China dairy deal leaves consumers with bad taste in the mouth
By Paul Mackintosh - 13/05/13
Got milk? Kohlberg Kravis Roberts (KKR) and CDH Investments have a lot less now, but they probably feel healthy enough anyway, after selling out their 26.92% combined stake in flagship PRC investment China Modern Dairy Holdings Ltd to China Mengniu Dairy Co Ltd for US$410 million, bringing the total return on the sale and Modern Dairy’s 2010 IPO to around a reported 2.9x.
According to Reuters, the PE investors sold out of their position at a 12.1% discount. Standard Chartered research concluded, unsurprisingly, that KKR took this hit partly to cement relations with China Mengniu’s state-owned enterprise (SOE) patron China National Cereals, Oils and Foodstuffs Corporation (COFCO), the food manufacturing and processing giant which is the ultimate shareholder. The discount would also have helped the general partners (GPs) avoid any suggestion of unduly profiteering, while still achieving a handsome overall investment return. KKR bought in to Modern Dairy after the 2008 contaminated milk scandal, paying $150 million for 34.5%, which it cut back to 24% in the company’s IPO. China Mengniu is already Modern Dairy’s largest customer, so the deal brings natural synergies.
The result also vindicates the choices of the limited partners (LPs) who committed to the $6 billion KKR Asia Fund II instead of the ill-starred North America XI Fund vehicle that KKR recently cut back, citing preferential demand for the Asian fund. The new vehicle is on track for a June final close, according to Bloomberg, with its predecessor already earning a 14% net internal rate of return (IRR). This latest deal is just what investors in the new fund will be hoping to see, and a precedent, hopefully, for similar results in other investments.
Whether it does much to truly reform China’s foods sector is an open question, though. KKR and CDH may well have had a beneficial influence on quality control, standards and practices at Modern Dairy – after all, that was why they were invited to invest in the first place. But putting the asset back into the hands of COFCO, even indirectly, seems unlikely to remedy the underlying problem – independent oversight. China Mengiu still suffers from occasional food scares – the latest last year involving a poisonous contaminant aflatoxin, according to Reuters. KKR’s readiness to play nice with COFCO is surely in the interests of its investors, not least if other deals follow to help compensate the firm for the discount it absorbed in this exit, but its advantages to China’s food consumers are less immediately apparent.