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Food & Beverage

IPO crowns Feihe as China's homegrown baby milk champion

Formula maker overtakes foreign rivals like Danone with top-end offerings

Feihe has grown to become the No. 2 player in China’s infant formula market.   © AP

SHANGHAI -- After 57 years of churning out milk, China Feihe has found the formula for success.

The infant milk producer, whose shares are set to begin trading in Hong Kong on Wednesday following a 6.7 billion Hong Kong dollar ($856.1 million) initial public offering, has emerged as a domestic champion able to take the fight to global market leaders like Nestle and Danone.

This comes as a relief to Beijing which has repeatedly tried to curb Chinese families' seemingly insatiable appetite for foreign formula ever since the illicit use of melamine poisoned hundreds of thousands of babies in a 2008 production scandal.

In the years since, an underground supply chain has emerged to scoop up cans of formula from stores in developed markets. The resulting emptied shelves touched off tensions with local consumers, driving shops in places like Australia to limit purchases and the Hong Kong government to cap the amount departing travelers can take with them. Despite the cost of imports, around 80% of Chinese families rely on formula rather than breast milk.

Authorities unhappy with foreign brands' dominance of the local milk market have pursued them over alleged quality and safety problems and supposed anti-competitive behavior with little effect, as recapped in a report on Feihe by Ming Lu, an analyst with Aequitas Research in Singapore who published on the Smartkarma platform. "The public does not believe the results," he said.

In May, the National Development and Reform Commission set a goal for domestic producers to take a 60% share of the country's formula market without setting a deadline. As of last year, local brands commanded 46.6% of the market, according to Frost & Sullivan research cited in Feihe's prospectus.

Feihe, a former state-owned enterprise privatized by executives Leng Youbin and Liu Shenghui in 2001, has emerged as the authorities' best bet in pursuing self-sufficiency.

In just the last three years after turning its focus to "super premium" products, Feihe has more than doubled its share of sales to 7.3% from 3.4% to become the No. 2 player in the country's formula market, according to the Frost & Sullivan data. While the prospectus does not identify Feihe's competitors by name, it implies Feihe now trails Nestle only slightly and has surpassed Danone.

In the first half of the year, Feihe generated 5.89 billion yuan ($840.47 million) in revenue, more than it took in for all of 2017. Net profit reached 1.75 billion yuan, up 60.4% from the same period last year.

"The company is the only domestic player who has emerged as a winner of the foreign vs. domestic battle in the Chinese IMF (infant milk formula) market," according to an analysis by LightStream Research on Smartkarma. "The Chinese government's initiative to increase the local production of baby formula should favor companies such as China Feihe more as the company already has a significant share in the Chinese IMF market."

By contrast, Chinese formula maker Beingmate, previously the leading domestic producer, has seen its market share dwindle ever since New Zealand's Fonterra bought a 18.8% stake in 2015 for $750 million New Zealand dollars ($476.68 million).

Fonterra disclosed to the Shenzhen Stock Exchange, where Beingmate is listed, on Oct. 30 that its interest has gone down to 17.8% as it has started selling off its holdings, which have lost two-thirds of their value. Meanwhile, Mark Robins, an executive with the company's China arm, told Nikkei Asian Review, "We would like to do more business with Feihe as it expands."

By its own account, Feihe's success comes from its local focus. "Our products are designed to closely simulate the composition of the breast milk of Chinese mothers through in-house research and development formulations, with the aim of achieving an optimal balance of key ingredients for Chinese babies based on their biological physique," the prospectus said.

Zhang Ziyi   © Reuters

With help from movie star Zhang Ziyi, known for her roles in "Crouching Tiger, Hidden Dragon" and "Rush Hour 2," Feihe pushes its brand message through seminars with parents, staging some 300,000 such events last year.

Solar engineer Bao Zunrong, a resident of Nanjing, is an indirect convert who now relies on Feihe's leading Astrobaby brand for his 15-month-old daughter. "Foreign brands may not suit the physique of Chinese people," he said. "Friends recommended Astrobaby to us and our girl has no problem consuming it."

According to Feihe's prospectus, the rapidly growing super-premium segment, defined as products selling for at least 450 yuan per kilogram, is on track to represent 26.4% of China's formula market by 2023, up from just 6.8% as of 2014. The company says its Astrobaby and Organic Zhenzhi brands have given it the top share of the super-premium market, with a quarter of total retail sales.

Feihe's IPO priced at HK$7.50, the bottom of the range at which the shares were offered, but still giving the company an initial market valuation of HK$67 billion.

This underscores the success of the company's push into the top-end of infant formula. When its focus was on fresh milk production, its shares traded on the New York Stock Exchange under the name Flying Crane U.S. It delisted there in 2013 in a $147.1 million buyout, citing low trading volumes and liquidity.

Following the Hong Kong offering, the 43.3% controlling stake of Leng Youbin, 50, in Feihe will be worth HK$29.03 billion. The private equity arm of Morgan Stanley, which took part in the 2013 buyout, will have a 18.6% stake. A unit of Chinese agribusiness conglomerate New Hope Group, which became a shareholder in May, will hold a 1.9% interest. 

The largest portion of the IPO proceeds will be used to repay offshore debt, the prospectus said, with other funds to be used to support acquisitions and fund the operation of a new cow and goat millk formula factory the company has built in Canada to create its own import supply line into China.

Feihe's rivals are not standing still. China Mengniu Dairy, among the country's largest general milk producers, has been turning its attentions increasingly toward infant formula. In September, it reached a $1.5 billion Australian dollar ($1.03 billion) deal to buy out Australian baby milk maker Bellamy's, which had been having trouble securing Chinese import clearances on its own. The deal still needs shareholder approval.

Additional reporting by Nikkei Asian Review deputy editor Zach Coleman in Hong Kong.

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