The infant formula industry has been struggling in recent months thanks to reports China wants to increase domestic suppliers to at least 60 per cent of the market and several new players emerging.

But yesterday’s news that one of the largest Aussie players, Bellamy’s (ASX:BAL), had received a takeover bid at a hefty premium (nearly 60 per cent higher than Friday’s closing price) from Hong Kong-listed dairy company Mengniu shows just how keen Asia is in injecting cash into Aussie players.

Bellamy’s directors unanimously recommended shareholders accept the offer and the share price shot up.

It has been a wild ride for Bellamys’ shareholders with a hike from $1 to $13 in just two years, then a retreat below $4 as sales took a hit.

It spiked as high as $22 in early 2018, but gradually fell again and will be acquired at $12.65 per share – subject to shareholder and Foreign Investment Review Board approval.

However, Bellamy’s still does not have a licence to sell in China nearly two years after it applied for it.

But Mengniu CEO Jeffrey Minfang Lu said he still saw Bellamy’s as a premium product hence its potential value to his business.

“Bellamy’s is a leading Australian brand with a proud Tasmanian heritage and track record of supplying high quality organic products to Australian mums and dads,” he said.

“This leading organic brand position and Bellamy’s local operation and supply-chain are critical to Mengniu.”

So what does this mean for Aussie small caps?


China prefers non-Chinese brands

Infant formula small caps have been struggling for several months. One of the catalysts was China aiming for a 60 per cent self-sufficiency ratio in its infant formula market.

The Asian behemoth has not said how this would be achieved, but there has been speculation that the Chinese government would subsidise domestic companies.

On top of this, bigger companies such as Nestle indicated it wanted to enter the Chinese market after previously avoiding it.

In the last 12 months, ASX infant formula stocks have lost an average of 17 per cent.

Code Name Price Market Cap 1Y % Return 6M % Return
BUB BUBS AUSTRALIA LTD 1.21 $614.0M 75 59
CLV CLOVER CORP LTD 2.08 $348.5M 36 21
JAT JATENERGY LTD 0.055 $46.3M 29 -2
A2M A2 MILK CO LTD 13.59 $9.7B 19 -2
BAL BELLAMY'S AUSTRALIA LTD 12.94 $927.3M -13 -26
SM1 SYNLAIT MILK LTD 8.56 $1.4B -30 -22
HRL HRL HOLDINGS LTD 0.11 $54.3M -35 36
BXN BIOXYNE LTD 0.021 $13.4M -36 5
LON LONGTABLE GROUP LTD 0.18 $36.3M -59 -8
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The boss of one start-up incubator who did not want to be named, told Stockhead that a high proportion of Chinese consumers trust non-Chinese brands more than local brands.

For example, Tasmania-headquartered Bellamy’s is the number three organic brand among Chinese consumers.

This explains the practice of daigou where Chinese consumers buy goods in bulk on behalf of others. It can either be among tour groups or locals of Chinese descent, shipping to relatives back home.

Companies such as Mediland Pharm (ASX:MPH) and AuMake (ASX:AU8) have taken advantage of this — selling to the Chinese market without the red tape. The former stock listed in February and has gained 60 per cent since.

And one analyst reckons China’s move to increase its share of the infant formula market is unlikely to affect non-Chinese players.

“We think China’s latest plan to boost domestic infant formula output should not hurt companies for the foreseeable future,” Bloomberg Intelligence analyst Kai Tung Pang told Stockhead.

“Consumer habits are difficult to change and preferences may take generations to shift, particularly for products like baby milk which is only fed for a relatively short period of time.”


Potentially more tie-ups

China’s push to grow its domestic infant formula market could also benefit companies considering a tie-up with a larger player.

The Bellamy’s deal also shows Chinese companies are willing to pay a premium.

“We see the proposed transaction in line with the rhetoric from the recent Chinese NDRC action plan,” Goldman Sachs analyst Sophie Carran said.

She noted the deal was valued at 29 times Bellamy’s 2019 enterprise value to earnings ratio, while prior transactions in the space averaged 18.8 times.

Mengniu will be coughing up $1.5 billion and will finance 40 per cent of this with debt.

The acquisition is likely part of the major’s goal of generating ¥100 billion ($20.6 billion) in revenue by 2020.