Why Nestlé can win over China’s consumers

July 7, 2011, 8:33 PM UTC

FORTUNE — In what could be one of the biggest foreign takeovers of a Chinese company, Nestlé SA is in talks to buy Chinese candy maker Hsu Fu Chi International Ltd. Discussions are in the early stages and it’s unclear whether the deal would include acquisition of the entire company or a share of it.

And yet, there’s already skepticism circling any possible deal. Media reports have hinted that talks could take the path of a deal that went awry involving Coca-Cola (KO) and juice maker China Huiyuan Juice Group. In 2009, China’s Ministry of Commerce rejected Coke’s bid to acquire Huiyuan on grounds that the Atlanta-based drinks maker would unfairly dominate the market. Coke’s bid also spurred a fury of nationalist opposition from Chinese who didn’t want to see a successful homegrown brand land in foreign hands.

Nestlé, the world’s biggest food company known for brands such as Haagen-Dazs and Nescafe, is one of many big Western companies that have been looking to increase sales in emerging markets amid slower growth in the U.S. and Europe. The company’s interest in Hsu Fu Chi, which is worth around $2.6 billion, could very well go in any direction. And admittedly, large-scale takeovers are complex and rarely easy to pull off.

But it makes little sense for skeptics to bring the memory of Coke’s failed $2.4 billion bid into the picture, says Shaun Rein, managing director of China Market Research Group. Whatever issues killed the Coke deal likely won’t happen with Nestlé’s bid to buy China’s biggest confectioner.

For one, Rein notes, there likely won’t be a monopoly at issue because Hsu Fu Chi’s dominance in China’s confection market is not as big as Huiyan’s control of the fruit juice market. When Coke pursued Huiyuan, the Chinese juice maker controlled about 42% of the country’s pure juice market. By contrast, Hsu Fu Chi commands about a 5.5% share of China’s confectionary market. That’s still a sizable chunk given that the market is very fragmented, but local and foreign players have been doing well.

“I don’t see it getting the same scrutiny and raising the same red flags,” Rein says about Nestlé’s interest in Hsu Fu Chi.

The deal has been viewed as a way for Nestlé to tap into China’s growing confectionary market. The Switzerland-based company is looking for ways to increase sales in emerging market from about 30% currently to nearly 50% within a decade.

At the other end, Hsu Fu Chi has been working to strengthen the company’s brand and has been in talks with other companies. The Chinese candy maker, which makes chocolates, pastries and other sweets, was founded in Taiwan and has been operating in southern China since the early 1990s.

Depending on how serious talks with Nestlé gets, negotiations could ignite nationalist outcries just as it did with Coca-Cola’s negotiations with Huiyuan. A deal would likely have to pass Chinese regulators if Nestlé or another company acquires all of Hsu Fu Chi, making it one of the biggest deals by a foreign company in China.

But the chance of Nestlé having to overcome nationalist fervor is unlikely, says David Hoffmann, North America director for InterChina Consulting, which advises companies doing business in China. Unlike Huiyuan, Hsu Fu Chi is not considered a key mainland Chinese brand but one more associated with Taiwan and traded in Singapore.

It remains to be seen how negotiations will pan out. So far, Nestlé has continued deepening its grab onto the growing Asian market. In April, the company said it planned to acquire a majority stake in one of China’s best-known regional food groups, Yinlu, a family-owned company that makes ready-to-drink peanut milk and ready-to-eat canned rice porridge. Nestlé didn’t disclose the purchase price, but analysts have estimated it to be $1.1 billion. The deal still needs China’s regulatory approval.

Indeed, Nestlé is reaching far and wide. And it appears going after relatively smaller Chinese firms as opposed to the few big household names could put Nestlé in the favor of Chinese regulators.