China Consumer

Must do butter

Third time lucky for French dairy firm in China?

Danone w

If at first you don’t succeed...

Almost exactly a year ago Song Kungang, chairman of the China Dairy Industry Association, declared that the quality of domestic dairy products, especially infant formula milk powder, “is the best in history, and consumers can buy with confidence.”

Two months later two Chinese firms, Mengniu and Hunan’s Ava Dairy, then recalled baby formula containing high levels of aflatoxin, a carcinogen produced by fungus in cattle feed. A third company, Yili Group, announced a separate recall after “unusually high” levels of mercury were found in its main product line of infant milk powder.

Small wonder, then, that many Chinese consumers have continued to ignore Song’s advice, choosing instead to travel to Hong Kong to secure stocks of infant milk formula. Cross-border trading even prompted the Hong Kong government to bar outbound travellers from taking more than two tins of formula out of the city in March.

But one man’s misfortune can be another’s opportunity. Last week French dairy group Danone announced two new deals in its latest effort to crack the China market. In the first, it will establish a joint venture with food giant COFCO to purchase an 8.3% stake in Mengniu (leaving Danone with an indirect 4% stake, while COFCO continues as the biggest shareholder in Mengniu with 27.8%). In the second, Mengniu will consolidate its 12 yogurt businesses into one group and sell 20% of that group to Danone too.

Danone has seen its previous efforts thwarted in China. Most spectacularly it had a severe falling out with beverage maker Wahaha, culminating in a bitter row that was cast by Wahaha boss Zong Qinghou as a patriotic struggle against foreign money. Danone ended up selling its 51% stake back to Wahaha for $450 million, exiting the joint venture completely (see WiC39).

Danone’s troubles didn’t end there. In 2001, it also bought a 5% stake in Bright Dairy, a firm owned by the Shanghai local government. Danone then boosted its stake to 20% in 2006. Shortly afterwards, the Shanghai government announced a plan to merge Shanghai Bright Dairy Group, the holding company for Bright Dairy, with several other Shanghai-based enterprises to form a conglomerate named Bright Foods. The restructuring was aimed at strengthening local food and beverage groups in the face of foreign competition. Danone sensed that it was unlikely to be able to build its own holdings substantially in the government-controlled enterprise so sold its stake to the other shareholders in 2007. The deal wasn’t as big a setback as the Wahaha debacle but Danone’s exit price was still only 13% higher than what it paid for the stake.

Will the deal with COFCO for the stake in Mengniu turn out to be third time lucky for Danone? Doug Young, author of the YoungChinaBiz blog, describes COFCO as a better choice of ally than Danone’s previous partners. The French firm is hoping to rely on COFCO’s central government contacts to resolve any future disputes, Young says. Entities close to the central government are usually more dependable than locally-controlled partners due to Beijing’s desire to see them succeed.

The direct tie-up with Mengniu could also help Danone boost sales in the yogurt market, by giving access to its Chinese partner’s extensive local distribution.

Euromonitor estimates the yogurt sector will grow 57% to Rmb71.6 billion ($11.7 billion) by 2015 – or more than double its value in 2010. Danone’s market share now is just 2%, far lower than Mengniu’s 19% and also trailing market leader Bright Dairy, which has 26%, says the Economic Observer.

Mengniu also has a lot to gain, not least in tapping into Danone’s know-how on how best to improve quality control among its local suppliers, says the EO.

“Even though [Mengiu’s] revenues in yogurt are stable – reaching Rmb4.6 billion last year – the domestic yogurt industry is in the process of consolidation with many small local brands in the market. Mengniu hopes that through the joint venture with Danone it will improve its quality and strengthen its management, which could tilt the market competition to its favour,” suggested Chen Yu, chief agricultural analyst at CnAgri.

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