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Keith Woodford says Fonterra’s short-term problem is asset sales, asset values and earnings; the longer-term problem is a capital structure that is no longer fit for purpose

Keith Woodford says Fonterra’s short-term problem is asset sales, asset values and earnings; the longer-term problem is a capital structure that is no longer fit for purpose

Fonterra’s delay in announcing its results, driven by Fonterra’s need for discussions with its auditors about appropriate asset values, provides an opportunity to reflect on Fonterra’s capital structure and whether it is still fit for purpose. The simple answer is that it is not.

The value destruction that has occurred and which is now coming to light means that inherent conflicts between the interests of farmer shareholders and investor unitholders have become too great to be papered over. Co-operatives do not survive long-term unless everyone’s interests align.

Two former directors of Fonterra, Colin Armer and Nicola Shadbolt, have both come out recently and said that reworking Fonterra’s capital structure is not the immediate priority. I agree with them. The immediate and urgent priority is to sell assets and create a new slimmed-down and financially-efficient organisational structure, with many fewer high-paid executives.

However, asset sales and creation of the new slimmed-down and non-bloated operating structure can only be the first stages of traumatic overall restructuring. Fundamental flaws in the current hybrid structure of farmer shareholders and non-farmer unit investors mean that a new capital structure will also be needed.

Fonterra’s current structure was created in 2012 following at least five years of angst searching for a new structural pathway. The leader of that journey was Chairman Henry van der Heyden, now Sir Henry.

The key argument was that Fonterra needed to have permanent capital, whereas in a traditional co-operative the farmer shareholdings are not guaranteed as permanent.

If a farmer leaves a traditional co-operative, the shares owned by that farmer have to be redeemed, although the redemption can be delayed. Hence, the argument was that there needed to be a mechanism to allow cash outflows from share redemptions to be balanced by new cash inflows from non-farmer investors.   

The challenge in finding such a mechanism was that farmers were not willing to let non-farmers have a vote in regard to company policy. The supposed solution was to create a structure where non-farmer investors could buy units in a new structure listed on the NZX and called the Fonterra Shareholders’ Fund. These units would have the same economic rights as shares but no voting rights. If farmers departed, then the number of units would be correspondingly increased, and hence the redemption risk would be solved.

The name ‘Fonterra Shareholders’ Fund’ is an inappropriate name. In fact, it is aimed at non-farmer investors.

The legal structure of the Fonterra Shareholder Fund (hereafter the ‘Fund’) is complex. I won’t go into the details here. The overarching principle is that the Fonterra-nominated Custodian can hold shares to Fonterra and sell units to their economic rights. The shares themselves stay with the Custodian but hold no voting rights for anyone.

The Fund is a key part of the overall capital structure called ‘Trading Among Farmers’ (TAF). This too is an inappropriate name as much of the trading actually occurs between farmers and non-farmer investors. 

It can be useful to think of the Fund as a balloon, with a two-way umbilical cord through to Fonterra itself that is managed by the Custodian.

If farmers sell their shares, then new balancing investor units are created in the Fund. In this way, the number of units in the Fund get pumped up.  Also, a payment passes via the Custodian through the umbilical cord from the purchasers of the units to the departing Fonterra farmers.

Conversely, if farmers are buying shares from Fonterra, then the Custodian can sell shares to the farmers and buy units from the Fund at the same price.  These units are then cancelled. The money that the farmers have paid the Custodian is shovelled on to the departing unit-holders and the size of the Fund shrivels.

It sounds complex and it is complex. However, the system has now been working for close on seven years and it has indeed worked, at least until recently, largely as intended.

Over these years, farmers have been able to buy and sell shares, unitholders have bought and sold units, and the Custodian has managed the process such that the price of shares and units is always within a cent or two of each other.

Two other outcomes have been that Fonterra has received no new capital when farmers bought shares, and Fonterra has not had to pay out money when farmers departed.

A key insight relevant to how the Fund works in practice is that the size of the Fund is largely determined by farmer decisions to buy and sell shares. These decisions are largely driven by their need to hold one share for each unit of production, measured as one kilogram per annum of ‘milksolids’ (fat plus protein).

Another key insight is that although the number of units in the fund is largely determined by farmer decisions, the price of units and hence also the price of Fonterra shares, is determined by willingness of non-farmer investors to buy and sell units.

Once the Fund had been bedded down at the end of the July 2013 financial year, the Fund had 108 million shares, valued at $7.30 and the total Fund value was $788 million.

Fast forward to 1 January 2018, the fund had ballooned to 139.7 million shares valued at $6.38 with a total value of $891.6 million. This reflects that farmers were predominantly selling shares, unit-holders were predominantly buying units, and prices were holding up reasonably.

Fast forward again to 1 September 2019, the Fund had shrivelled to 102.1 million shares, each valued at $3.18 and the Fund value was $325 million. This reflected that farmers had predominantly been buying shares, allowing unit holders to exit and hence the fund to shrivel, but still the price of units had tanked.

It may seem surprising that farmers have continued to buy shares despite Fonterra’s total production no longer increasing. The reason is that many farmers were using a Fonterra scheme called MyMilk that allowed them to delay the purchase of shares for five years. There are still some farmers who need to buy shares because of this scheme.

The longer-term problem going forward is that Fonterra is now likely to lose production, in part because of competition for milk from other processors who can afford to outbid Fonterra, and in part because of farmers exiting the industry linked to compliance problems.  The key question is who will buy the units that will then flow across the umbilical cord from the Fonterra Custodian to the Fund?

Over the past 18 months, the dominant perspective of non-farmer investors has been a wish to exit the fund, not enter it. Most of the major institutional investors have now achieved this.

Most of the unit-holders are now retail investors who, operating generally with weaker information, did not see the bad-news tsunami coming along.  Now, with Fonterra’s aura so badly damaged, they too will be looking to exit.

What this means is that the redemption backstop is no longer reliable. Hence, Fonterra’s problems have now got a whole lot bigger.

So how is it that Fonterra’s leaders and its high-priced consultants did not see this scenario back at the start when the new structure was introduced in 2012? That is Part 2 of this story.

*Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. Previous article on Fonterra’s challenges can be found at You can contact him directly here.

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"What this means is that the redemption backstop is no longer reliable."

Enter, Joe Taxpayer!

I reckon we could call the salvaged entity something new and snappy, like..... The New Zealand Dairy Board.....

Oh brother...So, if I understand correctly, the three issues are:

  1. The unit price has tanked, reflective of the woeful overseas ventures' fates, but affecting farmer and FSF valuations alike, with domino effects on the farmers' financiers collateral.
  2. There are still farmer liabilities for the deferred part of shares buy-ins, which will fall due precisely when sentiment and likely net incomes are falling.
  3. Production itself, and thus cash flow, asset utilisation rate, and gross profit, will fall because of competition and more stringent supplier operational constraints.

I look forward to Part 2....

Part 2 : " brother can you spare me a dime ... or better yet , $ 5 to 10 billion to bail me out ! "

Any idea what is the NZ banks' total exposure to Fonterra and it's farmer owners ?

Last I saw dairy was about 10% of NZ banks' lending. Remember this? -

That was 3 years ago. May be more now ? How much of it is impaired now ? Any reserves held by the Banks ?
Do the highly paid Auditors report/comment on them, sector wise or otherwise ?

“Bank lending to the dairy sector stands at around $38 billion, which is approximately 10 percent of the banking system’s total lending. We would expect losses of the order seen in the stress scenarios to be absorbed largely through lower bank earnings rather than through an erosion of bank capital.”

But Banks have been reporting increased profit since then, so what gives ?

By way of banks control of the whole process.
Moving people in bankrupt situations on, but not bankrupted in name.
Lands and Survey were more generous.
Some of the beyond the grave tail agreements they place folk in are crippling. Breaking people.
Ponzi value properties passed on to to new bank funder borrowers.
Seems the loan value is more important than the property value.

Properties transacted at their productive, or informed buyer level the banks would be themselves be bankrupted.
Banks have written failed loan business, yet do not bear the fruits of their incompetence.
Australian banks to boot.
Poor guardians of agricultural credit.

Excellent article thanks - looking forward to Part 2.

It was never a good idea to raise additional capital by splitting off a subsidy in the first place. Motivated by a handful of elite farmers, board and executive members to control decision making, and do some inside deals. This split was always going to create tension, which was the less than ingenious motivates of the instigators. Henry, are you there?

The best thing Fonterra could do going forward is to progressively by back the company they floated and by resolution require capital retention of 10% earnings to smooth global commodity price fluctuations. Once management have gained trust from the farmers, they could then use those retentions to move into more value added propositions; creating them locally at their plants to support the surrounding community.

Move there head office away from Auckland. Its distanced itself from the shareholders, and delivered nothing but extra cost. Another hair brain scheme cooked up by Craig Nogate; god rest is sole.

Let grass feed quality produce speak for themselves, and profits circulate locally.

"require capital retention of 10% earnings"
But there in lies a problem the shareholders aren't earning anything, there is no profit to retain.

Can Peter Thiel help ?

Good Samaritan, I've posted a comment below. I think there were bigger issues at play when that split was made - particularly a very strong lobby from non-farmer interests wanting a slice of the industry.
Your comments about the relocation to Auckland, I applaud. I look at Zespri and that it continues to maintain a slim administrative structure. I reflect on the bloating of NZAPMB then ENZA and it's unwillingness to slim itself down, contributing to deregulation and massive loss if capital in production areas. Fonterra needs to take a very sharp razor to it's management/administrative structure.

Fonterra's board has been a boys club, with dominated by very business acumen and politics.

Zespri are not perfect either. The directors have been enriching themselves their too. Zespri shareholder returns of 15% have been double that of the growers, and it would be interesting to see how they justify this? If I was a grower, I'd be matching down to head office and demanding changes.

Zespri's other rort is allowing the gold licenses to be resold for more than twice the price they sell them for. The sensible thing here would be to restrict purchasers of licenses to the land they control, to stop the speculation. Speculation is no good for anyone other than the margin trader, and hardly in the long term interests of the wider industry. One suspects this is engineered to create asset bubbles, where the large predators scoop up the resultant train wrecks.

I watch closely what influence Peter McBride has on the Fonterra Board. I've seen him down at the pub with Colin Armer.

Time for a claw back, backed by a Royal Commission hearing on the Business and Banking in NZ ? Think so.

The two aren't far removed. Zespri has grown rich on the appalling exploitation of orchard staff and orchard owners gamed the government at Zespris encouragement when the psa bailout was offered. Zespri also had more than enough retained earnings to rework the affected orchards itself...but no...the taxpayer got to fund the repair work instead.

I'd add that Zespri also used the "growers fund " but always inferred it was Zepri paying the money. Some did really well out of PSA, those iin the know in early


The Fonterra model as we know it today is finished. Overly complex, ambitious, bloated, embedded conflicts, hubris and weak governance have all contributed to its demise. There is absolutely a role for an NZDB style centralised corporate function (and Fonterra did some positive things such as GDT), it's just how we get back there from here (messy or orderly).

@TeKooti ........... HUBRIS ............ a good word to describe the Fonterra executive

Bring out the lifeboats - they cant get the required capital in time to save themselves without taking many farmers down, they are low on milk and several factories are not running efficiently because of it. Australia is a disaster that they are trying not to talk about and the SAME executive team are still clinging on to power and paying themselves huge salaries and bonuses.
Change wont come until they run an efficient management structure like Open County and Synlait and Tatua but they will make lots of excuses why they cant do that. They have never made a cent off value add yet they pay themselves as if they have. they are a commodity company - all you can control are costs yet they do the opposite. I have no faith in any new strategy designed by the same people who let farmers lose over 4 billion dollars in value while the mgmt team made millions.....shame on them and the Board and the Shareholders Council.

So why are the FSF units holding in at $3.20 if this is the case?

Have the Kiwisaver funds invested in Fonterra ? If so, any idea how much ?

Well at least the super fund is clever enough to avoid after June 2015 - latest holdings below.
Wonder if they had a meeting with the board and the first thing they said when they got back to the office was "Sell the lot"

Thanks Keith, I too look forward to part 2.
But please clarify for me about the establishment of the non-farmer unit fund. My recollection is that there was a big push from non-farmer factions (I think NZX was prominent) to be able to get a slice of the dairy pie at a time when that pie appeared to be eternally profitable and growing. At the time I think there was a strong lobby to deregulate Fonterra.
If my recollection is correct, then the instigation of the units scheme would have been partly a defensive strategy to protect the farmer cooperative. Therefore, do those non-farmer interests now lamenting the parlous state of Fonterra share in the responsibility for that decline?

TAF was an ego project on behalf of Henry. All he wanted was to get it across the line, he had no capacity to truly understand what he was doing.
TAF was always going to tank, especially because the funds it freed up were used by mgmt to purchase businesses offshore - we can all see what that led to - if you have an M & A department and you have capital available then there is only one outcome.
So, Henry employed Theo, got TAF across the line through a combination of bullying and other behaviors and China farms, and Beingmate.......and they made him a knight.....

It was a scheme designed to free up Fonterras need to hold capital in case farmers traded in shares or left the COOP. It freed up around $ 550 million which freed up a lot of access to debt. This was all spent on bad businesses and salaries and offices and other ego-led projects.

Non-farmer interests had no say in the units being set up beyond schmoozing the Fonterra board and mgmt.

I'd put it another way. It shifted all of the risks of redemption onto the shareholders as individuals. Another stab at killing Fonterra as a co-op. I never understood why farmers didn't see it as such and voted for it.

It was defensive in regard to the feared retention risk, and the NZX did benefit form lots of brokerage, and the unit investors did think (wrongly) that they could smell money. But the thrust camefrom the Board and managers, and eventually the farmers went along with the recommendations of their leaders. No outsider had any real sway to make that happen. The Government could have blocked it but didn't do so. To do so, would have been extremely interventionist.


May have been posted already, but interesting little interview of similar vein -

Excellent interview. I particularly liked his reminder to farmers that if they want to retain the co-op then they have to buy it back (rebuild the balance sheet) or someone else will buy it and it will go the same way as Murray Goulburn in Oz (or I add Westland)

Excellent interview. I particularly liked his reminder to farmers that if they want to retain the co-op then they have to buy it back (rebuild the balance sheet) or someone else will buy it and it will go the same way as Murray Goulburn in Oz (or I add Westland)

Oops sorry, very slow internet in Timor Leste

Was a good interview. But once again he's assuming all the buy back money is coming from shareholder farm owners with a lowering of the milk price. Reality is much of it will come from sharemilkers and Mymilk suppliers amongest others.

Keith do you mean the NZ taxpayer is about to become a cornerstone PARTNER in Fonterra? I would prefer my tax dollars buy back the energy assets of this country thank you very much. Only this morning on I was reading of a farmer who thought it was environmentally enlightened of himself to allow his stock to graze in the forest stands on his property. Hopefully he was running the herd through his pines and wasn't letting them up into any regenerating bush to graze on the successive seedlings... but if thats as forward thinking as the industry gets, I don't want to back it. Close down the dairy farms and plant hemp...and medical cannabis, its going to be huge.

Maybe read that article again ... One of the best that operator.

They've moved greatly with the times...

"Downing acknowledges farming is having an impact, but look how far we've come, he says. When asked for evidence, he tells the story of his old dad, back when Lloyd was a lad, taking the farm's rubbish and chucking it in the river. I used to shoot at the used light bulbs, he says, as they floated away! Nobody does that any more!

No, I am not suggesting that the taxpayer become a conerstone pastner in Fonterra. That would create more problems than it would solve.

Current directors Leonie Guiney and Donna Smit did see the through the folly of TAF and advocated strongly against it.
Keith it’s not accurate to presume cooperatives have a problem retaining permanent capital. A true traditional cooperative has non-tradable shares set at a nominal value, and retain a portion of profit for capital renewal. Such cooperatives are strong, stable and intergenerational, and this is where Fonterra has gone wrong since DIRA; in great part due to Sir Henry and cronies, and naive farmer shareholders.

Bang now.

Henry, the mole, has gone to ground again.

Neither LeonieG nor Donna S were directors when TAF was introduced. Yes, they may have argued against it. A significant proportion of farmers were against it.
Yes, traditional co-ops can be stable entities.

You're right Keith, they weren't directors at the time, the current chairman was. They were definitely against the introduction of TAF. You're also right that a significant proportion of farmers were against TAF because they could see the incompatibility with cooperative stability it would introduce as evidenced by numerous examples nationally and globally. The exact number of shareholders against TAF was intentionally withheld by the board. This highlights another anti-cooperative aspect of Fonterra in that constitutional matters are decided on share backed milk solids as opposed to the cooperative principle of one vote per shareholder, thereby fostering and promoting division.

Keith, how far can the shareprice fall?