Type of deal: Joint Venture
Danone (Market Capitalization as of 23/05/2013 €34.63bn)
COFCO: state-owned food company in China
China Mengniu Dairy Company Ltd.: (Market Capitalization as of 23/05/2013 HK$ 46.87bn, i.e. €4.68bn)

On May 20th 2013, with a press release, Danone, the world leader in fresh dairy products, announced its third attempt to enter the Chinese dairy market. The French company signed two agreements to form as many joint ventures. The first agreement was signed with COFCO, the state-owned largest food company in China and the major shareholder of Mengniu, in order to form a joint venture controlling an 8.3% stake in China Mengniu (one of the leading dairy product manufacturers in China). At the same time, Danone signed one more agreement to create a joint venture directly with Mengniu to exploit synergies in the yoghurt market.

This attempt comes after Danone’s previously unsuccessful efforts to penetrate the high pace growing Chinese dairy market. The first involved a joint venture with the Chinese soft drink maker Hangzhou Wahaha Group Co., which started in 1996 and ended after 13 years following more than 30 lawsuits from both sides. Danone accused the Chinese company of selling products outside their agreement and, eventually, sold its 51% stake for $450m. The second attempt occurred in 2006, when Danone signed a series of joint venture contracts with Mengniu itself, but both parties agreed on the automatic termination of the joint venture in 2007 after they did not manage to obtain official authorization for further investments.

After these attempts, Danone is now trying to put a more conservative step in the Chinese market investing in a smaller share of its targets. Danone’s financial commitment for the two operations will amount to €325m (roughly 1.1% of its total assets). The size of the investment will allow Danone to spur its business in China assuming a low risk profile and limiting its downside risk, with the chance to further increase its exposure in the future.

According to the first agreement, COFCO will sell 140,014,022 shares in China Mengniu (8.3%) to the newly formed joint venture that will be owned 51% by COFCO and 49% by Danone. Danone will effectively become a strategic minority shareholder in Mengniu with an indirect ownership of about 4%, valued around $230m, while COFCO will remain the largest shareholder in Mengniu with an overall stake of 27.83%.

Under the second agreement, Danone and Mengniu agreed to establish a joint venture operating in the Chinese yoghurt market by combining their assets in the country, with an estimated market share of 21% and total 2012 proforma net sales of about €500m. Mengniu will hold 80% of the new venture and Danone 20%. Danone will contribute its assets and liabilities relating to its Chilled Business in the China, its equity interest in the Danone Chilled Business Subsidiaries (subsequent to restructuring) and cash, in exchange for its stake. According to the Framework Agreement, the initial term of the partnership will be 30 years whereas the initial Agreement can be terminated by both the parties at any time and by Danone if the sino-foreign JV will not take place by 18 months from the execution of the Framework Agreement itself.

Danone’s move is based on the contrasting dairy market situation in Europe and China. As the former market is shrinking and demand has stalled, the latter is booming as dairy sales rocketed to $7.43bn last year and Mengniu held the largest market share of 17%, as opposed to the 1.6% of Danone.

Even though Danone’s Chinese revenues rose last year, as Chinese consumers were suspicious about the quality of domestic products, they still amount to only 6.4% of group total sales. In fact, with 1.3bn of dairy product consumers the Chinese market is too important and potentially profitable to miss out. However, it would be too risky and expensive for Danone to continue strengthening its presence in China autonomously.

The ventures will allow Danone to enter the market with the support of two well-established players and to take advantage of the wide logistic and expertise platform provided respectively by Mengniu and COFCO in order to reach the increasing demand of a growing population. As Frank Riboud, CEO of Danone, argued, the tie-up will result in a “winning combination”, as the synergies created by the three companies will “unlock the potential of the Fresh Dairy Products category in China”.

On the other hand, Mengniu will have the chance to back its products with an international brand, which is perceived as safer by Chinese consumers after Mengniu’s brand was hit by the scandal over toxic infant formula in 2008.

As a consequence of the announcement, Mengniu’s share price closed at HK$27.10 on May 20th, gaining a 10.2% on the previous closing. Danone’s stock price closed at €59.17, gaining 1.8% over the previous closing.

A final remark should be made regarding the possibility that the relevant authorities still have to approve these transactions, which are expected to be finalized in the following months. In particular, regarding the Danone-Mengniu JV, the completion of the agreement is subject to particular conditions and authorizations imposed by the relevant authorities, such as the achievement of relevant licenses and permits under the PRC law, the clearing of transaction with the aforementioned framework by the Anti-Monopoly Bureau of the Ministry of Commerce of the PRC and, finally, the green light by the government.


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