Most costly takeover boosts China's dairy restructuring

China Mengniu Dairy Co., Ltd. has signed a deal to buy Yashili International Holdings Ltd. for over 11 billion H.K. dollars (1.42 billion U.S. dollars), marking the most costly merger in China's domestic dairy sector, China Securities Journal reported Wednesday.

The purchase on Tuesday afternoon was deemed part of the restructuring of the Chinese dairy industry that is being promoted by the central government.

China's Ministry of Industry and Information Technology (MIIT) brought together 127 dairy enterprises for a conference on Tuesday that drew up measures to improve the quality of dairy products and recover consumer confidence in the scandal-plagued sector.

Gao Fu, assistant inspector of the MIIT's consumer goods department, said the State Council, or China's Cabinet, had urged the MIIT to encourage mergers and restructuring among infant formula companies.

"The MIIT plans to help integrate 10 dairy groups with annual sales worth over 2 billion yuan in the next two years," Gao said.

By the end of May 2013, China had 127 baby milk-producing enterprises with a total output of 600,000 tonnes, and only three of these companies can produce over 30,000 tonnes every year, according to China Securities Journal.

The ministry promoted the restructuring to weed out incompetent producers, so as to upgrade the whole dairy industry, Gao added.

Mengniu offered to acquire 75.3 percent of Yashili's stakes, with 3.50 H.K. dollars in cash per share, or 2.83 H.K. dollars in cash plus 0.68 of a share in an acquisition vehicle, a private entity 100-percent owned by Mengniu, said a statement filed to the Hong Kong stock exchange on Tuesday.

Wang Liming, director of the MIIT's consumer goods department, said Mengniu will become a pillar group in domestic production of formula, which contributed only 1 percent to the company's 2012 revenue of 36 billion yuan (5.84 billion U.S. dollars).

Yashili, which is based in south China's Guangdong Province, saw its sales of milk powder grow 29 percent year on year to 3.13 billion yuan in 2013. Only two domestic enterprises sold more milk powder in the 12 months.

It has several factories producing formula in China and secured approval last December to build a factory in New Zealand.

Demand for infant formula is booming in China, but trust in domestic producers has been hammered by a 2008 milk scandal. Six infants died and 300,000 were sickened after consuming baby milk tainted by melamine.

Mainland Chinese have since flocked to Hong Kong and other markets to buy foreign-brand baby milk powder.

Sales at Mengniu, China's biggest dairy company, fell 3.5 percent between 2011 and 2012.

The company has been trying to rebuild its image by buying into more reliable businesses. It teamed up with Danish-Swedish dairy group Arla Foods in June of 2012 to develop dairy products.

In another bid to regain consumer confidence on May 21, it announced an investment by French dairy group Danone, the world's largest yoghurt maker, which will set up a joint venture with Mengniu for the production and sale of yoghurt in China.

Zhu Hongren, the MIIT's chief engineer, said the quality of Chinese dairy products has largely improved but it will take time for consumer confidence to recover.

In 2012, testers passed all but 0.77 percent of Chinese baby milk products as qualified for sale, while 1.13 percent of foreign brands failed to reach the standard, according to examinations by China's General Administration of Quality Supervision, Inspection and Quarantine.

Sun Yiping, president of Mengniu, described Tuesday's deal as a win-win takeover of Yashili that will provide better and safer dairy products.