farm operations, such as breeding, nutrition and purchasing. The procedures increased single-cow productivity – i.e. the amount of milk it’s able to extract from a single cow – and allowed Modern Dairy to expand rapidly by rolling out its operating and managerial models in new markets.

“KKR and Modern Dairy worked together to improve the performance of key functional areas by implementing best practices across all farms to increase milk productivity,” says Wolhardt. “As a result, since KKR’s investment, Modern Dairy has increased milk yield by 34 percent.”

3. Feeding growth

As you’d expect, animal feed is a big deal when you’re dealing with this many cows.

“The quality of the cows’ feed determines the quality of the milk they produce”, says Xiaoyu Xia, head of KKR Capstone for China. “We helped to ensure there was a quality control process in place to ensure that the cows were fed the best quality feed to help them produce milk safely and efficiently.”

KKR Capstone helped design a standard feed planning and procurement process, plus ‘feed optimisation tools’ that identified costs savings. As a second step, the team developed a process that included demand planning, contract negotiation with local providers of the corn silage used to feed Modern Dairy’s cows, land and yield inspection and harvesting planning.

Despite KKR Capstone’s many talents, optimising cow feed was slightly beyond its field of expertise. So to improve these technical functions, it sought external expertise from outside the firm: for example, in order to increase the quality and quantity of corn silage, it worked with a well-known silage production expert from Australia.

All feed purchasing managers, at headquarters and in every single Modern Dairy farm, now use exactly the same process and tools on a daily basis. This helped Modern Dairy reduce costs by 3 percent and drove an estimated 4 percent increase in EBITDA in 2010.

After implementing this long list of operational improvements, Modern Dairy’s cows were producing at a rate at least 40 percent higher than the average farm in China, and with much better quality, according to Xia.

Management incentives and risk mitigation initiatives have also helped Modern Dairy maintain an incident-free record of providing safe milk to consumers.

“The quality of the milk from Modern Dairy is far better than that of other daily producers in China and even exceeds the standards in Europe and the US in terms of higher protein levels and lower bacteria counts,” Xia adds.

4. Strategic partnerships

In order to preserve and ensure further growth, KKR helped the company secure insurance coverage for Modern Dairy’s most essential asset – its dairy cows.

It’s also been advising the company on strategic acquisitions and partnerships. This included a 10-year agreement with Mengniu Dairy, the leading branded milk player in China, to ensure 100 percent up-take of Modern Dairy’s production. This also opens up another interesting angle: a possible exit route. According to newspaper reports in August this year, Mengniu Dairy was said to be mulling a takeover of Modern Dairy, although the company has thus far denied that it is in talks to be sold.

KKR also helped Modern Dairy to build on its banking relationships: this helped it improve its working capital management and secure long-term bank loans, which will support new farm expansion and development projects. At the time of KKR’s original investment, the company had four farms; now it has 20, with an additional two under construction.

Lastly, as is usual with KKR’s investments these days, the Capstone team instigated some cost-saving environmental initiatives: Modern Dairy managed to reduce electricity and water usage on a per cow basis by at least 10 percent and increase its utilisation of bio-gas electricity generation.


As China’s raw milk industry continues to consolidate – individual farmers still supply about 95 percent of China’s raw milk, compared to roughly 50 percent in the United States, for example – Modern Dairy is planning to develop new products to generate revenue from a broader customer base, according to KKR.

The firm says it’s currently transitioning from providing day-to-day operational support to Modern Dairy to “ongoing counsel”. But that doesn’t mean it’s finished on the operational improvement front:  future projects in the pipeline include a second wave of feed purchasing optimisation initiatives, to achieve further cost savings and a collaboration with the chairman and chief executive officer to develop an organisational blueprint for long-term growth.

So it seems that private equity and cows have a lot in common: continuous nourishment is the best recipe for generating a strong return.