Yili milks success with bid for rival

China’s largest diary producer Yili Group is planning to buy a stake in a Hong Kong-listed rival for around $680 million, doubling down on a high-growth sector that has been beset by multiple scandals.

Yili Group turned to equity investors for a private placement over the weekend, giving it more than enough firepower to buy a 37% stake in Shengmu Organic Milk, enough to trigger a mandatory general offer according to Hong Kong rules. The deal was well-received by investors, sending Yili’s stock 10% higher on its Monday open.

That came as little surprise to analysts covering the stock, who said that — despite a series of scandals in China’s dairy sector — the deal had obvious benefits for both companies.

“We believe this alliance is a win-win for both, as Yili will secure quality raw milk while Shengmu will benefit from Yili’s strong execution and nationwide distribution,” Credit Suisse analysts told investors.

China has a chequered history of milk scandals, sometimes involving Yili. In 2008, several Chinese infant formula brands — including one made by Yili — were found to be contaminated with the chemical melamine. In 2012, Yili’s milk was reported to record an “unusual” level of highly toxic mercury and need to recall some of its baby formula products.

Twin transactions

Yili has agreed to pay HK$2.25 per share to Shengmu’s major shareholders, including the US venture capital Sequoia Capita and Greenbelt Global. The firm will buy around 2.35 billion shares, although that total could go higher in the event that Shengmu issues new shares.

The offer represented a 7.4% discount to Shengmu’s last closing price of HK$2.43. The stock was halted on Monday.

At the same time, Yili also announced that it had raised Rmb9 billion ($1.33 billion) through a private placement after issuing 587.1 million news shares. The deal was priced at Rmb15.33 per share, representing a 4.84% discount to Yili’s last closing price on September 14. (The stock has been suspended since then.)

Five third-parties investors subscribed to the share placement. They were Qingdao Jinshihaorui Investment, Ping An Asset Management, Tibet Jinmeibua Investment and a pair of funds backed by the Inner Mongolia government — Hothot City Asset Management Investment and Inner Mongolia Traffic Investment. These investors agreed to a five-year lock-up period.

While 51% of the proceeds from the equity placement will be used to fund the Shengmu acquisition, 6% will be for the construction of a new production line in New Zealand, 27% will go to domestic production quality improvement and 13% is being allocated to research and development and other operational costs, according to a statement from Yili.

The private placement could also be part of an anti-takeover strategy, since Sunshine Insurance Group’s stake will be diluted to 4.6% from 5%, according to a person familiar with the situation.

Ain’t no Sunshine

Some investors were concerned about a potential hostile takeover by Sunshine Insurance Group last month when it announced it had increased its stake in Yili to 5%, becoming the Inner Mongolian state-owned Hothot Investment and Yili’s core management team.

“The private placement can act as a poison pill to demonstrate Yili’s determination to continue to be a market leader rather than being taken over,” said a fund manager based in Hong Kong.

Most analysts estimate an earning-per-share dilution of between 3% and 4% after the private placement and the 37% acquisition of Shengmu — so in short- term, the deal is not earnings accretive.

But in the long-run, analysts think the deal could enhance long-term growth for Yili. Deutsche Bank analysts, for example, said Yili’s sales growth in the coming years would make “the transactions EPS incremental from a long-term view.”

After the acquisition, Yili will be the largest shareholder of Shengmu, followed by Chinese agriculture company Da Bei Nong’s, which holds 19%, and Goldman Sachs, which has a 6% stake.

According to a statement by Yili, the acquisition was independent of the private placement. If the placement fails — which at this stage, would only happen if the China Securities Regulatory Commission rejected the deal —  Yili will use its own cash to complete the transaction.


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