Investors in China are literally putting their money where their mouths are.
Capital invested by financial sponsors in China’s food and beverage sector rose by almost 10% last year, as the industry continues to consolidate and demand for higher quality goods prompts a need for stronger company operations.
Although other sub-sectors catering to Chinese consumers, such as personal goods and vehicles, saw a decline in investment between 2012 and 2011, private equity investment in the food and beverage sector rose to $111.7 million last year from $103.2 million in 2011, according to Dow Jones VentureSource, which is also owned by Dow Jones & Co.
The sector has attracted private equity shops, which see a clearer exit path as corporations snap up acquisition targets in the field. Most recently Kohlberg Kravis Roberts KKR +2.57% & Co. and CDH Investments sold part of their stakes Wednesday in China Modern Dairy Holdings Ltd. 1117.HK -4.60% to China Mengniu Dairy Co. 2319.HK +7.34% in a deal worth $407 million. The transaction brings together two of China’s largest dairy companies in the hopes of restoring consumer confidence after concerns about milk safety. However, it also offers KKR and CDH a chance to recoup some capital after making initial investments five years ago.
After the deal, KKR holds around a 3.6% stake and CDH has a 1.5% shareholding. In 2008, KKR invested roughly $150 million into Modern Diary, originally taking a 34.5% stake. The firm then sold down some shares at the company’s IPO in 2010, which left it with a 24% stake.
One Shanghai-based portfolio manager said the partial sale was a ‘good’ deal for the PE firms, noting that if they had retained their larger stakes they likely would have struggled to sell shares at a decent price in the open market, given the lack of liquidity of smaller sized Modern Dairy. Over the long term, the cash flows from milk aren’t too attractive either, he added.
That said, getting some Chinese companies’ operations and professional management to a high enough standard to make them potential acquisition targets can be a challenge, said Derek Sulger, managing partner of Lunar Capital, which last month bought a majority stake of about 70% in Chinese snack food maker Guizhou Yonghong Food Co., committing up to $50 million to the company.
Mengniu itself struggled with safety issues after government testers found melamine in nearly 10% of its milk samples in 2008.
Despite corporate governance challenges, industry insiders say that valuations for Chinese food and beverage companies look attractive these days, although they declined to provide specifics. They did say that premium , which remain popular among Chinese consumers seeking higher quality goods, tend to command higher pricing.
“China is one of the largest consumer markets in the world…and other than dying, eating is a certainty,” said Mr. Sulger, highlighting the benefits of investing in the country’s food and beverage sector at this time.