Fonterra May Sell Stake in Scandal-Hit China Venture

By Tracy Withers

Oct. 18 (Bloomberg) -- Fonterra Cooperative Group Ltd. may sell its stake in a Chinese dairy venture at the center of the milk scandal that killed four babies and sickened 53,000 children.

Fonterra, the world's biggest dairy exporter, said talks are under way on a third-party acquisition of Sanlu Group Co. The Auckland, New Zealand-based group owns 43 percent of Sanlu, which was the first of 22 companies in China identified as producers of contaminated baby-milk powder.

``Discussions are continuing around a number of facets of Sanlu's future,'' Fonterra Chief Executive Officer Andrew Ferrier said in a statement. ``These include the possibility of Sanlu being acquired by a third party.''

Last month, Fonterra wrote down the value of its Sanlu stake by 69 percent, or NZ$139 million ($85 million), because of the affect of the scandal on the company's brand. Selling the stake may enable Fonterra to re-invest in China, provided it can prove to the New Zealand farmers who are its shareholders that it can guarantee a secure supply of quality milk.

``There are some farmers saying `we've been burnt, lets get out of there,''' said Lachlan McKenzie, chairman of the dairy section of Federated Farmers Inc. ``It will be up to the company to show it can manage these risks.''

Chinese officials are investigating how melamine, a chemical used in making plastics and tanning leather, was added to raw milk before delivery to Sanlu's plant. Melamine artificially raises the protein content in diluted milk, allowing sellers to cut costs. In China, agents for processing plants collect milk from thousands of small farmers.

Supply Chain

``There has to be a change in the supply chain and the company has to demonstrate that'' before farmers will support new investment in China, McKenzie said in an interview.

The tainted-milk scandal has revived concerns about Chinese food-safety controls after previous scares over seafood, dumplings and pet food. More than 20 countries and markets in Asia, Africa and Europe have recalled or restricted Chinese dairy products after 20 companies including Sanlu and China Mengniu Dairy Co. sold contaminated products.

Concern that Chinese partners don't adhere to the quality standards of export markets might endanger the nation's ability to attract investment and technology.

Confidence Damaged

``Foreign investment will keep away from China's dairy industry in the short term,'' said Guo Changsheng, an analyst with Shanghai Securities Co. ``Consumer confidence over food safety hasn't recovered'' from the series of contamination scandals.

Last month, Ferrier reiterated that China is a ``core'' part of Fonterra's strategy. It owns a farm in China and also supplies the nation with products made in Australia and New Zealand.

Fonterra is involved in a number of discussions and the long-term future of Sanlu and Fonterra's stake ``remains uncertain at this stage,'' Ferrier said today.

``Any solution involving Fonterra's long-term involvement in Sanlu or other aspects of the Chinese dairy industry will hinge on us having sufficient influence over key aspects of the dairy supply chain,'' he said.

Feihe Dairy, a subsidiary of American Dairy Inc., was invited by the Chinese government yesterday to a meeting to discuss the future of Sanlu, Xinhua News Agency said, citing an unidentified company spokesman.

Newspaper reports yesterday said Beijing Sanyuan Foods Co. and Hangzhou Wahaha Group Co. are also interested in buying Sanlu. Pan Chang, chairman of Inner Mongolia Yili Industrial Group Co., said yesterday his company was also invited to the meeting, adding he ``hasn't thought about'' buying Sanlu.

Over the long term investment in China will rebound, Shanghai Securities' Guo said. ``No one can ignore the huge Chinese market.''

To contact the reporter on this story: Tracy Withers in Wellington at twithers@bloomberg.net.