China Mengniu Dairy Co., the country’s largest dairy producer, offered HK$12.5 billion ($1.6 billion) to buy a local infant formula maker as baby food demand surges and the government pushes for safer products.

Mengniu agreed to buy 75 percent of Yashili International Holdings Ltd. from Chairman Zhang Lidian’s family and Carlyle Group, it said in a statement today. It will also offer to buy the rest of the company at HK$3.50 a share in cash, or about 5 percent more than Yashili’s last trading price.

The investment will help Mengniu build a bigger presence in China’s baby formula market that is projected to expand more than 70 percent to 133.5 billion yuan ($21.8 billion) by 2015, according to Euromonitor International. The Hohhot, Inner Mongolia-based company is making its third deal in two months after scandals including contaminated milk powder and rat meat sold as mutton have fueled demand for safer products and pushed the government to tighten regulations.

“The government is trying to consolidate the industry by backing Mengniu to take control of smaller ones so it can better monitor both upstream and downstream food quality,” Todd Yang, an analyst at Guosen Securities Co., said by phone.

China will push to ensure the safety of baby milk products and draft policies to support deals among producers, the State Council said this month. COFCO, the state-backed agricultural and food industry supplier, owns 19 percent of Mengniu, according to data compiled by Bloomberg.

Milk Source

Yashili says it sources all its milk from New Zealand and is building a plant there, according to its annual report. It has 1,500 regional distributors across China for its milk powder, it said.

Mengniu listed Yashili’s “high brand recognition, imported premium dairy raw materials and a proprietary formula” among reasons for the acquisition.

Mengniu was among 22 dairy companies found to have sold products containing the chemical melamine in 2008, when tainted powder killed at least six infants in China. Moldy cattle feed led to excessive toxin levels in its milk, Mengniu said in 2011. Since then, the company has run marketing campaigns emphasizing product quality to draw consumers back.

Shareholders will have the option of selling for HK$3.50 in cash or a combination HK$2.82 in cash and 0.681 share in a private company set up by Mengniu. Yashili went public in 2010 at HK$4.2 a share.

Mengniu and Yashili will resume trading tomorrow after they halted the shares since June 13.

Danone Stake

Mengniu bought a stake last month in China Modern Dairy Holdings Ltd., the country’s largest raw milk producer, to get greater control of milk supplies. Danone, owner of Activia yogurt and Evian water, said last month it will spend about 325 million euros ($435 million) to form a joint venture with Mengniu for yogurt products in China.

The Paris-based company will also have an initial indirect interest of about 4 percent in Mengniu, with the aim of increasing that in the future.

Founded in 1983, Yashili is about 52 percent owned by Chairman Zhang Lidian and his brothers, and 24 percent by Carlyle. The company reported a profit of 468.5 million yuan in 2012, an increase of 53 percent. Its baby formula brands include Yashily and Scient.

Glenview, Illinois-based Mead Johnson Nutrition Co. had a 14 percent share in the Chinese milk formula market last year. Hangzhou Beingmate Group Co. was second with a 10 percent share followed by Danone’s 9.2 percent and 7.8 percent by Inner Mongolia Yili Industrial Group.

Yashili ranked seventh with 4.7 percent share while Mengniu ranked 23rd with 0.2 percent.

Consumer Distrust

Mengniu sells liquid milk products including UHT milk and yogurt under its namesake brand in China. It also produces ice cream and other dairy products such as cheese and milk powder. The company has the biggest share in China’s drinking milk market, controlling more than 34 percent share in 2012, according to Euromonitor International.

Chinese consumers’ distrust of local milk has been driving domestic companies to look overseas. Inner Mongolia Yili Industrial Group said in December it plans to invest NZ$214 million ($171 million) in a baby formula project in New Zealand. UBS AG is lead financial adviser, while HSBC Holdings Plc and Standard Chartered Plc. are joint financial advisers to Mengniu.

Subscribe Now

Complete access to real-time information and analysis of news and trends in the industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.