Capitalizing on the need for safe, reliable sources of dairy in China, investment firm KKR (KKR -1.26%) is partnering with private equity firm CDH Investments and the country's largest dairy farmer, Modern Dairy, to provide premium raw milk to Chinese consumers.

Source: SXC.hu

China has been rocked by scandal after scandal involving its milk supply. From melamine added to infant formula to boost apparent protein levels to fake milk powder that resulted in the deaths of more than a dozen infants, the Chinese consumer has suffered from a deficit of reputable, safe dairy sources. 

More recently, the international companies that took advantage of the crisis to gain a wedge into the market, including not only Nestle, Groupe Danone (DANOY -1.03%), and New Zealand-based cooperative Fonterra, the world's largest dairy exporter, but also Abbott Laboratories (ABT -0.19%) and Mead Johnson Nutrition (MJN), all stand accused of colluding to fix prices. 

While local Chinese producers like Synutra International remain tarnished and damaged goods from the earlier scandals, Fonterra has become embroiled in yet another one as a botulism-causing bacteria was found in its milk.

Danone, which counts Fonterra as a supplier for the whey-protein concentrates, or WPC, it uses in its infant formulas, was forced to recall products from eight countries because they were possibly contaminated with Clostridium botulinum. While tests found the products actually contained a nontoxic strain of the Clostridium bacteria, Danone says investors can expect to see sales fall in the current quarter's report because of the recall, and it's looking to recoup those losses from Fonterra. Coca-Cola's China subsidiary also quarantined its WPC supply out of an overabundance of caution, though tests revealed it was safe.

That's the backdrop against which KKR sees an opportunity to provide Chinese consumers with a safe, reliable supply of raw milk.

Earlier this year the investment house had sold its ownership stake in Modern Dairy, China's largest unpasteurized milk producer, to China Mengniu Dairy, a producer whose name was sullied in the earlier tainted-milk scandals, for $410 million. But KKR is back again, investing $140 million in a joint venture with the milk producer and CDH to build two 10,000-cow dairy farms.

The market analysts at Euromonitor say China's total dairy consumption grew at a 10% compounded rate during the last five years, but with premium dairy product consumption growing even faster than the overall market, concerns arise about the country's dairy supply. The market share of the premium niche has nearly doubled to 19% from 10%.

Even so, consumption of milk remains low in China compared to other countries. While the U.S. gulps down some 78 kilograms annually, China consumes less than 10 kilograms. Maybe if consumers weren't worrying about getting ill every time they had a glass of milk, that amount might increase, which is undoubtedly what KKR is hoping for.

The P/E firm has an exit strategy in place, however, as the deal includes an arrangement for Modern Dairy to buy back the joint venture farms in three years' time. Just as the Chinese word for "crisis" supposedly contains elements signifying both "danger" and "opportunity," KKR risks Mengniu failing for a third time, though the chance to finally give Chinese consumers the milk supply they need and deserve is one too large to ignore.