Fonterra’s purchase of minority assets at Chilean Prolesur is a divorce that had to occur, but it is just the first step in resolving Fonterra’s Chilean situation

Fonterra’s announcement that it is purchasing the minority shareholding interests in Chilean dairy company Prolesur solves an acrimonious relationship between Fonterra and the Fundación Isabel Aninat. This may prove to be an early step in the rationalisation and eventual divestment of Fonterra’s Chilean operations.   

Fonterra’s Chilean operations are managed under a complex structure. The major asset is the almost wholly-owned Soprole, which in turn owns 70.5 percent of Prolesur. Fonterra also owns additional shares in Prolesur through another structure, giving it a total Prolesur holding of 86.2 percent. 

The key minority shareholder in Prolesur is Fundación Isabel Aninat which has ties to the Catholic Church. The Fundación shareholding has been 13.6 percent. There are additional minority shareholders who hold less than 0.2 percent of Prolesur and they too are now expected to sell.

Most of Fonterra’s Chilean supply of milk is processed through Prolesur into butter, cheese and milk powder. It then passes to Soprole which undertakes the marketing of consumer goods. The problem is that the transfer-pricing between Prolesur and Soprole has led to almost all the profits since 2016 being earned by Soprole rather than Prolesur. That has led to the directors of Fundación Isabel Aninat getting very angry, as they have received minimal dividends from Prolesur.

The dispute between Fonterra and the Fundación has been slowly working its way through the Chilean legal system.  It had the potential to become destructive. Whatever the legal outcome, Fonterra was always going to be the loser in the court of public opinion, and from there through to the market place. It was a problem that Fonterra had to solve.

The simplest solution was to buy out the interests of the Fundación and to pay whatever was necessary to make that happen.

The agreed price of $NZ29.3 million for 13.6 percent of Prolesur suggests an overall Prolesur value of $NZ215 million.   However, the book value of Prolesur in the Prolesur accounts was around $150 million in December 2017, with these being the last published figures. So, on the surface it looks like the Fundación got a good deal.

In fact, it is a win-win for both sides. It was a divorce that needed to happen.

Although the Fundación wanted to get out of the business, it would also have known that it held some strong cards, in that Fonterra needed to get rid of it.

The question now is whether the divorce will help to create a pathway whereby Fonterra can exit Chile.  Under Fonterra’s new strategy of being a marketer of New Zealand milk, rather than a global force in dairying, there is no reason for it to be in Chile.

In recent years, Fonterra has demonstrated very clearly that it does not understand Chile, and it has been seriously out-performed both by local co-operative Colún, which is now the market leader, and also by Nestlé, to whom Fonterra has been losing milk supply.  Fonterra’s overall profits in Chile have been declining each year as it dropped from first position to third position in market share.

The first step could be to bring Soprole and Prolesur together as one business. They both depend on each other and neither is saleable without the other.

Once Fonterra has complete ownership of Prolesur, then the book value of all of Fonterra’s Chilean assets will be around $NZ650 million. Currently, the Chilean assets do not show up anywhere in Fonterra’s accounts because they are not separately listed. Instead, the asset estimate comes from direct analysis of the Soprole plus Prolesur accounts published in Chile. However, the various components all have to be there somewhere, built into the Fonterra’s aggregated assets, liabilities and equity. 

I have previously written about how Fonterra’s Chilean assets are performing poorly. Fonterra must undoubtedly know that reality, although for a long time its directors seemed oblivious to what was happening, with loss of supply and loss of market share. The question is whether or not any Chilean company will now come up with the money to buy them out, and if so, how much money.

My Chilean friends have been telling me that none of the other dairy companies are likely to want to buy Soprole, so it probably needs to be a non-dairy food company that wants to diversify. However, Chile is currently in social and economic turmoil.

It’s almost two months since I flew out of Santiago, and looked across at a city that was burning from multiple fires. I had waited in an overcrowded airport for 24 hours, with aircrews unable to get to the airport because of the widespread rioting and consequent curfews.

The recent Chilean rioting and social upheaval have come as a great shock to the Chilean people who, since the ousting of military dictator Augusto Pinochet, had seen 30 years of peace and economic growth within a democratic framework. In recent years, Chile has had the highest living standards in all of South America.

The poor and lower middle-class people have now rebelled. Democracy by itself is not enough if it does not deal with entrenched inequalities.

In the current climate, finding a buyer has becomes even more difficult. Fonterra may therefore have no option but to hold on in the meantime. 

Right now, there are parallels in Fonterra’s Chilean and Australian operations, with both entities struggling and having been outmuscled by competitors within a difficult operating environment. Whereas elsewhere in the Fonterra business there have been asset revaluations and hence book losses that have been brought to account, there is more red ink yet to show up for both Australia and Chile.

Fonterra has recently reported that across its overall business it is on track for modest ‘normalised profits’ in the current year. However, revaluations are treated as a ‘one-off events’ that are not considered part of ‘normalised profits’. This is why Fonterra could still face a situation this year, just like last year, with an overall loss despite making a normalised profit.

In terms of what is real and what is theoretical, it is the overall profit or loss, and not the normalised profit or loss that is the bottom line.

*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 https://keithwoodford.wordpress.com/category/fonterra. You can contact him directly here.