KKR, CDH to exit China Modern Dairy for a second time

China Mengniu Dairy will acquire 965.5 million shares in Modern Dairy from the two PE firms for HK$1.94 apiece, a 3.2% premium to the January 3 closing price, according to a filing. Its stake in the business will rise from 25.4% to 39.9%, triggering a mandatory cash offer for all outstanding shares. Mengniu expects to end up with a 94.4% holding in Modern Dairy.

This represents the end of KKR and CDH's second spell as shareholders in Modern Dairy. They first invested in 2008 following a food safety scandal that saw infant formula tainted with melamine, causing six children to die. They recognized an opportunity in creating a milk producing outfit that operated to global standards, to cater to consumers who had turned their back on domestic brands.

Mengniu entered into a 10-year milk supply off-take agreement with Modern Dairy the same year and the company listed in 2010. Mengniu took a substantial stake in the business in 2013, enabling KKR and CDH to exit most of their remaining holdings. They completed their exit in 2014.

In 2013, KKR, CDH and Modern Dairy created the cattle farming venture, investing $140 million and building two farms. The PE firms sold out in 2015, receiving 477 million shares in Modern Dairy. Ahead of the agreement with Mengniu, they exercised an option to receive a further 488 million shares in the company. Given the drop in Modern Dairy's share price, the value of the entire position on exit is roughly equal to the value of the shares awarded in 2015.

Modern Dairy established itself as a fully integrated business, expanding from three farms and 24,000 cows in 2008 to 27 farms and 225,500 cows in 2015. It is the largest producer of raw milk in China, selling 924.092 tons in 2015.

The company generated RMB4.05 billion ($585 million) in raw milk sales for the year and a further RMB1.5 billion from sales of liquid milk products under its own brands. Overall revenue came to RMB4.83 billion, down from RMB5.03 billion in 2014, while net profit fell to RMB343.7 million from RMB762.9 million.

The business is underpinned by strong fundamentals, notably a willingness to pay a premium for better quality products among China's emerging middle class. However, Modern Dairy said in its 2015 annual report that the industry is at a difficult phase, with raw milk prices under pressure due to oversupply and the sale of reconstituted milk as quality product. The business posted an unaudited loss of RMB565.7 million in the first half of 2016.

KKR's involvement in China's dairy industry stretches back to 2002 when the China team - then at Morgan Stanley Private Equity Asia - investing in Mengniu alongside CDH. The executives who led the dairy investments, David Liu, KKR's co-head of Asia private equity and head of China, and Julian Wolhardt, regional leader of China, recently departed to launch their own PE firm. KKR is currently raising its third pan-regional fund with a target of up to $7 billion.

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• Topics
• Greater China
• Trade sale
• Consumer
• Industrials
• China
• KKR
• CDH Investments Management
• Exit
• Agriculture