As the only listed dairy company that avoided being caught up in the industry scandal, Sanyuan has benefited in the past months not only from an increase in sales, but also a boost to its brand image. Many individual cow breeders in Beijing and neighboring regions who lost confidence in dairy giants such as China Mengniu Dairy Co. Ltd. and Inner Mongolia Yili Industrial Group Co. Ltd. have decided to provide raw milk to Sanyuan.

The company currently gets 60 percent of its revenue from sales in Beijing and adjacent areas and sticks to a subscriber-based sales model in urban areas. Now the biggest winner in the industry scandal is considering expanding into other markets through Sanlu's sales networks.

In early December, Sanyuan invested 5 million yuan ($731,000) to set up a wholly owned subsidiary in Shijiazhuang, the location of Sanlu's headquarters. Sanyuan's Shijiazhuang operations later proved to be a vehicle for its future takeover of Sanlu's assets, allowing the company to control and operate local dairy resources. Through the local operations, Sanyuan rented Sanlu's local production facilities at the end of last year after Sanlu entered bankruptcy proceedings.

Some of Sanlu's six plants in Shijiazhuang have already resumed production, but their products have undergone name changes. They were relabeled with Sanyuan's logo when they hit supermarket shelves in Hebei and Shandong provinces early this year.

Tailor-made requirements

Sanlu set a few requirements for potential buyers of its assets, which almost secured Sanyuan a chance of winning the deal. Sanlu required potential bidders to have 10 years of experience in producing liquid and powdered milk. It also required bidders to have operating revenue of no less than 1 billion yuan ($146 million) from the last fiscal year and registered capital of no less than 500 million yuan ($73 million). The most important requirement is that the bidders had to be companies with good reputations and a complete quality control system that had been executed effectively. They also could not have injured any infants with melamine-contaminated milk formula.

"These requirements about a bidder's qualifications sound tailor-made for Sanyuan," said Kang Jingdong, a food industry analyst at Cinda Securities Co. Ltd., in an interview in the evening newspaper Mirror. Because of the "no melamine scandal involvement" requirement, Sanlu has rejected dairy giants such as Mengniu and Yili, which were blacklisted by the Ministry of Health. Because of its revenue and size requirements, it likewise turned down small and medium-sized dairy companies that were not involved in the scandal.

Sanyuan met all these requirements, although later tests found that some products warehoused in one of Sanyuan's subsidiaries contained the chemical melamine. Sanyuan would be the perfect company to acquire Sanlu's assets through the government-mediated auction, Kang said.

Previous negotiations over Sanlu's assets came to a standstill when all potential buyers refused to take on its massive debt and legal liabilities estimated to be nearly 700 million yuan ($102.3 million) to compensate those who became ill or died after drinking its products. Sanyuan finally agreed to bid for Sanlu's assets, because the governments of Hebei Province and Beijing Municipality said they would shoulder part of the company's debt. The two governments have not disclosed which portion of the debt they are covering.

Uncertainties ahead

Even if Sanyuan purchases Sanlu's assets, some uncertainties remain about whether Sanyuan could digest them in the auction package and turn Sanlu's loss-making productions, which currently are not running at full capacity, into an engine of growth. To make it more challenging, Sanyuan would have to take on all Sanlu's employees who had signed contracts with the company before it entered the bankruptcy proceedings, as Sanlu required.

Sanyuan first would promote large-scale cow breeding as part of its efforts to consolidate milk supplies and establish standards for quality milk after it took over Sanlu's assets, said Zhang Fuping, Sanyuan's Board Chairman, in an article in Mirror on January 13. Compared with a guarantee of quality milk supplies, milk processing would not be a problem, he added.

Sanyuan has contacted former product sellers of Sanlu to recover the latter's sales networks in six provinces, including Hebei, Henan, Anhui, Jiangsu, Shandong and Shanxi, according to a The Beijing News report on February 17. Sanyuan may promote the sales of both powdered milk, based on Sanlu's production capacity, and its liquid milk through these networks, the report said.