Redemption risk for Fonterra

Dairy giant Fonterra is wrestling with ways to avoid swinging debt from farmers cashing in shares, a problem that looks like resurfacing as suppliers reduce stock in a low payout year. Fonterra is set to announce phase two of its capital restructuring programme on September 18 after farmers clearly rejected a public share listing or outside ownership entering the co-operative reports Stuff.  This will tackle the difficulties of managing a business with share money washing in and out of the co-operative - referred to as redemption risk - particularly when borrowing money is difficult in a worldwide economic downturn. The problem arose in the 2007-08 season when drought stung farmers and high- priced shares were cashed in and rebought the next year at a lower price, leaving Fonterra out of pocket. The fair value share price is currently $4.52 a kilogram of milksolids, from $5.57 in 2008. Fonterra may yet seek to get around this by capital raising, with more farmer investment a possibility, but is yet to signal its intentions. The unattractive alternative is selling assets at a lower price in a downturn. Fonterra commercial milk supply manager Jason Minkhorst said farmers this season were de-intensifying farms because of a tough winter and a low payout, which would result in excess shares and money washing out of the co-operative. "We again face farmers cashing in these shares and they could buy back at the end of the following year. We have another risk again and while we do not think it will be at the scale of the [2007-08] drought, it could be a third of the share drain." The net equity loss of $600 million from the drought would have been $746 million had there not been so many dairy conversions. "That is pretty significant and caused by farmers able to cash out shares at a high price and buy back in the next season as the share price fell in the financial crisis. For the co-operative, that was a major impact."