KKR, CDH near end of dairy value-add story
After months of conjecture, and even a regulatory disclosure outlining its intent, China Mengniu Dairy has finally built up a commanding stake in its long-standing milk supplier China Modern Dairy. Mengniu already owned 1% of the company and has now added a further 26.9%, allowing private equity backers KKR and CDH Investments to make a partial exit for HK$3.18 billion ($410 million).
They have a generated a 2.9x gross return on their investment.
KKR's holding in Modern Dairy will fall from 24% to 3.5%, while CDH will be reduced from 8% to 1.5%. KKR originally paid $150.4 million for a 34.5 holding in the company with CDH investing $52 million for 10.5%. Both made partial exits when Modern Dairy went public in Hong Kong in 2010, raising HK$3.5 billion. KKR's total proceeds from the investment now stand at $310.6 million.
Neither Mengniu nor Modern Dairy expects the transaction to alter their relationship. Mengniu says it has no plan to acquire KKR and CDH's remaining holdings or appoint any executives to the Modern Dairy board. It will continue to buy all of the company's raw milk output.
Modern Dairy stresses that closer ties with Mengniu will support business expansion but has also previously cited KKR as a true partner that "works alongside us at every stage of ... development."
The private equity investors' involvement with Modern Dairy is curious due to the circumstances in which it came about. Autumn 2008 saw the country hit by one of its worst food safety scandals as infant formula tainted with the chemical melamine cost lives of six children and hospitalized hundreds more. Consumers turned their backs on domestically processed dairy products.
The origins of the scandal lay in poor oversight of the fragmented supply chain through which Chinese dairy brands - led by the likes of Mengniu - sourced their milk. KKR saw an opportunity in creating a milk producing outfit that operated to global standards.
"A lot of people rushed in and invested in the milk processing companies because the stocks were down 30%," tells Joe Bae, head of Asia at KKR, told AVCJ last year. "We stepped back and said the issue is there are no large-scale dairy farmers supplying milk in a safe way, there is an opportunity to create value for the industry by developing some."
The private equity firm brought in experts from the US and Australia to work with Modern Dairy. KKR's Capstone unit spent 16 months on the ground, focusing on operational efficiencies and making improvements across feed purchasing, breeding, disease reduction and risk prevention. It even helped the company secure insurance cover for its cows.
According to a study by the Emerging Markets Private Equity Association (EMPEA), costs fell by 3%, contributing to an estimated 4% increase in EBITDA in 2010.
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