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Discussion document:

Dairy Market CHINA:

www.raffel.eu

Dairy Market CHINA:

Chances from Key Trends for European Firms

Hong Kong / Shanghai / Munich, January 2014

Raffel GmbH • 80333 München • Tel +49 (89) 242 086 590 • Email [email protected]© Raffel GmbH Corporate Development All rights reserved. Proprietary and confidential.

Content

1. Preliminary remarks and Management Summary 2

2. General trends in the Chinese food market 5

3. Sub-sector of food – Dairy 10

DP_1401_Dairy_Chinawww.raffel.eu

1Raffel GmbH • 80333 München • Tel +49 (89) 242 086 590 • Email [email protected]© Raffel GmbH Corporate Development All rights reserved. Proprietary and confidential.

4. E-commerce for food 13

5. M&A in the Chinese food sector 19

6. Strategic Implications from MelchersRaffel 23

www.raffel.eu2

Raffel GmbH • 80333 München • Tel +49 (89) 242 086 590 • Email [email protected]© Raffel GmbH Corporate Development All rights reserved. Proprietary and confidential. DP_1401_Dairy_China

▐1. Preliminary remarks and Management Summary

� This paper intends to share the most recent shopping trend and buying behavior

changes of food market in China and our main perspectives on the opportunities

present in this sector

� The data shown in this paper is for reference only to understand the general trend

and competitive environment, whereas some of the numbers being best estimates.

Examples given here are selected for illustrative purpose and should not be

Preliminary Remarks

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considered as an exhaustive list

� MelchersRaffel would be glad to discuss strategic impacts and strategic options

with interested management of food companies.

� General growth of food market in China is further triggered in a top market segment

for international and imported brands due to many food scandals in the past.

� Beside “classic” distribution channels, e-commerce shopping for food is more andmore used by Chinese consumers.

� For international brands, there is a potential to grow in the huge Chinese food

market with hybrid distribution activities.

� Chinese companies are very interested in European food markets for partnership,

acquisition etc. as they want to make use of the European brand, market access

Management Summary

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and quality standards.

� Besides a well designed and functioning organic growth strategy with aligned

marketing and sales elements, European food brands should look for partnerships

in terms of acquisition or “network capital” with well established and suitable

Chinese players.

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▐2. General trends in the Chinese food market

716 774 867 979 1.065 1.154 1.247 1.344 1.444

The Chinese food market has experienced strong growth in recent years and is

expected to continue to grow at a CAGR of 8% in the next 3 – 5 years

▐ The Chinese food market has been growing at a rapid pace for several years. The number of high-income earner is surging, benefiting from a significant rise in wages. This has resulted in a soaring demand for new products, concepts and brands

Current situation

Overview of the Chinese food industry

China packaged food market value

Bn RMB

(c. 168bn EUR)

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2008 2009 2010 2011 2012 2013 2014 2015 2016

▐ Both international and domestic grocery retailers are expanding quickly in China with diverse formats and entering new regions

▐ Hypermarkets and supermarkets continue to account for the greatest proportion of overall sales. Meanwhile, internet retailing is booming due to its competitive prices and home delivery services

China packaged food industry distribution

Hypermarket, supermarket;

63%

Food & drinks

specialists; 18%

Convenience store and gas station; 16%

Others incl. online; 3%

Source: Euromonitor

China’s Top 10 Grocery Retailers in 2012

Local Chinese companies dominate the grocery sector in China, only 2 foreign

companies can be found in the top 10 players list

Ownership Company name China retail sales, bn RMBGrowth

2011-2012# of POS

# of provinces

in operation

Chinese Bailian Group 3.3% 5,147 20

Chinese Vanguard 13.8% 4,423 27

Chinese RT-Mart 17.7% 219 21

Foreign Walmart 3.6% 395 2058

72

94

122(14bn EUR)

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Foreign Walmart 3.6% 395 20

Chinese Chongqing Trading 14% 327 3

Foreign Carrefour 0.2% 218 21

Chinese Dashang Group 4.7% 170 NE/N/W

Chinese NGS Group 0.2% 2,734 5

Chinese Yonghui Group 37% 249 4

Chinese Wuhan Wushang 29.8% 98 126

27

30

37

45

54

58

Date Food

category

Key description

2003-2004

Infant milk powder

� Babies were found to have abnormal big heads because of the in-take of toxic milk powder

2005–2006

Egg � Sudan dyes, an industrial addictive, was found in the “premium red-hearted” eggs

2008 Infant milk powder

� Milk powder produced by the Hebei SanluGroup was found to be contaminated with Melamine

Numerous toxic food scandals were reported in the past 10 years in China. Worries

about food safety have led many Chinese consumers to turn to imported goods

In 2008, problematic Sanlu milk powder

was recalled and destroyed by the

Shanghai government

List of major food scandals in China in the past 10 years

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Melamine� Babies began falling sick with kidney

problems as early 2007

2008 Wine & spirits

� 95% of Maotai, a brand of traditional Chinese spirits, is believed to be fake, made from industrial-use methanol

2010 Cookingoil

� Several Chinese workshops were chargedfor turning discarded waste and sewage into recycled cooking oil, creating food hazard

2011 and 2013

Ginger � Aldicarb, a highly poisonous carbamatepesticide, was used at “three to six times” above the recommended level on ginger crops in Shandong

In 2010, poisonous chemicals contained in recycled cooking oil were found to be

100-times more toxic than Arsenic trioxide

Source: MelchersRaffel analysis

Market size of imported food in China, 2007 – 2018EBn RMB

Mainly driven by the growing middle-class and food safety concerns, the imported

food market in China is expected to reach c. 480 bn RMB by 2018

480

▐ Growing middle class

▐ Increasing demand for food variety

▐ Rising concerns on food safety

Key drivers of increasing imported food

(c. 56bn EUR)

“China will become the world’s largest

market by 2018.”

- American Association of Food Industry

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3663

2008 2012 2018E

CAGR: 15%

CAGR: 40%

▐ Increasing diversity of distribution channels

▐ Recent surge in prices for domestic products, driven by inflation, has made foreign food products more affordable

▐ Government's efforts to lower tariffs on imported food has also made them more accessible for Chinese consumers

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▐3. Sub-sector of food – Dairy

The Chinese dairy market reached 293 billion RMB in 2012, and has grown

75% from 2007 till 2012

128

51

57

63

35

38

41

44

Market size of dairy Products in ChinaBillion RMB

293

332

372

415

462 (55 EUR)

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100 104 113 124 137 153

170 188

206 225 23 29

37 45

55

67

80

94

110

128

20 22

26

30

34

40

46

23 26

25

27

29

32

2007 2008 2009 2010 2011 2012 2013e 2014e 2015e 2016e

Other dairy products

Yoghurt & sour milk

Baby/infant milk formula

Drinking milk products

Source: Euromonitor, Currency: 1Euro= 8.3 RMB

Total= 167181

226

201

256

25%

23%20%

5%

4%

23%

Mengniu

Yili

Bright Dairy

Wahaha Group

Want Want

Other

The top three players Mengniu, Yili and Bright Dairy controlled an aggregated

market share of about 68% of the Chinese drinking milk market in 2012

▐ After the melamine scandal in 2008, unlike in the infant formula market, the domestic brands in the liquid milk market recovered quickly. Foreign brands are disadvantaged by high transportation costs and insufficient access to the market.

Current situation

Top company shares for drinking milk in China

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▐ Domestic brands still dominate the liquid milk market in terms of sales.

▐ Inner Mongolia`s Mengniu Dairy Industry (Group) is expected to continue to lead the drinking milk segment.

▐ Customers tend to upgrade for high-end products after the 2008 melamine scandal.

Year

Established1999 1993 1952

Brands

Milk

sourcesDomestic Domestic

Mainly domestic

Production

base

Mainly Inner Mongolia

Mainly Inner Mongolia

Shanghai

Mengniu Yili Bright

Source: Euromonitor, Oriental Patron

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▐4. E-commerce for food

568

254

152

101

China

United States

India

Japan

China has the largest internet user population in the world, despite its penetration rate

is still far behind developed countries such as the US and Japan

Internet population base by country, 2012Million users

42%

81%

13%

79%

Internet penetration rate

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99

76

68

56

55

54

Brazil

Russia

Germany

Nigeria

United Kingdom

France

50%

53%

84%

33%

87%

83%

Source: International Telecommunications Union; MelchersRaffel analysis

Examples of online shopping sites for fresh food products and packaged food

Given the huge online population base, quite some B2C online food shopping sites

emerged in China reaching consumers in a wide geographical range

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http://www.womai.com/index-0-0.htm

http://www.yhd.com/ http://www.sfbest.com/

http://www.tootoo.cn/

Source: MelchersRaffel research

Key highlights:

Organic, Natural & High quality

Despite the current small channel size, online shopping channels for food are

expected to grow rapidly in the next 5 years in China, reaching RMB 40 bn by 2018

Overview of the Chinese online food market

Total online sales of fresh products in China

Bn RMB

11,5

40

CAGR: 37%

▐ In contrast to the mass market positioning of traditional offline supermarkets, on-line grocery stores usually target a specific customer group:

� Relatively young

� High-income consumers

� Willing to pay for convenience, high quality and safety standards

Current situation

(c. 4.7 bn EUR)

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Types of online food platforms

2013 2018E▐ Product mix:

� Focusing on fresh and premium products

� Large % of imported goods

▐ Unique selling point:

� Own logistic system to deliver directly from the farm to the consumers, cutting out the middlemen in order to increase freshness and increase food traceability

▐ Key challenge:

� High costs to develop nationwide cold chain logistics

Integrated; 68%

Vertical; 27%

Special food; 5%

Shanghipremium B2C food

Source: Industry expert interviews; MelchersRaffel analysis

What customers said about online grocery

In addition to food safety concerns, convenience and rich product variety are also

key motivations for Chinese consumers to buy food from online platforms

�Female

�Female

�Beijing MNCmanager

�Age: 44

▐ “The vegetables are really fresh.”

▐ “Supermarket food doesn't look that fresh, especially if you only get there in theevening. Or you can also get some cheaper vegetables in markets during day

time, but I really worry about the safety of the products sold there."

▐ “I stopped buying domestic milk brands two years ago. Due to safety concerns, I

would prefer to buy imported milk, although it's much more expensive than

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�Male

�Accounting professional

�Age: 35+

�Young officelady

�Age: 29

would prefer to buy imported milk, although it's much more expensive thandomestic milk.

▐ “Now I usually buy the imported milk from reputable online platforms. Quality isguaranteed and delivery service is free of charge at a certain purchase amount.”

▐ “I would buy packaged food online since they have more choices available. It

would be time-consuming for me to search for those niche, festive Japanese foodgift set in a traditional supermarket.”

▐ “I am also impressed by the efficiency of the delivery. It’s very convenient whenyou can order soft-drinks and snacks by clicking a few buttons online, especially

for party occasions like BBQ gathering for a big crowd.”

Source: Customer interviews; MelchersRaffel analysis

An online B2C food platform in China, Yihaodian, has seen skyrocketing sales growth

in the last years, reaching c. RMB 7 bn in 5 years time since its establishment

4 46805

2720

6800

Annual sales revenue of Yihaodian

Mn RMB

▐ Founded in: Jul 2008

▐ Founder: Gang Yu and Junling Liu

▐ Ownership changes:

� 2011: Walmart first acquired minority stake

� 2012: Walmart controlled 51% of ownership

▐ Competitive edge:

Brief introduction

1

CAGR: 429%

Introduction to a major online food shopping platform – yihaodian.com

(c. 790 mnEUR)

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2008 2009 2010 2011 2012

Mobile shopping functionality of yihaodian.com

▐ Competitive edge:

� Accurate response:

− Launched “On-time arrival” for Shanghai, Beijing, Guangzhou, Shenzhen, etc.

− At additional RMB 3 – 5 per order, customers can specify which 2-hour interval the goods shall be delivered

� Efficient operation:

− <1.5 minute is required to sort out the products from the warehouse per order (on average each order has c. 16.7 items)

1. Partial annual revenue for 2008, operated since Jul 2008

1

Source: MelchersRaffel research

Mobile sales revenue accounts

for 10% of total

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▐5. M&A in the Chinese food sector

Sub-sector of the target

company

Type of acquisition /

partnership

Recent deals example

Confectionery / snacks � Chi. acquired Chi. � In 2012 Jan, Shanghai Maling (canned food manufacturer) acquired Guanshengyuan (processed food such as candies, honey, noodles, etc.)

� Intl. acquired Chi � In 2011, Nestle acquired Hsu Fu Chi (Chinese manufacturer of various confectionaries and snacks)

Beer � Chi. acquired Chi � In 2011, China Resources Group – Snow beer acquired HuzhouBeer and Hangzhou West Lake Beer

Processed meat � Chi. acquired American � In 2013, Chinese Shuanghui (largest meat processor) acquired

Cross-border and domestic acquisitions commonly occurred in the Chinese food

sector in the past 3 years

Examples, not exhaustiveRecent M&A activities – all sectors

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Processed meat � Chi. acquired American � In 2013, Chinese Shuanghui (largest meat processor) acquired US Smithfield Foods

Breakfast food � Chi. acquired European � In 2012, Chinese Bright Food Group acquired UK breakfast brand, Weetabix

Dairy � Chi. acquired Chi. � In 2011, Sanyuan (agriculture and animal husbandry SOE) acquired Hunan Taizinai (dairy)

� Intl. acquired Chi. � In 2011, Nestle (Dairy, confectionery, etc.) acquired 60% share of Xiamen Yinlu Group (canned food, dairy, etc.)

� Chi. partnered with European

� In Nov 2013, Chinese dairy group, Yili formed partnership with Italy’s Sterilgarda Alimenti SpA to enhance its technological capabilities and for securing better milk sources

� Chi. acquired Australian � In January 2014 Bright Foods, Chinas second largest dairy company, announced its acquisition of the Australian dairy firm Mundella Foods

Selected examples for cross border M&A and long term partnerships in the dairy sector:

Chinese dairy companies seek and offer equity participation with foreign

partners to secure their milk supply

Selected examples for cross border M&A and long term partnerships in the dairy sector:

Date Acquirer Target Deal value Details of the deal

2010 Bright Dairy Synlait

370 mn RMB(45 mn EUR)

51% stake

- Bright Dairy, China's third-biggest dairy company by volume, bought a majority stake in New Zealand`s Synlait, which by then had a new milk powder processing plant under construction, allowing to double its output capacity in the following year

2012 Arla Foods Mengniu

1.9 bn RMB(226 mn EUR)

- Arla Foods, a world leader in dairy farming and related production processes purchased an indirect equity share in China´s largest dairy company Mengniu.

- The deal allows Arla Foods to participate in China´s vast

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2012 Arla Foods Mengniu(226 mn EUR)

6% stake

- The deal allows Arla Foods to participate in China´s vast and growing dairy sector and enables Mengniu to secure their milk supply and benefit from the latest sector related production techniques and know how

2014 Bright Dairy MundellaNot disclosed

yet

- Bright food announced in January 2014 to acquire the cheese and yoghurt maker through their Australian arm Manassen Foods. The Chinese company acquired a 75% stake of Australia's Manassen in 2011.

2012

Partnership

770 mn RMB(92 mn EUR)

- Synutra and Sodiaal signed a long term cooperation agreement in which Sodiaal supplies Synutra´s newly established milk powder processing plant in France with demineralized liquid whey and milk.

Synutra Sodiaal

Cro

ss-b

ord

er

Currency: 1Euro= 8.3 RMB

Examples of Sino-foreign partnerships in the dairy sector

By partnering with domestic companies, multinationals getting well positioned to

access consumers with their wide range of products

▐ In May 2013, Danone and the Chinese dairycompany Mengniu announced plans to set up adairy venture in China, a JV will invest in and

▐ In 2011, Nestle announced the acquisition of a60% stake in China's family-owned Yinlu

Jointly 2.4 bn RMB(0.28 bn EUR)

2.5 bn RMB(0.3 bn EUR)

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dairy venture in China, a JV will invest in andmanage a portfolio of chilled yogurt in thecountry

▐ Danone will hold a 20% stake in this partnership,which will operate 13 plants across China

▐ The tie-up will help Danone to boost sales inChina’s yogurt market, Mengniu held a 16.8%market share in the Chinese yogurt market in2012, Danone held a 1.6% share, according toEuromonitor. Through the partnership, Danonewill benefit from Mengniu’s extensive distributionchannels in China, and also gain access to theChinese dairy company’s production bases.

60% stake in China's family-owned YinluFoods Group, the shareholders will jointlyinvest $394 million to expand current and buildnew production facilities nationwide

▐ This deal will strengthen Nestle’s penetration inChina and demonstrates its long-terminvestment in the Chinese market andcommitment to the further development of localbrands

Currency: 1Euro= 8.3 RMB

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▐6. Strategic Implications from MelchersRaffel

Summary of Strategic Implications for European Food Companies

1. Food Market China shows

strong growth

2. International brand‘s

business is booming

� How to get access to the booming Chinese market?

� Is e-commerce the right sales

Strategic Questions:

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business is booming

3. Internet sales is

booming

� Is e-commerce the right sales channel for us?

� Which partner or acquisition target should be considered?

Strategic time window for a successful positioning of international brands in China is narrow.

� Founded: 1806 in Bremen, Germany

� Group Companies: more than 50 in the world – focusing on Europe, Southeast Asia, and Greater China

� Branches and representative offices in Asia: 25

� Other locations: South Africa, Ethiopia

� Employees in Europe: ca. 600 (ca. 500 in Germany)

� Employees worldwide: 1,700 (1,000 in Asia).

MelchersRaffel is the company for successful Euro-Asia endeavours

� Access to Know-how and network of 1,700 employees in technology, consumer and luxury markets in Europe and in 25 offices in Asia

� Experience from 150 years of successful business in China

DP_1401_Dairy_Chinawww.raffel.eu

25Raffel GmbH • 80333 München • Tel +49 (89) 242 086 590 • Email [email protected]© Raffel GmbH Corporate Development All rights reserved. Proprietary and confidential.

� Employees worldwide: 1,700 (1,000 in Asia).

� Experience in advising companies in the larger middle class. The employees of Raffel CD have both industrial and consulting experience in the international environment.

� For M&A activities (purchase and sale of companies and business units), Raffel CD combines the necessary M&A technique, strong strategy and market expertise. This allows the creation of outstanding value for the customer.

� Offices in Shanghai, Hongkong, Singapore and Munich, Germany

� Client Service:StrategyBusiness DevelopmentDesigning Business Models

M&A

Acquisition and Desinvestment of CompaniesStructuring Joint Ventures and Alliances

� Contact:www.melchersraffel.comE-mail: [email protected]

MelchersRaffel has offices and access to networks in all relevant Asian

countries

MelchersRaffel Shanghai

13 floor, East Ocean Centre

588 Yan-An Road (East)

Shanghai 200001 / PRC

[email protected]

MelchersRaffel Ltd. Hongkong

MelchersRaffel Munich

Loewengrube 12

80333 Muenchen, Germany

Tel +49-89-24208659-0

[email protected]

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MelchersRaffel Ltd. Hongkong

Shun Tak Centre West Tower

168-200 Connaught Road Central

Hong Kong

[email protected]

MelchersRaffel Singapore

101, Thomson Road

# 24-01/05 United Square

Singapore 307591

[email protected]

office location of the Melchers group office location of MelchersRaffel

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