Investors acquiring thirst for dairy assets

A rising demand for milk draws financing from industrial giants, private equity firms and wealth funds

The nation's dairy sector has become a magnet for money, with the latest heavyweight investor being Xu Jiayin, chairman of Ever-grande Real Estate Group Ltd. The property tycoon is reportedly visited potential projects in the Inner Mongolia autonomous region and Heilongjiang province where the country's best dairy farms are located.

Though Evergrande didn't confirm the purpose of Xu's trip, itwouldbeno surprise if the company got involved in dairy farming, a sector that has drawn strong interest among private equity firms.

In July, Alibaba Group Holding Ltd Chairman Jack Ma moved into the sector. Yunfeng Capital, a private equity firm co-founded by Ma and Target Media Holdings Inc Founder Yu Feng, together with CITIC Private Equity Funds Management Co Ltd, spent 2 billion yuan ($328 million) to acquire a 60 percent stake in a unit of dairy giant Inner Mongolia Yili Industrial Group Co Ltd.

According to Yili, the investment will help sustain milk supply sources, enhance farm-building capacity and upgrade the dairy source network to boost profitability.

The same month, Huaxia Dairy Farm Ltd, a high-end milk producer based in San-he, Hebei province, received investment from a group led by Government of Singapore Investment Corp Pte Ltd, Singapore's sovereign wealth fund, and Olympus Capital Holdings Asia, a leading regional middle-market private equity firm focused on Asia.

GICis investing $70 million, and Olympus Capital Asia is investing $30 million in the company.

The proceeds will be used to fund the expansion of Huaxia's farming operations as well as its retail dairy products business.

Existing shareholders, including Grand River Capital LLC, will invest $6 million.

Combined with its previous investments, Olympus Capital Asia has now invested $108 million in the company and is its largest shareholder.

Huaxia operates three farms in Sanhe, just outside of Beijing, with more than 13,500 cows.

The milk it produces is used to supply major dairy companies in China with premium products and for the production of Huaxia's own Wonder milk-branded products.

Last September, investment firm Kohlberg Kravis Roberts& Co LP, asset fund manager CDH Investments and China Modern Dairy Holdings Ltd established a joint venture to deliver premium milk to Chinese consumers.

KKR, CDH and Modern Dairy said they will invest $140 million over the next 18 months to build two large dairy farms, each with 10,000 cows.

Dairy farms have become a key link in the production process, fueled by growing domestic demand for high-end products.

Song Liang, an industry analyst, said agricultural investments have become more attractive to PE firms because of the economic slow-down.

The dairy sector, buoyed by surging milk prices, offers investors long-term profit opportunities, he said. And investment in the industry carries very little policy risk because the government encourages and supports dairy product safety.

Dairy farms are in short supply in China, with the raw milk shortfall standing at 3 million metric tons annually, of which more than 80 percent is imported from New Zealand.

In 2008, the country imported 128,000 tons of milk powder. The figure rose to 850,000 tons last year and is expected to reach 1 million tons this year.

But last August, there was a decline in confidence in products from New Zealand following a recall of dairy powder products by New Zealand-based dairy producer Fonterra Co-operative Group Ltd because of quality concerns.

Botulism-causing bacteria was found during safety tests. About 1,000 tons of products were affected by the recall across seven countries, but no cases of sickened consumers were reported.

China temporarily banned the import of the ingredient from New Zealand.

The incident pushed domestic dairy enterprises and food producers to look for sources in China.

Song said investment in the dairy sector originally focused on dairy products but has expanded to farms.

Under the terms of infant formula milk production permits issued by the authorities at the end of last year, dairy enterprises are required to have their own dairy farms to supply raw materials.

Dairy giants are also encouraged to form a complete industry chain to ensure product quality.

Song said that because prices of raw milk will remain high, more investors will be attracted to the sector for healthy profits.

In 2013, about 658 dairy companies recorded 18.7 billion yuan in profits, up 12.7 percent year-on-year.

According to Euromonitor International, China's total dairy consumption grew at an annual rate of 10 percent over the past five years, with premium dairy consumption nearly doubling its market share from 10 percent to 19 percent. This was due, in part, to continued consumer concern over food safety and increasing health awareness.

In July, Fonterra and US dairy giant Abbott Laborato-ries signed an agreement to develop a dairy farm hub in China.

The move is expected to leverage Fonterra's expertise in dairy nutrition and farming in China to help Abbott's localized production in the country.

Fonterra and Abbott plan to form a joint venture to invest a combined $300 million into the farm hub, which will contain up to five dairy farms and more than 16,000 dairy cattle, producing up to 160 million liters of milk annually.

The first farm is expected to be completed and start producing milk in the first half of 2017, and the remaining farms are scheduled to start operations in 2018.