A normally reticent Nestle this week admitted its interest in Chinese confectioner Hsu Fu Chi. The Singapore-listed firm is one of China's largest confectioners and, as Dean Best reports, analysts see the company's distribution in China and knowledge of local consumer habits as key factors in why the world's largest food maker could move for the business.

Nestle usually keeps its cards close to its chest, often refusing to comment when its name crops up on the M&A rumour mill.

This week, however, after speculation linking Nestle to a possible takeover of Chinese confectioner Hsu Fu Chi, the Swiss group admitted that it was in talks with the business.

Nestle's statement that it was in "preliminary confidential discussions" came after Hsu Fu Chi, which is listed in Singapore, revealed the two sides were in talks over a "possible transaction".

A spokesperson for Hsu Fu Chi also told Bloomberg that the two companies had been in talks over a possible partnership for a few years.

News that Nestle, the world's largest food maker, could once again invest in China, naturally grabbed the attention of industry watchers. But Hsu Fu Chi's profile outside China - and Singapore - is low. Why could Nestle be interested in the business?

Hsu Fu Chi, set up in Taiwan in 1992 and listed in Singapore in 2006, has developed into one of China's major confectioners. According to data from Euromonitor, Hsu Fu Chi is the third-largest company in what remains a fragmented sector, with a market share of 4% in 2009.

However, Euromonitor estimates that retail sales of confectionery in China increased by 8% in 2010 to reached US$7.2bn. The analyst firm estimates that the sugar confectionery category was worth $3.7bn. Gum sales, Euromonitor says, reached $2.2bn, while sales of chocolate, the fastest-growing segment, stood at $1.3bn.

Hsu Fu Chi leads the sugar confectionery segment, focusing on hard sweets and jellies, and accounted for 6.6% of retail sales in 2009, ahead of close rival Perfetti van Melle, which had a 5% share of the category.

The company's most recent financial results, published in May and covering the first nine months of its financial year, showed the business had enjoyed buoyant profits and sales over the period. 

For the nine months to the end of March, Hsu Fu Chi's net profit rose 17.6% to CNY675.9m (US$104.5m). Revenue was up 23% at CNY4.37bn. In Hsu Fu Chi's last full financial year, net profit climbed 30.8% to CNY602.2m. Revenue rose 13.8% to 4.31bn.

Hsu Fu Chi, as one of the largest companies in a growing sector, has enjoyed healthy recent financial results.

Industry watchers, however, look beyond the numbers and point to Hsu Fu Chi's reach across China. According to Access Asia, Hsu Fu Chi had 129 sales offices across China by the end of 2010.

Dave Hofmann, a director for business consultancy InterChina Consulting, believes greater distribution will be a "major reason" for Nestle's interest in Hsu Fu Chi.

"There are very few national brands. [Hsu Fu Chi] is well-established in lower-tier cities. It has brands across China. It's in both modern and traditional channels. It's a good opportunity from that perspective," Hofmann says. Improving distribution is a task that a number of international food and beverage manufacturers in China are "struggling with", he adds.

"They have penetrated first- and second-tier cities very well for the most part. How do they compete with Chinese companies that are coming up from the bottom? They have completely different distribution."

Nestle, which opened its first factory in China in Tianjin in 1996, has made inroads into the country's confectionery market. According to Euromonitor, the company accounted for 12.5% of retail sales of chocolate in 2009, making it the second-largest player in a category that, the analyst firm, says, is estimated to grow faster than Hsu Fu Chi's key sector of sugar confectionery. Euromonitor forecasts that China's chocolate category will grow at a compound annual growth rate (CAGR) of 8% between 2010 and 2015. It expects the sugar confectionery segment to grow at a CAGR of 3%.

Nevertheless, some industry watchers believe Nestle has lacked a portfolio that taps into local consumer habits in the country. "I haven't seen as much product development specifically for China," says Ben Cavender, an analyst at China Market Research Group. Cavendar, however, insists that branded companies from overseas can find it tough in the country. "It's really difficult for these large international brands like Nestle to, in a short period of time, develop products that are popular in China." Hsu Fu Chi's local know-how and knowledge of Chinese consumers could, alonsgide its distribution network, be another reason behind Nestle's interest in the business.

The talks also need to be seen in the context of Nestle's wider ambitions in the emerging markets. The company has repeatedly stated that it wants those markets to make up a greater proportion of its business. In 2011, Nestle has announced investments in markets including Indonesia, Malaysia, Zambia and Nigeria. And the company's commitment to China has been shown in just the last three months, with the opening of a new seasonings line in Dongguan (incidentally where Hsu Fu Chi's headquarters is located) and the acquisition of a controlling stake in Yinlu Foods Group.

What, however, does Nestle bring to the table? Before Hsu Fu Chi's confirmation on Monday that it was in talks with Nestle, the Chinese firm issued a statement that said it had "long been pursuing strategic talks with potential confectionery partners" in its quest for the "sustained development of the enterprise and its brands". 

Hsu Fu Chi said that "interactive contacts" had been made with companies in Japan and the US, as well as Europe. Euromonitor notes that Hsu Fu Chi's products are sold in the US, Canada, Japan and the UK, although it says the company's exports were affected by the financial crisis. It seems apparent that Hsu Fu Chi's discussions with other companies mean it wants to expand its presence outside China.

Cavender says that, for all the success Chinese companies may have domestically and for all the business acumen they can possess, some find it tough to take that outside the country. 

"[Chinese] companies are cash-rich and management has got a lot better but they do not necessarily have the resources or know-how to go international," he says.

Hsu Fu Chi's wider discussions also mean it could be a target for others, not just Nestle. The Financial Times reported on Monday that Kraft Foods was among the potential parties that had been interested in a deal. Nonetheless, while other multinationals could help Hsu Fu Chi expand overseas, the Nestle network is likely to prove attractive for a company to build a business outside its domestic market.

Nestle and Hsu Fu Chi could simply strike a deal where the Swiss company takes a minority stake in the Chinese confectioner. Nonetheless, both sides would still benefit - Nestle from Hsu Fu Chi's local knowledge and distribution and the Chinese firm from the food giant's international presence.