Opinion: Willy Leferink is not supportive of the size of the Fonterra DIRA provisions. He warns how large it could grow

Opinion: Willy Leferink is not supportive of the size of the Fonterra DIRA provisions. He warns how large it could grow

By Willy Leferink*

The Rubicon River Julius Caesar crossed 2000 years ago has come to represent a point of no return. To some dairy farmers that expression sums up Fonterra's proposed shareholders fund.

The shareholders fund, if we strip things to the naked truth, could be looked on as being either the partial demutualisation of our largest co-operative company or the dilution of its share value.

If Fonterra's farmer-shareholders vote for the fund in late June it will allow farmers to trade their shares in for cash.

Title to the shares will be held by an impressive sounding "farmer custodian", in reality, a share parking lot. Farmers will have a say in how Fonterra is run backed by a voucher but their dividends will flow to the fund instead.

The promise of safe Fonterra dividends in our largest business will entice "mum and dad" investors to buy units in the fund.

Fonterra will get "at least" $500 million for "at least" 8 per cent of its equity, but there is a snag. Investors may be "mums and dads" but will they be Kiwi mums and dads?

Fonterra's constitution means if a fund is approved by us farmer-shareholders, it could in fact grow to a quarter of Fonterra's equity before further shareholder approval is needed.

That is why the amending Dairy Industry Restructuring Bill before Parliament tags "at least" to the $500 million sum.

I'm not adverse to a shareholders fund but its potential size places it outside my comfort zone and my support.

Those with longer memories will recall how asset managers enthusiastically cited Kerry as the reason Fonterra should have floated in 2007. In 1986, Kerry Group transformed itself into a listed company with the co-operative retaining 51 per cent as a cornerstone.

Over 26 years this has slumped to 17.1 per cent but the Irish Farmers Journal put it best last year:

Where would this then leave Kerry milk suppliers? No one can foresee the future, but Kerry Group's journey has been an enormous success for all stakeholders to date ... Kerry milk suppliers were once the envy of all other Irish dairy farmers; could this change and could they find themselves outside the negotiating room and reverting to where they were in the early 1970s?

That's why over 85 per cent of the world's milk is traded through co-operatives.

Farmers formed co-operatives to give small suppliers scale and control over the means of production. If you trade this in for short-term gain you risk becoming a small cog in the production wheel.

So how has Fonterra performed recently?

In 2008, it took Fonterra 14 months to generate revenue of $19.5 billion. In 2011, Fonterra generated revenues of $19.9 billion but took only 12 months to do so.

As if there's no other way, asset managers talk up floats and funds as giving Fonterra the capital it needs to grow. Milford Asset Management's Brian Gaynor said on radio that Fonterra's international growth ambitions were not as important to farmers as the milk price.

Federated Farmers predicts Fonterra may this season crack corporate New Zealand's four-minute mile, $20 billion in revenue.

One reason behind Fonterra's growth is that it now holds on to some of the payout farmers receive. Unbelievably, no such policy existed before 2009 and Federated Farmers knew this was not sustainable. In 2010/11, retentions amounted to $470 million and is only slightly less than the shareholders fund promises. The exception being it is a one-off whereas retentions are on-going.

Retentions can also be much larger if it was sold to shareholders. While we celebrate Fonterra revenues being two times Ireland's Kerry, Mars Corporation, of M&M fame, has revenues one-third larger than Fonterra's again. Despite this Mars remains a family-owned company; there is more than one way to skin the cat here.

Fonterra's core strengths are in processing, marketing and supply chain logistics, not being a corporate dairy farmer in China, Brazil and potentially India. After San Lu, Fonterra rightfully moved to protect in-market milk supply by piloting farms of its own.

This gave it direct control over milk supply but as things move well beyond a pilot, the risk of something adverse increases.

Being a Fonterra farmer-shareholder I have reservations my reputation and that of Fonterra hinge on the actions of a farm worker overseas.

I would be relaxed if Fonterra spun off these farming operations into a separately branded and listed company.

While the number of in-market farms is small, Fonterra now has systems, processes and a market that could see rapid expansion of its model. Here lies one route for capital while guaranteeing in-market milk for Fonterra.  It would also firewall Fonterra's core business and brand, but would New Zealand be the place in which to list?

Federated Farmers got its wish for farmers to have a final say on the controversial shareholders fund. It is now up to farmers to get together and discuss the pros and cons ahead of the collective fork in the road we've reached. Is our future down the co-operative road or the Kerry one? Or can we go down another one nobody has gone before?

At least Fonterra's farmer-shareholders, the ones with skin in the game, have their chance to decide.


Willy Leferink is Federated Farmers Dairy chairperson and an Ashburton dairy farmer. He is also a Fonterra farmer-shareholder. This piece was first published on the Federated Farmers website.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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For a co-operative to grow for the farmer, the farmer must own the cooperative.
Business serves capital. The purposes of public investors and farmer investors are conflicted and will result in lowered returns for farmers.
Re Kerry Gold: One long-serving Kerry executive described the tension created in the
business as:
“Riding two horses with one arse.” - Anonymous interviewee
His graphical description highlights that it is extremely difficult to serve both farmer and investor interests.

Originally the share fund was proposed as a way of Fonterra removing the redemption risk from its capital structure (i.e. following 2008 drought, Fonterra had to pay out millions to farmers for redeeming shares because their production levels had dropped). With farmers being able now hold 'dry' shares, and the share price remaining more stable, the redemption risk for Fonterra has been reduced significantly.
But the current proposals have morphed into a way to bring in outside investors. The problem is, these outside investors will want the dividend maximised. Farmers and sharemilkers will want the milk price maximised. You can't serve two masters without problems developing. Hopefully the Fonterra farmers will see through all the BS and spin and realise they are being duped into something which is not in their long terms interests.

As a large Fonterra shareholder Ive got to say that my gut tells me its all getting far to complicated and all basically because the industry is carrying far to much debt (that means both farmer debt and Fonterra debt). 
Fonterras business is now so complicated very few shareholders have any idea whats actually happening. In a world market that is presently extremely volitile I believe it would be prudent for the Fonterra board and a fair bulk of its suppliers to move back to its core bussiness (producing milk from grass and milk to powder + a few high margin products) and working out how to rebuild an indebted balance sheet.
NZ cannot afford another downturn as a result of the indebted Dairy Industry hitting the wall should the current dairy market continue to fall through the floor. 

A different world !
Grumpy - because of worldwide upcoming turmoil, I think we have to accept that events are following each other in quick successions. Accordantly we have to learn to adapt to the situation.
Stories/ events, which have good values today are often worthless tomorrow or with other words erasers are definitely becoming more important then pencils.

Yep agree Grumpy.  20 farms x $50m = $1billion.  That'll be our investment in to China farms.  As others have said there is conflict between 'what's good for the company and what's good for the farmer suppliers'.  It's not a happy Board.  Henry needs to leave the Board completely - not just step down as Chairman.

A Fonterra director tried to shut down a respected former dairy industry leader before his claim that Trading Among Farmers (TAF) is taking farmer-shareholders "down a most dangerous path" could be published............

More from the fonterra PR machine, We're thinking those corporate buzz works "stakeholder management", "customer service", ....
Fonterra chief executive Theo Spierings delivered the corporate equivalent of a "bitch-slap" to Federated Farmers' Willy Leferink which has not only resounded in farming circles but been heard all the way to the Beehive.

According to a blog called Love + Sex, a couple should be engaged for about a year. Maybe 18 months tops. Longer than that and the chance of a wedding recedes into the never-never.

Today we have been married longer than we "lived in sin" before we finally got married...considerably longer than 18 months....

My response to Fran Wilde....who?
TAF does not nullify redemption risk, redemption from unit holders in trading fund is more likely than from shareholding suppliers. If anything TAF increases redemption risk, and encourages trading behaviour consistent with the destruction of any successful cooperative globally, who have rejected their cooperative structure in favour of external investment to prop up the balance sheet.
Wherever capital comes from it has a home. Fran Wilde has absolutely no evidence to support claims that external capital will allow Fonterra to leverage its balance sheet to invest, grow and return profit. Nestle is a much older, more established, broad based company than Fonterra. It's a pipe dream to make comparison. As far as dairy farmers go there's no need, we produce a valuable relatively sustainable product, the demand for which is projected to grow by 100 billion litres in the next 20 years. Whether it pans out exactly like this or not is a mute point. No we don't need to secure volume to ensure relevance in this projected global market.
As a Fonterra shareholder I agree with Willy, and applaud him for questioning the debacle that is TAF and by default DIRA. Both will be to the detriment of the dairy industry and NZ economy. In fact the only way TAF will be successful as if it is not implemented at all. TAF is a cloaked proposal in response to misguided government regulation through DIRA, and also to assist half witted industry leaders who leveraged their own balance sheets after transferring generations of cooperative development capital to themselves at the formation of Fonterra. What a complete debacle, hilarious in its idiocy if the implications weren't so dire.
What's this talk about monopoly Fran, there has always been open entry and exit in the cooperative dairy industry. If independent processors have an innovative model that will add value to milk, they would be able to secure supply. Synlait sell cans of formula in China for $90, therefore should be able to secure milk supply, without to much of a dent in profit for the Chinese owners. Farmers who leave Fonterra have no right to take capital that has been contributed over generations, and which underpins the success and strength of the industry to date.
As far as getting hysterical Fran, why not placate us by pointing out examples where cooperatives have shed their structure in favour of a shaky corporate one, and gone on to prosper and serve their supplying shareholders? Don't know, thought not.

Apologies, I mean Fran O'Sullivan

Leferink has pointed out a solution that had occured to me, namely spinning off the international expansion stuff into a seperate listed entity and "firewalling" the  core co operative business. Im interested if this is an option that has been seriously proposed earlier and if it would be feasible?
 I would love to see dairy farmers protect their co op at all costs. You only have to look at the dogs breakfast's that are the other farming codes set ups to realise that you must stick together. Fonterra might not be perfect but at least you have the ultimate control of it
I must add that ive been following the debate on these dairy threads this week with real interest. There has been some extremely informative and enlightening contributions, probably the best collectively ive read on this forum. Well done to all involved.I hope the wider dairy industry is engageing similarly. This is a big decision.

Good question Sheep Shagger. There are two solutions. I put up one of them the other day which preserves co-operative ownership. The other solution is the one you touch on. In order to answer that question you need to consider the following. (I'll keep it short. Could write a 50 page thesis on it)

Businesses can grow either
(a) horizontally by merger and acquisition, a good example http://www.deanfoods.com
(b) vertically, example Fonterra

Fonterra has become a vertical conglomerate across a number of jurisdictions. Each division requires a different skill set. The jurisdictional issues raise further elements of complexity. Is the management of Fonterra up to the task. Is the conglomerate nature of Fonterra starting to over-whelm the co-op's (level one) strategic objectives.

To examine the spin-off idea, conceptualise Fonterra's structure in this light

Structural separation of the 4 activities
 . milk collection (co-op) or milk broking (corporate)
 . processing and manufacturing (co-op)
 . marketing and exporting (corporate?)
 . direct farm ownership and development (corporate?)

Then there is Treasury
 . Treasury (corporate?)
 (which of those divisions would you house the FX trading in?)

Can you put up any industry links that cover these issues?

Good work. Something on similar lines "spawning" or splin-out is in the nuffield doc in the first post.
And another example of dairy business growth.
Hamdi Ulukaya's tale is almost too incredible to believe. Seven years ago he bought an old dairy plant and hired five staff. This year his business is on track to sell $US1 billion of yoghurt

Read more: http://www.smh.com.au/small-business/entrepreneur/wild-ride-the-steve-jobs-of-yoghurt-shares-his-secrets-20120224-1ts8t.html#ixzz1vHKqq4Qr






I mentioned these guys a couple of weeks ago.

All this growth was done with not being listed. The company is private and uses bank debt.

What makes these guys noteworthy, is that I am told that the Chobani yoghurt is for sale in Australian Woolworths (manufactured in USA) for similar or less to other brands.


Henry: You might check that out a little further. (Deja Vu?). I doubt very much if Chobani is importing yoghurt into AU from the US. Bonlac (now Fonterra) had a moderate sized milk processing plant on the outskirts of Dandenong (the location of Chobani's AU operations). Check out whether they have shut it down, or sold it, or, is Fonterra supplying raw-milk to Chobani.

Interesting to go back to 2003 and review what Fonterra bought when they purchased Bonlac and the problems that Bonlac caused themselves trying to move up the food chain.

Plants only working at 75% capacity. Has Fonterra reversed that? See my comment elsewere about Goodwill on Fonterra's Balance Sheet.

Yes, me thought too, until I saw the iphone pic of made in usa label on the woolies shelf.

from the link above
The 40-year-old last July acquired Bead Foods in Melbourne’s Dandenong South, producers of Gippsland Dairy products. Work is under way on a $20 million expansion of the plant, which will see Chobani products also being produced on site by mid-year.

Maybe its in advance of the local factory gearing up..

bead sell a brand called Gippsland.....

There is another vic independent co, we were told about last xmas, where an engineer bought an old factory, it was one of oz's fastest growing co last year we heard.

Other issues are

Fonterra is capitalised at $6.5 billion on a share-valuation basis.
Fonterra's Balance Sheet shows equity of $5 billion, of which nearly $3 billion is intangible assets made up of Goodwill ($1bn) and Brands ($1.5bn) GlobalDairy Software Platform ($200ml). Extracting the intangible assets out leaves a mere $2 billion. Not a lot of capital.

Following the links in one of the other threads about 2 weeks ago (gone now) (cant find it) a paper reported Bright Dairy sinking $8 billion into its New Zealand operations. If that is right, that is a helluva a competitive risk to Fonterra which is pre-occupied with trying to fund its overseas operations, and TAF and DIRA and Select Committees etc etc.

What value of Brands
"products" fall into two broad categories
(a) products that can be distinguished from all other competitors (price premium)
(b) commodities (no price premium)

In the long run, as new entrants enter the market, ALL products (tend to) become commoditised and masthead brand values erode. And Product Premiums disappear. What risk does the entrance of Bright Dairy pose to $1.5 billion of Fonterr's Brand Values sitting on its balance sheet. With only $2 billion of working capital at its disposal will Fonterra be squeezed by Brights $8 billion.

Are there any other research sources covering these issues?

Which Business Division (above) do you include the Brands in?

Full Copy:
JFGT (20120501-08:32:19 to UTF-8) ART 6349 zh => en
Bright Dairy & Food Co., Ltd. announced foreign investment
All members of the Company and the Board to ensure that notice does not contain any false, misleading statements or material omissions, and its contents are true, accurate and complete jointly and severally accept responsibility.
Important tips:
● Target Company Name: Synlait Milk Limited (hereinafter referred to as "Target Company").
● the amount of investment shares and the shareholding ratio: intended to be 8,200 million New Zealand dollars (about 382 million yuan), to subscribe for 26,021,658 shares of new common shares at 3.15 New Zealand dollars, holding proportion of shares of 51%.
● Investment Horizon: Long-term
● Estimated investment rate of return: Internal Rate of Return (IRR) of 18.0%.

Iconoclast, I wonder if you are over complicateing your model as prescribed above. Would it not be simpler to split it more along geographical lines. Maybe the mature NZ and Aust operations , brands etc  retained as the core co op. Just spin off" Fonterra International" The JV,s with Nestle, dairy farms in China, world domination stuff which is stretching the current capital base and leading to the board prescribeing halfway house measures like TAF....although im sure its not that simple (remember im a humble sheep farmer:).
Im all for leverageing our dairy IP and bringing badly needed foreign dividends back to NZ, just not at the expense of loseing control of the co op. As farmers we have a healthy sense of scepticism of people wearing suits telling us whats best for us, so im picking that the dairy cockies wont let the wool be pulled over their eyes a second time.

Sheep Shagger
The short answer. I have put up two suggestions. The second one, structural separation of the divisions, is suggested to get you to think about the structure of the company. How do you know what the profitability is of those activities outside milk collection and processing. What is the capital demands of those operations? Where does the capital come from to fund them. From the co-op? Is that the business of the co-op? Have also tried to point out that "in the long run" the value of your brands will diminish. Now the question you might ask is "which brands"? The global wholesale commodity brands, or the processed manufactured retail brands.
Answer me this: What business is Fonterra in?
Fonterra on face-value is becoming a vertical conglomerate. These were fashionable in the 1980's when the world went on an acquisition binge and then spent the 1990's divesting themselves of non-core activities. A good example of this is not too far from home in BHP which was a mining giant. Mined anything and everything. In 2000 the company head-hunted Paul Anderson from Duke Energy in USA. He set about divesting the company of all non-oil-exploration, non-oil-production and non-copper-mining activities. Merged with Billiton SA and did the same. And look at the company today.
Then look at the Fonterra published reasons for TAF
Now go back and read my first suggestion. For you Casual Observer.

Regional seperation isn't even worth considering.

Fonterra has 1.4 billion share on issue.
Fonterra has 10,500 NZ members

That means on average
each member holds 14,000 shares.
each share holding is worth approximately $70,000
Sure, some will hold more, but, some will hold less.
The average NZ member receives $1 million in annual revenue (pay-out) each
What's all the fuss about some members wanting to "cash out"?

Seems to be a furphy

Thanks Mist
yeah, got the decimal point in the wrong place .. an idiot mistake
(a) Number of shares 140,000 (rounded up)
(b) Value $650,000

Mist42: Explain the steps. Suppose you wanted to sell your farm and found a willing buyer. How are the Fonterra shares dealt with. Are you obligated to surrender them, or can you sell them to the buyer of the farm? Are the shares attached to the farm or are they attached to you as the owner of the farm. What I'm curious about is why would a new buyer, in addition to purchasing the farm,  want to sink an additional $600,000 into shares in order to become a supplier to Fonterra, in order to receive a Farmgate income of $1,000,000 unless the dividends on the shares cover the funding costs of the debt used to buy the shares. What are the economic benefits of going the Fonterra route rather than going with an independent processor?

Iconoclast if I may, it seems most farms are sold shares included, if currently supplying Fonterra. Dividend on share covers cost of borrowing. TAF has raised the spector of tension between value of milk and profit derived from that milk. It seems above all else the key is to minimise the farmgate price of milk to ensure a healthy profit.
The question I have is with introduction of TAF, will dividend be uncoupled from farmgate milk price and by default the necessity of owning a farm, therefore reducing the price of land? Or can we count on foreign and astute corporate investment in underpinning the value of land?
Finally you pour cold water on two regional cooperatives, but it would have been one way to avoid the debacle that is DIRA, which our board has embraced with passion. Cooperatives could cooperate with one another to maximise value for shareholding suppliers.

Omno: I don't understand your last paragraph.

Wouldn't suprise me if I have the wrong end of the stick, I'm over my head in most debates on this site; but:
Regional seperation isn't even worth considering.

Aaaah. Cross purposes. Was referring to Inter-national Global Regions not intra-national regions.

Lack of comprehension on my behalf; and even a dim wit like myself can see TAF is a debacle.

Yesterday spent an hour wading through Fonterra's Constitution. Look at all the amendments. A lawyers nightmare or smorgasboard, whichever you prefer. Made the head spin. Gave up after a while. So far, after nearly two months following this, haven't seen anything to change an initial view/analysis that the "problem" boils down to the need for additional capital. Doesn't matter which way you dress it up, that's not going to change.

All TAF will do is put a finger in the dyke to prevent a drain on existing capital.

Agreed: Investing what
This was at the bottom of the press release:
Mr Spierings said the improved valuation was mostly due to a significantly higher value for
Fonterra’s Asia-Africa/Middle East consumer business reflecting continued earnings growth.
This was partially offset by a lower enterprise value for the Australia-New Zealand consumer business due to a continuation of challenging market conditions.
so how much of a loss (does this mean an accounting loss in next annual report) is to be taken on the ANZ consumer business (these are the earnings that the supermarkets have taken or destroyed).
Destroyed, for now all milk sales are gauged back to price in the consumers mind, milk sales now need to differentiate (ice coffee, greek yoghurt, A2 etc, etc) in the minds of consumers to climb back up the price line.
Who in Fonterra was watching the supermarkets, or being taken to lunch by them .....

Was being rhetorical about the dyke .. otherwise generally I agree .. but would have a weather eye on the $4 billion of term debt .. considering the maturity of the business that's a lot of debt, maturing in the next 4 years .. and if there is a GFC MK2 or a GFC MK3 or credit markets freeze up in the next couple of years and you cant roll those notes over .. you put the entire business and all the members at risk .. for what?

Theo explicitly states that Fonterra does not need external capital to fund (alchemy of) growth strategy.
Cooperatives fund strong balance sheets and growth through retentions, it worked wonders for 100 years of cooperative development, until leadership expropriated this intergenerational capital for their own use.
Our chairman is on a $400,000 annual stipend, and our executives are also paid handsomely. It’s necessary to attract appropriately qualified people. If our balance sheet is so precarious, it is beyond belief, and defies logic.

Mist42: Thanks. Good overview. Confirms my understandings of the "industry structure". Fills in some missing pieces.

Mist asks: Do you deal with property sales? Shares? Business?. You know how they talk the usual "buy low, sell high"?  You read Robert Kiyosaki? ... first books, and Martin Hawes too? Or anything on real marketing and advertising?
Yes to all of the above plus much more

To its credit Fonterra will pay (even if price is low), compare to the NZ Dairies in South Canterbury (not to say small co-ops have gone over on suppliers).
So factory as a counterparty is a noteworthy risk to think through.

Well said mist42nz.  Not always easy to explain  why we choose to supply a co-op rather than corporate.