Danone, the French yoghurt maker, has doubled its stake in China Mengniu Dairy from 4% to 9.9% for HK$5.1 billion ($657 million), in a rare example of a foreign company raising its stake in a Chinese state-backed company.
The increase – which will make Danone the second largest shareholder after state-backed Cofco – is interesting because most deals involving Chinese companies have been outbound.
“It is rare to see foreigners have stakes or board seats in state-owned enterprises,” said one source familiar with the deal.
That said, last year Germany's Daimler, the parent company of Mercedes Benz bought a 12% stake in BAIC and, in 2009, Japanese beer maker Asahi bought nearly 20% in Tsingtao from Anheuser-Busch InBev.
Danone's investment underscores the reality that multinational companies face in China, a heavily fragmented market that is undergoing consolidation: they often have to partner with a local company, even if it means taking a minority stake. UK retailer Tesco last year sealed a joint venture with China Resources Enterprise after failing to make it on its own in China.
“The China market is extremely competitive and Chinese consumers are as demanding, or even more demanding, than elsewhere. They do not have deep brand loyalty and an established brand name in itself is not enough,” said Vivian Lam, a partner at Paul Hastings specialising in China M&A. “Foreign brands have a better chance of success by partnering with a strong Chinese brand, which is what Danone is doing,” she added.
As industries in China undergo consolidation, multinational companies that lack scale have been forced to exit. Late last year, cosmetics company Revlon pulled out of China and, shortly after that, L'Oreal said it would stop selling its Garnier brand products in China.
Danone's yoghurt business accounts for less than 2% of China's yoghurt market, according to one analyst report. In addition to taking a stake, Danone also formed a joint venture to produce and sell chilled yoghurt products in China in May last year.
Dilutive but positive for partnership
The deal was struck at HK$42.5 per share, a premium of 15.3% to the previous day's closing price of HK$36.85. It was struck at an enterprise value to Ebitda ratio of 20.4 times and a price to earnings ratio of 38.6 times. This is below the mean consensus of 25.7 times enterprise value to Ebitda and price to earnings of 42.9 times.
Danone had bought its 4% stake from Cofco last year but its latest investment involves the issue of new shares, which will be dilutive to shareholders. The proceeds will be used to repay a loan HSBC and Standard Chartered arranged for China Mengniu in June last year to acquire infant formula maker Yashili International.
“It is positive in terms of sentiment and for the partnership but it is going to be earnings per share dilutive because the shares increase is more than what the company can save in interest costs, in other words, the savings is lower than the 6-7% dilution,” said one analyst at an investment banking who declined to be named.
Investors welcomed the move, despite the dilution, sending China Mengniu's stock rising to a 12 month high of HK$37.95 late Wednesday afternoon.
Collectively, Cofco, Danone and Arla have combined their stakes, which are now 16.3%, 9.9% and 5.3% respectively, into a jointly held entity called Cofco Dairy Investments - a move that will give them more clout. The group's stake rose from 27% before the acquisition to 31.5%, triggering a mandatory general offer.
Under Hong Kong takeover rules, the group is obliged to make a general offer to shareholders, but the group has applied for a waiver from making an offer, which is subject to approval by independent shareholders.
“Cofco, Danone and Arla are seen as concerted parties, and their collective stake crosses the 30% threshold for takeover so they need waiver from shareholders,” said the source familiar with the deal.
The notice of the EGM will be sent to shareholders by March 5 and the deal is expected to close end March.
Deutsche Bank advised China Mengniu Dairy. Moelis advised Danone. Somerley Capital is the independent financial adviser to the board and independent shareholders.
