July 29, 2009

The joint financial venture between China's largest agricultural trading and processing company and a private equity firm to purchase a stake in one of the country's leading dairy company has led to the largest share acquisition in the Chinese food industry.

China National Cereals, Oils & Foodstuffs Corporation (COFCO) and Hopu Investment Management Co agreed to buy a 20-percent stake in China Mengniu Dairy Co Ltd on July 6 in a deal valued at US$789.7 million.

The two companies co-established a special investment vehicle that is 70 percent owned by COFCO and 30 percent by Hopu, making it the largest shareholder of Mengniu.

Ning Gaoning, president of COFCO, said at a press conference on July 7 the acquirement of Mengniu's shares provides an excellent opportunity for COFCO to gain ground in the dairy industry. He added that with the selection of Mengniu, one of China's biggest dairy producers and suppliers, as COFCO's strategic partner, COFCO is able to expand its "whole foodstuff industry" territory on a mature platform.

From its humble origins of a team with only nine people and RMB9 million, Mengniu managed to sustain itself and expand after a short period of time. In 2004, Mengniu was listed on the Hong Kong stock market and its total value then amounted to US$516 million, with an average annual growth rate of 365 percent.

However, after its products were discovered to be contaminated in last year's melamine scandal, Mengniu's share, sales volume, and reputation fell sharply.

Mengniu reported a mid-year net profit of RMB583 million in June 2008 but it was dwarfed by the RMB1.5 billion loss suffered from the melamine scandal. Overall, Mengniu posted a net loss of RMB949 million in 2008, according to its annual report released in April 2009, which was a dramatic decline compared to its RMB936 million net profit in 2007.

The company's dire position was worsened as safety issues arose regarding the use of osteoblast milk protein (OMP) in Mengniu's Milk Deluxe in February 2009. Subsequently, China's General Administration of Quality Supervision, Inspection and Quarantine banned Mengniu from adding OMP to that particular high-end milk product.

Meanwhile, due to its atomised ownership structure, Mengniu has been plagued by hostile takeovers in recent years. According to international common practice, when the major shareholder's stock is less than 25 percent, the company may face potential risk of hostile takeover, said Niu Gensheng, founder of Mengniu, at the press conference.

However, Mengniu's crisis is averted with the appointment of COFCO as the biggest shareholder and its promise not to sell its share within the next three years.

As Mengniu's new long-term strategic investor, COFCO will place three non-executive directors on Mengniu's board of 11 directors but they will not interfere in Mengniu's day-to-day management and there will not be any changes to the dairy manufacturer's current management team or business strategy.