Compiled by Caijing staff

From Caijing Magazine

Sealed gates and a silent production floor greet visitors to the Chengdu headquarters of the Taizinai dairy company after a meteoric business plan crumbled in the hands of foreign investors.

By default, what’s left of Taizinai and its practically new but idled factories in five cities are now controlled by the British private equity fund Actis LLP and its American partners Morgan Stanley and Goldman Sachs.

Squeezed out of the company – perhaps serendipitously – were the defunct dairy’s Chinese founders Li Tuchun, Sheng Yanling and Li Shuai.

Taizinai was a victim of China’s recent tainted milk crisis, fierce competition in the dairy industry, and some apparently slick accounting that may have given the foreign investors a false impression of the company’s success.

Actis, Morgan Stanley and Goldman Sachs sank a combined US$ 73 million into Taizinai in 2006, a decade after Li Tuchun started the business with a yoghurt drink that gradually became popular across China. They added another US$ 30 million in November. The foreign investors also helped win a 500 million yuan loan from a consortium of six international banks led by Citigroup in September 2007.

Turning investor heads was a Taizinai report of pre-2006 annual growth rates of 50 percent and 2006 sales of about 1 billion yuan. The financial data also supported the company’s prediction that it would become the first Chinese dairy to list on a U.S. stock exchange.

Behind the Books

What Taizinai’s accounting books apparently failed to explain was that the dairy had been struggling to compete against several other popular makers of milk products including Yili and Mengniu, two of the country’s largest dairies, which won larger markets shares in major cities and developed their own yoghurt drinks.

And questions about the company’s financial data surfaced shortly after the foreign investors arrived.

Actis, Morgan Stanley and Goldman Sachs apparently hoped to join in preparing Taizinai for an initial public offering on U.S. or Hong Kong stock exchanges. It seems their strategy called for a post-IPO cash-out as well.

While helping the company prepare for an IPO on the New York Stock Exchange, however, the accounting firm Ernst & Young hit a brick wall; Taizinai financial officers refused to submit annual reports from three, previous years as required by the exchange. The accountants froze in their tracks, and the listing plan was shelved.

After failing in New York, investors looked at listing the company in Hong Kong. But once again, the company’s financial officers failed to meet reporting requirements, submitting data from 2004 and ’05 alone. The IPO plan went nowhere.

Nevertheless, Taizinai pressed forward with a business expansion. The bank loan financed construction of new plants in the company’s hometown Zhuzhou as well as Chengdu, Beijing, Huanggang and Kunshan starting in 2007.

Fuzzy Investment Deal

The investment agreement signed in November 2006 by the Chinese owners, led by company President Li Tuchun, laid the groundwork for what’s now a foreign takeover of the failed dairy.

For tax reasons, the dealmakers created an offshore joint venture, China Taizinai Co. Ltd.

Actis, Morgan Stanley and Goldman Sachs received a combined 30 percent stake in China Taizinai, while the company’s three founders led by Li Tuchun held on to 70 percent. Each foreign investor got one seat on an 11-member board of directors, and founder Li Shuai served as chairman.

One source told Caijing the foreign investors’ influence on the board was inadequate. An imbalance may have contributed to a dispute between Li Tuchun and other board members over where the firm should be listed. Most board members preferred a listing on a Chinese bourse or in Hong Kong, but the company president insisted on initially trying a U.S. IPO.

In addition, questions surround an “earn-out agreement” signed by Li Tuchun and the investors. Under such an agreement, private equity investors agree to a purchase over time with most money up front and the rest paid as goals are met.

The parties refused to disclose details of the agreement, although Caijing learned that it apparently required the foreign investors to reduce their stakes if the company’s growth rate reached the levels estimated by the founders. If the financials fell short of these estimates, the agreement said, the foreign investors were to win control of the company.

Yet the company’s business had turned bleak long before the milk powder scandal broke out in September and ravaged China’s dairy industry.  A source told Caijing that Taizinai posted sales of 1.1 billion yuan in 2007, down from 1.2 billion yuan in 2006. The scandal sent sales plummeting even faster.

Taizinai tried to expand into the food, clothing, liquor, media and real estate businesses. But none made money.

Having failed to reach the predicted growth levels, the founders bowed out and the foreign investors took over the company in November. Li Tuchun was demoted from president to honorary president.

But it seems the investors got the short end of the stick. A court ordered the company’s Chengdu facility sealed shut, Caijing learned December 5, after unpaid workers filed a lawsuit. Creditors are calling loans and, according to a Taizinai employee who spoke with Caijing in Chendu, now-idled workers haven’t been paid since May.

On November 21, the foreign investors coughed up another US$ 30 million to help Taizinai resolve a cash-flow crisis. A banker who worked with the company said the cash crunch had been lingering for a long time and that the latest investment would not solve the problem.

Several sources said they doubt Taizinai will resume production unless new investors emerge. So far, none has been found.

Caijing spoke with a source at a private equity fund that was recently approached by Taizinai’s owners. “We have been invited to visit this company,” the source said. “But we do not plan to invest.”

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