Andrew Gawith's view of Fonterra's capital restructure

Rural News

Fonterra's evolution vital for industry

1st Mar 11, 3:14pm by Tony Chaston

Andrew Gawith , now a director of Gareth Morgan investments, has an agricultural background with an economics degree from Lincoln University.

He looks at the Fonterra proposal to offer the public a stake in the dairy giant by creating non-voting shares.

He sees conflict in this hybrid approach to ownership, as farmer shareholders and outside investors have different goals, and only one grouping can influence change.

The milk price is the dividend for farmer shareholders while the return for other shareholders is what is left over after Fonterra have paid their biggest cost, the price of milk.

What are your views on how Fonterra can attract more capital but not lose farmer control of the Co-Op?

While the NZ public has been curdling over the price of milk in supermarkets, there have been interesting developments affecting the "other" price of milk: the price that farmers receive reports The NZ Herald. Fonterra and the Government are consulting on a proposal to offer the public a stake in the dairy giant by creating non-voting shares. But could such a deal turn sour for investors? For decades investment in our lucrative dairy industry was restricted essentially to farmers. As a result farmers, through the Dairy Board, and now Fonterra, effectively own a lot of the processing, distribution and even brands under which New Zealand's milk is sold.

The idea was that this "co-operative" model would prevent foreign dairy giants such as Nestle from setting up shop, wiping out all competition and eventually turning farmers into serfs on their own turf. The farmer shareholders tend to judge the value of their investment in Fonterra (wrongly but understandably) by the price they are paid for raw milk. Certainly, they are very keen to have all surpluses returned to them when milk prices are low, thereby stunting Fonterra's ability to consistently invest in developing new products and new markets.

By tying profit distribution so heavily to the raw milk prices it distorts the investment signal in favour of production and away from market and product development, areas that may pay steadier and larger dividends over the long term. What is happening is that a lot of the value Fonterra is generating is being capitalised into land prices, which is a great tax-free bonus for existing farmers.

What's in it for potential non-farmer investors? Access at last to one of New Zealand's most successful large-scale industries, which appears to have a bright future given the rapid growth in household wealth in Asia. But this is an equity investment with no voting power to influence the board, strategy or returns - no matter how good it looks this is a partial float of an odd corporate structure with no voting rights. It could turn to yoghurt.

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15 Comments

by Omnologo | 1st Mar 11, 5:27pm 1298953626

Fonterra is successful because it evolved on the shirt tails dairy farmings historic co-operative structure. Since formation it has operated with a corporate philosophy which has delivered no more benefit to the bulk of farmer shareholders or NZ as a whole. In fact it has probably undermined many dairy farming businesses via the establishment of shares whose value has been determined by financial hocus pocus, with capitalisation of percieved wealth into land.

Gareth Morgan et al have long moaned about Fonterra been farmer owned and the resultant inefficient use of capital so on and so forth. Can someone who agrees with this viewpoint please provide an example of a successful company on the scale and nature of Fonterra which has evolved into a corporate without going belly up. I would have thought the reason the milk price erodes profit and resultant investment is it's the most costly input required.

by Justice | 1st Mar 11, 5:53pm 1298955192

Not in NZ but how about Zen Noh?

by Omnologo | 1st Mar 11, 6:53pm 1298958828

I thought you would agree.

by Justice | 1st Mar 11, 7:09pm 1298959796

I do! 100% I'm just trying to give you an example for your question. No offense. Zen Noh is the worlds largest Agri co-op based in Japan

by Colin Riden | 1st Mar 11, 7:18pm 1298960329

"I would have thought the reason the milk price erodes profit and resultant investment is it's the most costly input required."

True, but you could also turn that around and look at profit from the milk producers point of view. Then Fonterra erodes the price the farmer is paid for their milk - that being the residual left after processing, bureaucratic overheads and dividends.

Until it is known what the price of raw milk would be in a competitive market (rather than what the Fonterra's board decides it will be) it is impossible to determine whether Fonterra is generating value or destroying it.

Andrew Gawith doesn't appear willing to distinguish a co-operative milk processor from a global corporate brands business. Until he does he is likely to continue being perceived as confused.

And if he doesn't have at least some understanding of why Fonterra was formed then he should not be inventing this sort of drivel:

"The idea was that this "co-operative" model would prevent foreign dairy giants such as Nestle from setting up shop, wiping out all competition and eventually turning farmers into serfs on their own turf."

by Justice | 1st Mar 11, 7:31pm 1298961107

Colin, could it be that this models time could soon be up?

Won't really know for sure until the FT talks with the US are made public. US want in via Nestle and so do Monsanto including their Pharma division, what was formally known as Upjohn Pharma

"Upjohn merged with Pharmacia AB, to form Pharmacia & Upjohn.^[2] Later the company merged with Monsanto Company and took the name Pharmacia; the company retained Monsanto's Searle drug unit and spun off the remaining interests, which became the "new Monsanto". Today the remainder of Upjohn is owned by Pfizer. Kalamazoo county retains major manufacturing capabilities as well as a large stake in Pfizer's animal health business."

This is why NZ Pharmac might be in for some serious changes

by Omnologo | 1st Mar 11, 8:02pm 1298962949

Thanks for putting me straight Justice.

by Colin Riden | 1st Mar 11, 8:32pm 1298964752

"Colin, could it be that this models time could soon be up?"

Justice, I am not sure exactly what model you are referring to?

by Justice | 1st Mar 11, 8:44pm 1298965493

The model of a sole NZ co-op having control over dairy here? Could the likes of Monsanto and for that matter Nestle not start meddling with our Dairy industry via Monsanto Pharma and via their IP rights? The US free trade dealings are about such things

by Colin Riden | 1st Mar 11, 9:21pm 1298967697

I am not sure what say Nestle would have to gain from our dairy industry that they can't have now. Nestle already has arrangements around the world with Fonterra. If Nestle or anyone else want a supply of reasonably priced good quality raw milk they are able to set up processing here. Fonterra helps by keeping the price it pays for milk low. More competition for NZ's raw for milk supply might eventually increase the price which would be good for farmers but put a lot of pressure on Fonterra and its questionable hybrid model.

Is that Fonterra model going to last? As soon as a co-operative arrives at a point where its competitors are willing and able to pay more for milk they are on a slippery slope. Fonterra is already moving to address some aspects of redemption risk. That may help in the short term, but sooner or later competitors that are better managed, more innovative or better capitalised will grow in numbers and scale. The sooner the better for the NZ dairy industry but the timeframe will be in years.

by Justice | 1st Mar 11, 9:37pm 1298968670

And......... the Monsanto aspect?

by Colin Riden | 1st Mar 11, 10:38pm 1298972312

Thats the drug company wanting to have Pharmac neutured? Remind me again why we want a free trade agreement! Because we think we will be able to export more dairy products or it makes the bureaucrats feel more important?

by Casual Observer | 1st Mar 11, 9:37pm 1298968678

As soon as a co-operative arrives at a point where its competitors are willing and able to pay more for milk they are on a slippery slope.

It amuses me how Fonterra's competitors set their prices based on the Fonterra milk price. None of them come out and set a price fundamentally higher than Fonterra.

It will be interesting to see how many farmers switch if the Share trading among farmers comes in. This will give farmers who want to take out in cash the value of their shareholding, but still remain part of the cooperative a real choice - one which does not exist at the moment.

by Colin Riden | 1st Mar 11, 10:42pm 1298972522

"This will give farmers who want to take out in cash the value of their shareholding, but still remain part of the cooperative a real choice - one which does not exist at the moment."

It will indeed be interesting, but for each supplier share taking the cash someone has to provide equivalent cash without getting voting rights. Processors will have to lift their game, and Fonterra may have to lower its milk price to lift its dividend. All you can be sure of is that the markets behind the share trades will be doing nicely.

If I was a Fonterra supplier I would be taking the cash ASAP.

by Omnologo | 1st Mar 11, 9:50pm 1298969444

There has been suggestion in some farming papers recently of suppliers to the corporate processors returning in large numbers. This suggest no competetion of consequence to Fonterra. It could be argued the only reason processors have started up in competition is because of access to DIRA milk, just ask John Penno. Fonterra does appear to be way outperforming them. Andrew Ferrier said that Olam who have a significant shareholding in OCC reported a 0.5 % return on investment. So we don't need the likes of Gareth and lackies trying to get into Fonterra unless they are prepared to milk cows, they can prop up Synlait, OCC etc, who will be grateful for their dough, and there you have it, a stake in the dairy industry.