China: from milk to meat?

Sluggish deal activity has frustrated GPs in China, so can the same investment thesis that worked for the milk sector also work for meat?

GPs have been getting frustrated in China, as sluggish deal activity exacerbates the steadily rising level of dry powder. So when a strategy emerges that can demonstrate not only dealflow, but also exits and returns, everyone wants a piece of the action.

That’s certainly what happened with Chinese dairy companies, which after a number of scandals involving tainted infant formula and milk, were in dire need of improving food safety standards and rebranding.

The Carlyle Group, Affinity Equity Partners, Yunfeng Capital and CITIC Private Equity were among the many firms to tap the sector – in the hope of acquiring cheap assets with plenty of room for operational improvement.

Now, some are betting that the same formula may work just as well for meat, too.

In early June, a private equity consortium joined forces to invest in COFCO Meat, the pork and poultry division of Chinese state-owned enterprise COFCO Group.

The consortium, which comprised Kohlberg Kravis Roberts, Baring Private Equity Asia, Hopu Investments and Boyu Capital, paid $270 million for 62 percent of the business, with KKR taking the largest portion of the interest ($150 million worth), a source close to the deal told Private Equity International.

COFCO Meat produces, processes and distributes meat in China, as well as importing and exporting, and is one of China’s largest pig producers.

“This is the same thesis on dairy, except on meat,” PEI’s source, who worked on the COFCO deal, explains.

The KKR-led consortium will focus first on improving the supply chain, so the meat cannot be tainted at any level, from production to sales. They will also recruit American, Canadian and Danish food experts to help implement best practices in the business, with Hopu and Boyu providing key relationships to help find the right land to farm pigs in the most effective and healthy manner. These steps are almost identical to those taken by private equity firms who invested in China’s downtrodden dairy companies.

And other firms are starting to notice the resemblance.

Olympus Capital, investor in China’s Huaxia Dairy, is now focusing its efforts on meat – a product that has a similar supply/demand dynamic to milk, explains Pete Cimmet, managing director at Olympus.

“We are mostly focused on beef right now. There is a supply/demand gap developing that is similar to dairy. For beef, we believe that part of the business model may include importing beef from other markets where the production cost is lower, such as Australia.”

And it is essentially private equity’s operational value-add that companies are looking for. PEI’s source says COFCO chose to partner with private equity because of its previous experience with the asset class.

KKR exited its investment in China Modern Dairy in a strategic sale to COFCO-owned China Mengniu Dairy Company in May last year for HK$2.41 billion (€237 million; $310 million). This, along with the firm’s previous sale of shares, meant a gross cash-on-cash return of 2.9x. KKR had also previously been an investor in Mengniu, while Hopu has previously teamed up with COFCO’s agriculture division for a joint venture called Noble Agri.

But while GPs hope meat will produce similar results to dairy, the industry is still waiting to see a successful exit off the back of the strategy. Perhaps the highest-profile example of this kind of deal, CDH Investments-owned Chinese pork producer Shuanghui International (now WH Group), is still yet to complete its long-anticipated IPO in Hong Kong.

Reporting by Clare Burrows