KKR, CDH go greenfield in China

The three investors are putting $140 million into the joint venture, which will see the construction of two, 10,000-cow farms in Shandong province. KKR will take a 61.5% stake, with CDH and Modern Dairy owning 20.5% and 18%, respectively.

The relationships that underpin the joint venture actually stretch back to 2002 when KKR's China team, then part of Morgan Stanley Private Equity Asia, invested alongside CDH in China Mengniu Dairy. Around this time they met the team that will manage the joint venture. The group had built farming operations that were ahead of their time but couldn't scale the business.

Modern Dairy made the breakthrough in this area, expanding from 24,000 cows and three farms in 2008 to around 180,000 cows and 22 farms today.

"When we invested with Modern Dairy, the business model was not proven," says Julian Wolhardt, China regional leader at KKR. "Over the last six years, we demonstrated the investment thesis was correct. This time around, the risk is in the start-up nature of the business. But it is a manageable risk because we have built 18 farms in the last couple of years with Modern Dairy."

Indeed, many of the processes currently underway are similar to those undertaken at Modern Dairy. The investors are working with barn designers from the US to optimize the cows' living conditions, management expertise has been sourced from Australia, and the milking equipment is being shipped in from Israel.

Additional land has also been secured alongside the farms to grow corn for animal feed; cow manure will be used as organic fertilizer.

Modern Dairy is supplying cows to the joint venture and will buy the milk produced, which will eventually find its way into Mengniu branded products. Mengniu, now Modern Dairy's majority owner, has a longstanding master off-take agreement with the firm. Furthermore, terms have already been agreed for Modern Dairy to acquire full ownership of the joint venture farms in 3-4 years.

That the investment is an extension of the thesis behind Modern Dairy - China's food-safety conscious consumers will pay a premium for high-quality products - shows how much further the dairy industry has to go.

"China's dairy industry needs to become more institutionalized, with greater integration between the branded companies and the upstream suppliers - that is the only way the branded companies can tell consumers their milk is safe," says Wolhardt. "But it will take 15 years to get there. We went from 1% to 7% penetration of large-scale farms in the last seven years."

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• Topics
• Investments
• Early-stage
• Consumer
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• Greater China
• KKR
• CDH Investments Management
• China
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• Agriculture