Mengniu to buy controlling stake in Modern Dairy

China Mengniu Dairy Co Ltd, the country's largest dairy producer, is trying to improve product safety and recover lost market share with its acquisition of a controlling stake in China's largest raw milk producer.

Mengniu will pay HK$3.18 billion ($409.8 million), or HK$2.45 per share, for a 26.9 percent stake in China Modern Dairy Holdings Ltd, which operates 22 dairy farms across the country, according to a company filing with the Hong Kong stock exchange on Wednesday.

"Accelerating and expanding investments in quality farms will allow Mengniu to establish a safer and more stable value chain in the dairy sector, to provide healthier and better quality dairy products to consumers," said Sun Yiping, Mengniu's chief executive officer.

"Improving Mengniu's raw milk safety and quality is the first priority of the deal," said Gong Bo, an industry analyst at Beijing United Innovation Capital Ltd.

"At the same time, the move is in line with the strategy of China National Cereals, Oils and Foodstuffs Corp, Mengniu's largest shareholder, which aims to complete the whole industry chain."

Jerry Mao, senior vice-president and industry analyst with Lunar Capital Management, said: "This is a good signal released by Mengniu, showing they want to enhance quality controls on the upstream industry."

The company's brand image and sales were hard hit by a 2008 scandal, after toxic chemicals were found in its dairy products.

Its sales last year reached 36 billion yuan ($5.8 billion), a year-on-year decline of 3.5 percent. Its net profit was 1.26 billion yuan, down 20.9 percent year-on-year.

After the scandal, the dairy giant tried to tighten its food safety standards, which included launching cooperation projects with Danish dairy firm Arla Foods in 2012, and starting to build up its own dairy farms.

The Hong Kong-listed company said earlier that it will spend 3.5 billion yuan to set up eight to 12 dairy farms by 2015 to have 100 percent control over its raw-milk supply.

"Compared with building up its own farms, taking over well-established farms is a much less costly way to do things," Gong said.

"Chinese dairies are sourcing raw milk from New Zealand, the Netherlands, Australia and Ireland, where there's better quality milk, to win back market share and restore consumer confidence," Gong added.

"Along with the increasing food safety and health concerns among Chinese consumers, domestic dairy giants will have to take their product sources more seriously," said Mao.