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Diamonds and deals as Danone struggles for China bounce

By Adam Jourdan

SHANGHAI (Reuters) - In Danone SA's China, diamonds are free, milk powder is forever.

The French dairy giant is handing out the jewels as prizes in promotions to win back consumers it lost last year in claims of high prices, accusations of bribery and food safety scares.

On milk, it's spending big. With investors restless over its inability to grow in China, this month Danone paid $665 million to lift its small stake in the country's number two milk maker, China Mengniu Dairy Co Ltd <2319.HK>.

Sealed at a hefty premium, the Mengniu deal and Danone's aggressive online campaign to promote its Dumex milk powder brand show the world's largest yoghurt maker is determined to convince shoppers and investors alike it can make large profits in China after a string of failed tieups there.

A breakthrough remains some way off: Danone has a 0.5 percent share of China's dairy market, according to Euromonitor, and for some customers, its brand remains tarnished. The Paris-based company is just one of a string of foreign firms facing tighter scrutiny as China patrols pricing and product safety more closely, saying it needs to protect consumers in the world's second-biggest economy.

"I don't really trust Dumex," said Pei Qianqian, 29, an office worker in Shanghai with a 17-month-old daughter to feed.

"If it's just one problem then perhaps it's just the side-effect of industry competition, but if there's two and then three in a row, I think this milk powder really has problems."

The home of brands like Evian mineral water and Activia yoghurt reported earnings on Thursday, saying growth will accelerate this year after weakness in Europe and Asia woes weighed on its performance in 2013.

With much of its business rooted in lower-growth Europe, Danone has long targeted emerging markets like China as future growth streams. According to business consulting firm Frost & Sullivan, China's dairy market will nearly double to about $89 billion in 2017 from 2012.

Danone's China sales of early life nutrition products such as infant milk formula were virtually "zero" in December, the firm's leadership said in an investor call on Thursday. Danone said the firm would overhaul its offering for China in 2014, including launching a revamped Dumex product and making more use of other brands like Aptamil and Cow & Gate.

"Don't think we are going to rebuild the same animal, we are going to build a new one, a better one, especially in terms of margins," said Danone CEO Franck Riboud on an investor call. Riboud said Danone could not go it alone in China, but that he expected Mengniu to become the leader among China milk producers.

RECORD ONLINE NOISE

The shadow of a crisis in China can loom large over international firms, especially in more sensitive sectors such as nutrition and health. Amid fervent condemnation from the country's growing online community, KFC-parent Yum Brands Inc has struggled to win back consumers over a year after a food scare at a local chicken supplier.

Chatter around Danone's "1000 Day Plan" promotion drives on China's popular social network Sina Weibo has risen to record levels. Yet Internet watchers warn that a campaign designed to highlight Dumex milk powder safety after health scares across the industry in China last year may instead have the effect of keeping Dumex's problems in people's minds.

Mother Tang Jiahui, 27, said she was not swayed by Dumex's online campaigns and free give-aways. "All I'm looking at when I choose which brand of milk powder is quality; an online prize draw won't change my mind," the Shanghai resident said.

Still, in January alone, users re-posted its Weibo campaign messages over four million times, in the hope of being chosen in a draw for prizes including diamond-studded brooches or iPad tablet computers, according to a Reuters analysis.

At the same time, messages about Dumex that were not campaign-related tripled to 2.6 million in January compared to November, while those mentioning other international brands that were affected by health scares last year dropped back to pre-problem level.

Non-campaign posts often referred to issues Dumex faced last year, including an unfounded botulism scare and a state television report on corruption in the milk powder sector.

It's an effect that echoes that experienced by KFC-parent Yum Brands last year, with some Chinese diners being put off by its "Operation Thunder" and "I Commit" campaign to allay food safety fears.

"It's really hard to hide or delete the social buzz on the internet nowadays," said Linda Du, managing director of APCO Worldwide's Shanghai office. APCO has worked previously with Dumex in China on crisis management and social media strategy.

Danone's Dumex competes with international rivals Mead Johnson Nutrition Co , Nestle SA , Abbott Laboratories , as well as local competitors in the Chinese infant milk formula market.

A number of international dairies were hit last year in China. New Zealand's giant Fonterra Co-operative Group Ltd sparked product recalls in August after a false alarm over potentially fatal bacteria, while several firms were fined for price fixing. In September state TV accused some milk powder firms of bribing doctors to promote their products.

"Rivals have moved on faster than Danone because it wasn't just hit by one issue, but several altogether. Going forward, it's going to be tough for Danone to find a way to market itself for China," said Cherry Du, Shanghai-based project manager for marketing consulting firm SmithStreetSolutions.

INVESTOR QUESTIONS

Danone's troubles in China have concerned investors, keen to understand why the firm is struggling more than rivals to turn things around in its fourth-largest market, accounting for around 7 percent of its global revenue. The company first invested in China in 1987.

In October Danone cut its 2013 financial targets after its woes in China dragged on third-quarter figures, with sales in markets affected by the Fonterra recall seeing growth down 40 percent compared to pre-crisis levels. Dumex accounts for around half of Danone's China sales, according to analysts.

Danone shares are down around 3 percent since mid-October, while the Paris market benchmark CAC 40 index is up 2.6 percent.

Shaun Rein, Shanghai-based managing director of China Market Research Group, said his company has been contracted by a hedge fund that is invested in Danone to provide analysis of Dumex's performance in China. Rein, whose agency has conducted research for a range of corporate customers including Danone rival Nestle, declined to name the fund.

While the price tag in Danone's move to double its stake in Mengniu to 9.9 percent caught the eye - the deal came with a 15 percent premium to Mengniu's share price at the time - analysts broadly welcomed the deal, even if the French firm has a track record for falling out with Chinese partners.

In the highest-profile case, Danone and China's Wahaha food and drink group in 2009 settled a long-running dispute over a joint venture that had descended into litigation.

Mengniu has an 18.8 percent share of China's dairy market, according to Euromonitor. The closer tie-up with Mengniu, whose largest shareholder is China's state-owned COFCO, gives Danone better access to a large, nationwide distribution channel - and places it closer to the ear of China's watchful regulators.

"Danone doesn't have strong sales channels coverage and is not good at marketing in China. In those segments Mengniu can help Danone to do a better job after this deal," said Du at SmithStreetSolutions.

(Reporting by Adam Jourdan; Editing by Kenneth Maxwell)

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