BIG EXPENSE: Sanlu expects to have to pay compensation claims totaling 700 million yuan ($102.4 million) to consumers whose infants became sick or died after drinking its tainted baby formula

After months of waiting and speculation, the destiny of Sanlu Group Co., the dairy products maker at the center of a scandal over chemically contaminated milk, is starting to come into focus.

Beijing-based Sanyuan Group is reportedly set to acquire Sanlu's seven key affiliate milk plants in Shijiazhuang, capital of Hebei Province. Meanwhile, the Wondersun Dairy Co. Ltd., based in Heilongjiang Province in northeast China, is also expected to buy a plant located in the same province. Details about the acquisitions and disposals of Sanlu's other factories around the country remain unclear. Sanyuan and Wondersun are two of the few major milk producers that have largely skirted the crisis.

Sanyuan has not officially confirmed the takeover yet. Men Haitao, a company spokesman, told Beijing Review that the acquisition talks with Sanlu were not finished and declined to give further details. The company would immediately inform the public when a deal is signed, he said.

Industry analysts say Beijing Sanyuan Foods Co. Ltd., the Shanghai-listed unit of Sanyuan, may issue additional shares to the parent group in exchange for the plants. The acquisitions could be funded by government loans given Sanlu's heavy debts and the high amount of compensation the company could have to pay to consumers whose infants became ill or died after drinking the tainted baby formula, they said.

With each passing day, the latest news about who will take over the troubled formula maker has surfaced. The names of several domestic dairy giants have appeared on the list of potential buyers, including Wahaha Group Co. Ltd., the country's largest soft drink producer.

Industry analysts say Sanyuan could eventually gain control of the seven key plants because of the relative proximity of its plants to those of Sanlu's.

"The management and operation of Sanlu's plants would be easier for a successor who is familiar with the local markets," Chen Lianfang, a senior agricultural analyst with Beijing Orient Agribusiness Consultant Co. Ltd., told Beijing Review. "The rest of Sanlu's plants may also go to dairy companies near them," he added.

"But the whole breakup process of Sanlu would still take some time given its complicated asset structures," Chen said. "It may finish by the end of the year."

Sanlu, 43 percent owned by New Zealand's Fonterra Cooperative Group Ltd., had invested in more than 40 affiliated plants that are interconnected to each other.

But the takeover would be a mission impossible without the Chinese Government's help. On October 17, responsible government departments invited five dairy companies, including Sanyuan and Wondersun, to a closed-door meeting to discuss the restructuring of Sanlu.

Besides this, the municipal government of Shijiazhuang also has come up with a special team headed by a vice mayor to work with major interested parties. More importantly, the local government was believed to have been a matchmaker when the negotiations reached a deadlock after Sanyuan refused to shoulder Sanlu's debt and compensation to affected consumers. Sanlu estimated that it had entailed a total debt of 395 million yuan ($57.8 million) by the end of 2007 and will receive a massive amount of compensation claims worth as much as 700 million yuan ($102.4 million).

"Sanyuan may have partly compromised on that condition of government financing," Chen said.

Although Sanlu's misery is largely of its own making, its employees and numerous dairy farmers who supplied the company have also been affected by the scandal. The company ceased production in mid-September after tests had found the industrial chemical melamine in its baby formula.

Now that customer confidence in its products has faded, Sanlu has been pushed to the edge of bankruptcy, leaving its nearly 10,000 employees jobless and the local dairy farmers with nowhere to sell their milk. That could explain why the government has spared no effort to push for the deal.

"It has been the government's top priority to rework the production lines and supply chains of Sanlu," Chen said.

Previously, seven of Sanlu's non-key affiliated plants had resumed production by the end of October after changing their names. Analysts say the Sanlu brand is almost certain to disappear from the market given the acute damage to it.

"But some other Sanlu's prime assets such as sources of milk supplies, production lines and sales networks would still give a boost to Sanyuan in pursuit of expansion beyond the market of Beijing," Chen said.

Sanyuan's gains from the industry's upheaval are even more than that. Since September 11, when the country's health department blacklisted 22 domestic dairy producers as having tainted products, Sanyuan has seen its liquid milk sales almost tripled because it was not included on the list, although later tests found that some of its products in stock were lightly tainted. Besides this, the company's shares surged to the upper trading limit of 10 percent for six days in a row, hitting 5.59 yuan ($0.82) per share on September 25.

But Chen discounted prospects that Sanyuan could challenge the dominance of Mengniu Group Co. and Yili Group Co. in domestic dairy markets even if it gains control of Sanlu's assets.

"Mengniu and Yili are bound to resume their lost ground after a break," Chen said. "More importantly, it remains to be seen whether Sanyuan could well digest the purchased assets given its inadequate marketing and management capabilities."