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Fonterra launches consultation on capital restructure proposals that appear to close the door on any non-farmer investment in the co-operative

Fonterra launches consultation on capital restructure proposals that appear to close the door on any non-farmer investment in the co-operative

Fonterra is mulling buying back the NZX-listed Fonterra Shareholders Fund as it launches a round of consultation on capital restructure proposals.

In the meantime the co-op has suspended trading of shares by farmers into the shareholders fund and put a "temporary cap" on the fund - a move that will likely come as a big surprise.

The Fonterra board says it has "reached a preliminary view" that having no fund would be its preference.

However, a buyout of the fund would require a 75% vote in favour - so presumably the price would have to be right for shareholders of the fund units, who include outside, non-farmer investors.

But Fonterra was indicating on Thursday it wasn't prepared to buy out the fund at any price.

"If we cannot reach an acceptable arrangement to buy back the Fund that 75% of voting unit holders support, then a Capped Fund would also work. In other words, we would only seek to remove the Fund at a reasonable price that was acceptable to unit holders, fair to farmer owners and made sense to the Co-op compared to the Capped Fund alternative," the board said.

Consultation is going to run for some time, with decisions not likely to be made till November.

Closing the door

While no decisions have been made, it appears the giant dairy co-operative is moving towards closing the door on any non-farmer investment in the co-operative.

Outside investment in Fonterra has long been opposed by farmers.

Earlier the co-op had conducted a survey of its farmers which gingerly raised the subject of outside investment in the co-op - and the farmers gave this a vigorous thumbs down.

The Fonterra Shareholders Fund (FSF) is a mechanism through which farmers may trade their shares in the co-operative.

The FSF units are traded on the NZX and are open to investment from outsiders - but the units confer no power on the co-operative and are simply a means of sharing in the performance of the co-op through the receipt of dividends - if dividends are being paid.

Fonterra on Thursday said to allow its farmers to have "open conversations" and consider all options during consultation, the co-operative was temporarily capping the size of the shareholders fund by suspending shares in the Fonterra Shareholders’ Market from being exchanged into units in the fund.

At the moment Fonterra is in a trading halt on the NZX, which is to be lifted on Friday.

The temporary cap on the fund will be effective once the current trading halt is lifted when the market opens on Friday and will remain throughout the consultation process.

Fonterra chairman Peter McBride said if the temporary cap was not in place, anyone holding ‘dry shares’ – those shares held in excess of the ‘wet share’ requirement linked to milk production – would have been able to exchange them into units in the Fund during consultation.

"This could have more than doubled the size of the Fund and made the option of buying it back unaffordable in the context of the co-operative’s current balance sheet targets."

Options considered

The options for consideration by farmer shareholders for the capital restructure are included in a consultation booklet.

However, McBride said the board has put forward a preferred option – a “Reduced Share Standard with either No Fund or a Capped Fund.”

“We believe the best option for our co-op is to move to a structure that reduces the number of shares a farmer would be required to have and either removes the Fund or caps it from growing further, to protect farmer ownership and control,” he said.

Under this option, the minimum requirement for farmer owners would be one share for every four kilograms of milk solids supplied to the co-op, compared with the current requirement of one share for every single kgMS supplied. At the other end of the scale, farmers could hold shares up to a maximum of four times their milk supply. But farmers will be encouraged to share their views on these and other features.

"This would make it easier for new farmers to join the co-op and give more flexibility to existing farmers who may want to free up capital or who are working through succession," McBride said.

"A key outcome of this change is that shares would be bought and sold between farmers in a farmer-only market."

McBride said the changes "could impact the price at which shares in our co-op are traded, and there may not be as much liquidity in the market".

"Ultimately the price for farmers’ shares would be determined by the performance of the Co-op and trading between farmers.

'A more sustainable proposition'

“We believe this is a more sustainable proposition over the longer term than the alternatives we are confronted with."

McBride said that this was the board’s "current thinking", but it was open minded about adjusting that direction based on farmer feedback on any of the options.

Other options examined in the consultation document include:

  • dual share structures, which would move from the current single co-operative share to a compulsory supply share and a separate non-compulsory investment share
  • unshared supply structures
  • a traditional nominal share structure
  • a split co-operative model

McBride said over the coming months, the co-operative’s farmers will have the chance to share their views through a series of meetings, webinars and other opportunities – and if the appetite for change remains – the board will do further work to refine the preferred option or options and have a second round of consultation. If the Board decides to seek change to the Co-operative’s capital structure, it would likely aim for a farmer vote around the time of the Annual Meeting in November and the approval of 75% of votes from voting farmers would be required.

If the preferred outcome is to buy back the Fund, it would also require the approval of 75% of votes from voting unit holders.

'Raising additional capital is not the purpose of this review'

The consultation document says having adequate and sustainable access to capital to fund the co-op's strategy is always front of mind, "and raising additional capital is not the purpose of this review".

"We will fund our strategy through a strong balance sheet, cashflow, and through leveraging our IP and innovation capability to partner in new products and categories where it makes sense.

"This capital structure review is about prioritising New Zealand milk, protecting farmer ownership and supporting a sustainable milk supply over the longer term.

"Our strategy is dynamic, and we will always be reviewing our portfolio – asking ourselves what each asset is worth to us now and into the future. We will continue to turnaround key parts of our portfolio and divest non-core businesses to support new investments as necessary.

"Our focus is on maintaining a strong balance sheet to support growth."

See dairy payout history and economists' price predictions.

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19 Comments

So another one of TheeOh's experiments being shut down?

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Pre theo

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Theo arrived in late 2011 and TAF ( the current capital structure) was put in place in 2012. But you are correct in that the essentials of the scheme were designed pre-Theo
KeithW

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The implications are wide ranging. Lots to be worked through!
KeithW

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Under the preferred option, “the minimum requirement for farmer owners would be one share for every four kgMS supplied to the Co-op, …. At the other end of the scale, farmers could hold shares up to a maximum of four times their milk supply.”

So where do they see the demand for dry shares coming from?

Especially considering they go on to say “declining milk volumes or more flexibility for farmers’ shareholding requirements could cause the Fund size to grow significantly.”

Why not simply remove the cap? What's wrong with a two class share structure one with voting rights one without?

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More surprises. They actually sound open on this and other things. This is not Fonterra of the first 20 years.

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No it pre-dated Theo. My interpretation of the tea leaves is that the current dysfunctional capital structure was a result of narrow minded political and and corporate interests influencing policy and industry leadership at the time of dairy board deregulation and subsequent dira re-regulation.
It seems the current proposal is a realisation from leadership that if farmers don't have investment control, they constitute nothing but a cost to be minimised and easy money for corporate investors to exploit, as evidenced throughout history.

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Looking and assessing inwards, consolidation, self dependence and hopefully more financial consultation and accountability to its shareholders. If that is the basic tenet at play, makes some sense. Suggest wider New Zealand and New Zealanders would not mind some of the same.

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Good recollection

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As a non-dairy farmer (hereditary only), I always wanted to own part of the spoils of the industry through share ownership. Not really interested anymore. Anyway, very bullish on the Westgold consumer brand in Asia.

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That is good to hear about Westgold. Any specific insights you have come across?
Keith

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I think I may have mentioned to you before that Westgold is now the #1 foreign butter brand in Japan in terms of share and sales volume within 2 years. In the Vietnam market, the UHT and butter products have been blowing away all other brands at the shelf with clever 'moment of truth' activations. For the butter in particular, they have an interesting price point that sits just below Anchor and the other European brands. I know the distributor and was communicating with them the other day. We discussed Westgold. I will admit that I don't know how well they're doing with the food service channel where Fonterra had put much of their energy over the years.

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Was one of my worst investments. Ignoring of course all the bad investments in China and general mismanagement, when times are good the milk solid price goes up, margins are squeezed, earnings are down. But when milk solid prices collapse, Fonterra actually pays farms more for milk solids than it needs to (cheap loans etc) to support the farmers and maintain supply as it did back a few years ago. So margins are lower than they should be. This is the case of the outside minority investor getting shafted by the farmers. At least this is my interpretation of it.

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Mmmm I really don't think your risk exposure is anything approaching the farmer (oh they own Fonterra) faces. Your investment is really only milking the milkers. You really have no skin in the game.
You also seem to have a perspective that a farmer owned cooperative is the same as an open shareholding company. They a fundamentally and philosophically different as the raisson d'etre is maximizing return to the farmer suppliers. Your corporate model works the other way round - hence peasnt farmers.

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As it was set up nd sold, I'd almost totally side with ACB . From the advent of trade able shares it was never meant to be a co-op, the direction was always corporate. He's quite right that when the payout dropped the dividend return should have been way higher, but equally shareholders refused to acknowledge just how badly run Fonterra was. It's debatable wether the milk price or the dividend ever reflected reality. The best that can be said about the shares was that some owners made huge gains when it lifted and banked them.

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Not sure how investing money into any business is not "skin in the game"? And where did my money go to then when I bought the shares? Dollar for dollar, I have the same exposure (arguably greater given I have no voting rights) as any farmer's equivalent shareholding in Fonterra. Yes, farmers generally carry more exposure to Fonterra because they are likely to have more shares in it than any sensible investment portfolio has but also as suppliers of milk solids to Fonterra. But that is their choice. Yet I suspect that shareholders have been treated unfairly relative to suppliers (arms length commercial terms are questionable). That farmers might be indifferent to that view, because they are both shareholders and suppliers, is partly the reason why Fonterra is so poorly performing and the share price performance dismal. Indeed I understand the separation between supplier and shareholder was an important reason why FSF was set up in the first place i.e. to give farmers transparency and accountability over where the value in dairy farming is, is it Fonterra or at the farmgate?

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I have always wondered whether the whole concept of Fonterra is a mistake. I always feared that it would becomes a large, bloated, not very efficient or creative near monopoly. I think that I was right and the best solution may be to split it into two competing companies. How smart would it be if Japan amalgamated all it's car companies?

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Keith stated it plainly - 96% of our dairy production is exported. The competition for efficiency you are seeking, is the bulk of the NZ dairy complex competing in off shore international markets. Domestic competition exists but is only around the export surplus. That makes NZ virtually in the global dairy complex.
Each farmer is a stand alone business. Through the cooperative, they achieve a combined marketing strength to foot it in the highly competitive international market place and arguably over a rolling time period receive the best return for their production and maintain individual business viability.
There's a risk that Fonterra becomes bloated. We saw that with the NZAPMB/ENZA but we have not seen that develop in Zespri. It's for the owners of Fonterra to demand accountability and it looks like current governance is delivering that.
One issue for farm profitability is the capital structure of individual farm businesses, level of debt. But that is an individual farm business choice rather than a Fonterra issue.
Those investing in non voting shares should have their eyes open - of course the entity they have invested in is going to prioritize it's voting shareholders. And in Fonterra's case that is the raw material supply base. There are other processing companies competing with Fonterra for that supply. Arguably those other companies find it tough to secure supply because Fonterra benchmarks raw product supply price. And there in lies the fundamental difference between a farmer owned cooperative and the corporate operator. Both are focused on benefiting their shareholders - Fonterra shareholders are the first link in the value chain (farmer suppliers); corporate shareholders probably have no link to the supply base and expect lowest cost supply to maximize profit extraction from the further processing to marketable product.
Fonterra is the farmers' "company" not the property of the broader investor community. The farmers need to consider the proposals from the perspective of how Fonterra will give each farmer's individual business the best chance for sustainable profitability.

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I think you're right, it became all those things.
But many of us would say that happened due to its corporate direction and thinking ( capital for growth, growth for growths sake, quantity over quality, market share) . With co-operative direction back in control there's a chance to right things.

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