KKR's dairy farm plan points to future of China's milk industry

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Published September 24, 2013

| Reuters

KKR & Co LP is leading a joint venture with China Modern Dairy Holdings Ltd <1117.HK> and a Chinese private equity firm that will invest $140 million in two large dairy farms to help meet rising domestic demand for premium milk products.

KKR's latest Chinese milk deal comes just as the country's top leaders are orchestrating an industry consolidation. The government's effort stems in part from the 2008 tainted milk powder scandal that killed at least six babies and sickened thousands more.

Modern Dairy, China Mengniu Dairy Co Ltd <2319.HK> and Inner Mongolia Yili Industrial Group Co Ltd <600887.SS> are among the Chinese companies expected to eventually hold a dominant share of the milk industry as larger operators seize control of the market and scoop up smaller players.

The KKR joint venture will once again link up the New York-based private equity firm with Modern Dairy. With CDH Investments, a Chinese private equity firm, the companies plan to build two, 10,000-cow farms in Shandong province over a two-year period.

KKR will hold 61.5 percent of the venture, while CDH will own 20.5 percent and Modern Dairy 18 percent, the companies said in a statement on Tuesday, confirming an earlier story by Reuters.

China's expanding middle class is driving sales of dairy products, which market research firm Frost & Sullivan says will double from the present $45 billion to $89 billion through 2017.

Despite the fast growth of regular milk consumption and even faster growth of the premium market, China lags its peers. Per capita consumption is less than 10 kilograms per year in China, compared with 32 kilograms in Japan and 78 kilograms in the United States, says market research firm Euromonitor.

"What they lack is some reliable milk source. The main issue is that consumers are still lacking confidence in the products," said Steve Chow, an analyst at Sunwah Kingsway Research. "You either find a way to secure some good quality milk sources from overseas or you build up your own farm."

Chow said China's previous production standard was collecting raw milk from smaller farms, where quality control issues led to the scandals, crushing consumer confidence in the market. Importing cows from countries such as New Zealand was viewed as a costly and temporary solution.

China expects its top 10 dairy companies to account for 80 percent of the domestic market by 2018, according to state media, with the largest three to five firms targeting annual sales of over 5 billion yuan ($817 million).

OLD PARTNERS

KKR and CDH invested in Modern Dairy in 2008, selling out of their holding in May this year to Mengniu Dairy. China Modern Dairy grew its herd from 24,000 dairy cows and three farms to around 180,000 dairy cows and 22 farms during those five years.

KKR's exit from the Modern Dairy stake appears more to do with locking in a profit and exiting a deal to boost interest in a new fund, rather than selling out of a company at its peak. KKR closed its new $6 billion Asia private equity fund in July, the largest such fund ever raised.

Modern Dairy said it has agreed to invest in the latest KKR-led venture for various reasons. They include breeding, raising and selling dairy cattle, production, processing and selling of raw milk, production of processed milk under original equipment manufacturers contracts for other processors and sale of fertilizers.

The joint venture will also purchase about 6,600 dairy cows from Modern Dairy, the Hong Kong-listed company said.

For the statement, click http://www.hkexnews.hk/listedco/listconews/sehk/2013/0924/LTN20130924029.pdf

(Additional reporting by Saeed Azhar; Reporting by Stephen Aldred and Donny Kwok; Editing by Michael Flaherty and Ryan Woo)

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