(Bloomberg Gadfly) -- The cows are coming home. But China Mengniu Dairy Co., which is taking over China Modern Dairy in an $892 million deal from KKR & Co. and CDH Investments Fund Management Co., should be concerned less about owning the farm and more about getting the right products on supermarket shelves.
Modern Dairy gives Mengniu access to a plant in New Zealand and farms throughout China. The timing is good, because milk prices are recovering after a multi-year glut: Mengniu, the nation's second-biggest maker of milk products after Inner Mongolia Yili Industrial Group Co., is working to keep costs down, and control of raw materials will help.
However, the larger issue for Mengniu, which warned of a "substantial loss" for 2016, is competition rather than costs.
Inner Mongolia Yili and foreign brands are eating into its share not just of the milk market but also of infant formula, where sales are poised to grow after China abandoned its one-child policy. Memories linger of the 2008 infant fatalities caused by tainted milk, so convincing Chinese consumers of the value of a domestic firm won't be easy.
The real fight for Mengniu, if it wants to win overall share from Yili, will be expanding fast enough in the premium market -- organic milk and high-end yogurt. Yili late last year went upmarket by acquiring more than one-third of China Shengmu Organic Milk Ltd., the largest such producer.
Higher-margin premium products will be key to winning over affluent urban consumers. The bulk of Mengniu's offerings, as Bloomberg Intelligence analyst Thomas Jastrzab notes, remain mass-market products like fresh milk "with limited product differentiation" -- one carton is much like another, unless it's a foreign brand.
Deal premium
7%
Mengniu shares fell after the deal was announced Thursday morning, even though the transaction, at a slim 7 percent premium to Modern Dairy's Jan. 4 close, isn't particularly pricey. The HK$1.94 bid price is well off the HK$2.13 high for 2016 reached in November.
Investors declined to congratulate Mengniu less because of worries about indigestion than over disappointment that it didn't go organic.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.
To contact the author of this story: Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net.
To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net.
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