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Fonterra's Trading Among Farmers scheme to remove redemption risk established, springboard for new capital raising

Fonterra's Trading Among Farmers scheme to remove redemption risk established, springboard for new capital raising

By Allan Barber

The day when outside investors can apply for units in the Fonterra Shareholders Fund to be listed on the NZX and ASX has arrived at last.

Getting to this point has been a long and tortuous process during which Fonterra has consulted its members, finally gaining the required majority vote in favour of establishing Trading Among Farmers (TAF).

TAF will enable those Fonterra’s shareholders that wish to free up some capital to deposit shares in the fund, provided they retain enough shares to match their milk supply.

These shares can either be bought by other shareholders who would like to increase their shareholding or exchanged for the units with rights to dividends and share price value changes.

This process, the Fonterra Shareholders Market, will provide the liquidity for the units to be listed in the fund.

In the short term Fonterra will make up any shortfall in the Fund to bring it up to a maximum value of $500 million plus $25 million of oversubscriptions.

The key point about this whole exercise has been to ensure that shares can only ever be owned by members of the cooperative, not by outside investors who could threaten the principle of 100% ownership by dairy farmers. There remain critics of TAF and the establishment of the Fund, notably Lachlan McKenzie, previously chairman of Federated Farmers dairy section.

These critics maintain the principle of cooperative ownership no longer applies to Fonterra which has become a farmer-owned company. In a discussion with Bernard Hickey in June, McKenzie said the current generation of farmers would sell to the highest bidder, as has happened with Irish dairy company Kerry whose suppliers ended up as the lowest paid farmers in Ireland within a generation.

Fonterra chairman Sir Henry van der Heyden is adamant the integrity and security of the cooperative will be maintained even strengthened under TAF.

It will remove the redemption risk inherent in having to pay out farmers for reduced seasonal milk supply or when they leave the company, thereby stabilising the balance sheet.

The formation of Fonterra 10 years ago combined about 90% of the dairy industry under a single cooperative and it has been a very successful business, becoming the world’s single largest dairy exporter. At the same time there has been an impression Fonterra has underperformed when compared with global marketing giants like Nestle and Danone which have larger revenues and a bigger focus on milk based added value products.

Despite this Fonterra has succeeded in building a large branded business, as well as an extremely successful food ingredients business and, according to Rabobank, it is the fourth highest turnover dairy company in the world after three European companies, Nestle, Danone and Lactalis.

The security from the changed capital structure will enable Fonterra to pursue its global ambitions which include increasing the proportion of milk produced on overseas farms that it owns, notably in China where it has just announced two more dairy farms west of Beijing. It can also increasingly make selective processing investments, as it has in Sri Lanka where it processes local milk and produces yoghurt, and Chile.

As New Zealand’s biggest company, Fonterra inevitably attracts a lot of attention from many different groups: its farmer shareholders, the New Zealand public and government, and international competitors and customers. Now it will attract even more attention because of the investment status of the units.

None of this attention is necessarily unhealthy or unexpected, but there will be a great deal of interest in the behaviour of shareholders (will they trade as anticipated and how much trading will there be?), decisions by the board of directors (what balance will they decide to apply between milk payout and dividend and what will the share price be?) and company strategy.

Critics of TAF and the Shareholders Fund will be extremely sensitive to signals from the board. All hell will break loose if there is any suggestion that the external investors, through the mechanism of the units, have any influence on company strategy in general and the milk payout in particular.

Time will tell whether any of the fears expressed during the run up to TAF are in any way justified.


Allan Barber is a commentator on agribusiness, especially the meat industry, and lives in the Matakana Wine Country where he runs a boutique B&B with his wife. You can contact him by email at or read his blog here »

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Hows this AB:
Here we have the first set of outsider feedback: From yesterdays Australian Financial Review:
However, one concern among potential investors is the amount of debt it contains.
The investor roadshow for Auckland-based Fonterra hits Asia this week as the world's biggest milk processor looks to raise $NZ 500 million from institutional and New Zealand investors.
Joint lead managers on the issue Craigs Investment Partners/Deutsche Bank, UBS, Goldman Sachs look to be taking their lead from the successful QR National (Queensland Rail) float at the end of 2010.
In this case, the JLM s worked hard to garner support offshore sa as not to be held to ransom bt the domestic fund managers when it came to price.
The raising will create a Fonterra Shareholders' fund providing outsiders a share in the future earnings of the co-operative, while farmer members will retain voting control.
Unit holders in the fund, which will be listed on the Australian Securities Exchange and NZX, will be paid dividends and enjoy any capital growth but will not have voting rights. Farmer members will be able to trade shares between each other on a separate market.
Fonterra, which makes well-known brands such as Bega, Nestle Ski and Western Star, said this was the first structure of ist kind anywhere in the world.
However, one concern among potential investors is the amount of debt it contains.
Looking back, and some commented at the time, the run up to near $8/shared kg was too much, the co-op forewent retentions, has suffered low ANZ brand business earnings, is now looking to raise $500m and has too much debt (as soon to be investors are saying)...
We think that when these folk are investors, and they say/repeat co-op has too much debt, the dairy MS payout will reduce (while dividends are retained maintained)....

Henry, one of the JLM brokers told me liquidity will be a problem and Fonterra will have to issue bonus shares, or do a share split.  How will this affect farmer shareholders-equity etc? My understanding is that bonus shares are issued out of dividends and a share split isn't. Do either of these mechanisms affect Fonterra debt level?
An example of what I am trying to understand is this:
Current share standard requirements are 1share/1kgms. (This will be on a 3 year rolling average under TAF). So if a farmer has 100,000 shares and via bonus shares/share split this increases to 150,000 shares that would mean the farmer could increase production to 150000kgs without buying more shares?  So therefore farmers would be better not to buy units/shares for any expected production increase until they need them as they may find they don't need to purchase any at all? 
Any confirmation or otherwise of the above from anyone most appreciated. :-)

It seems to us that Fonterra have effectively self under writeen the units, i.e if few farmer sellers, F issues new shares.
The issue of shares, for units and the cash from units, passed back for the shares, will not reduce debt $ (unless F repays debt - not what having cash for redeeming shares would mean), rather (all other things being equal) it will change the debt ratio (the %).
$500m is aboyt 7.5 of Fonterra cap. so your calc. is more 100k goes to 107k shares.
If F issues new or bonus shares
1. either way there will be the "same" dividend amount of $ to go round more numbers of shares.
they increase the $ there for to be paid for dividends (by reducing the $ otherwise there for to be paid for MS.
The mechanics with reference to SS is something we are trying to think through too.

Thanks. :-)
............. Comment From Raj As this scheme is dividend only scheme..much like debentures this open ended and encashable at part at any point from purchase? Will dividend be at same rate as farmers

Con Williams: 
The cash dividend will be the same as farmers. The target range to pay out has been 60-75% of total earnings.

Comment From stephen
Where do you see the payout in the next 3 years?

Con Williams: 
Milk price averaging around $5.70-$6.00 per kg MS and dividend before retentions of around $0.50-0.60 per share. Although as noted earlier there will be volitality, espically in the milk price.


Timing: Not happy times for listed milk processors:
WARRNAMBOOL Cheese and Butter has blamed the high dollar and ''soft trading conditions'' for a surprise profit downgrade.
The dairy company said on Monday that its net profit for the first-half of the financial year would likely be about $20 million lower than the previous corresponding period's profit of $30.7 million.
Shares in the company fell 24¢, or 6.2 per cent, to $3.66 in response to the news.

Read more:

USDA thinks things, at least for US producers, are looking up...
Page 4 under Livestock...

Who needs a processor....... fresh milk can retail for more than $7 a litre in China...
FRESH Australian milk will be flown directly into China by the container-load under a bold plan by dairy farmers to cash in on the Asian giant's burgeoning middle-class.
But the plan, which is set to deliver a massive new market, risks being scuppered by Chinese red tape and the state government has been asked to step in and smooth the way.
David Lord, the chief executive of Warrnambool Cheese and Butter, told The Age it had secured ''formal arrangements'' with Chinese distributors, who had a growing appetite for high-quality Australian milk due to better knowledge of nutrition and greater purchasing power and had been put off local product due to the prevalence of food-safety scares in China.
But the lucrative deal, for up to a billion litres a year, is being held back by Chinese quarantine rules - which require milk to be held and tested for two weeks upon arrival in the country. The issue was raised by the delegation led by Premier Ted Baillieu on a recent trip to China.
Premium fresh milk can retail for more than $7 a litre in China, a stark contrast to the heavy discounting at supermarket giants Coles and Woolworths in Australia ...................

read processor/ing into non liquid products...

Or maybe the sharemarket has got it broadly right: farming is just too tough. Many investors remember the drought years and it does not take a particularly fervent imagination to see more drought coming - particularly with climate change.

Read more:


Why can't we build our own multinational commodities powerhouse, a BHP of agriculture? Should agriculture be recognised as a separate asset class - perhaps alongside other so-called alternative assets such as infrastructure and private equity.
Australia's own sovereign wealth fund has tried to address this conundrum. Last year it committed $125 million to invest in Australian cropping properties and water entitlements, alongside PrimeAg, which also kicked in $125 million. The unlisted PrimeAg Agricultural Fund was meant to grow to $600 million but in its first year, despite various offers, it made no acquisitions and the strategy is now on hold.



The Chinese government is eyeing a stake in New Zealand farmer-owned dairy company Fonterra's new sharemarket-listed fund, according to the Wall Street Journal.
The WSJ said China Investment Corp was "in talks" with Fonterra about potentially investing in the New Zealand dairy company's newly-launched shareholder fund.
CIC is an investment institution and a wholly state owned company of the People's Republic of China headquartered in Beijing.
The report will serve to  confirm the fears of Fonterra farmer-shareholders who opposed Fonterra's new share trading among farmers (TAF) scheme which created the fund, and shepherded in a capital restructure of New Zealand's biggest company which for the first time allows investment by outside, non-farmer, sharemarket investors in the $19 billion annual revenue company.
No comment from Fonterra's board or farmer watchdogs was available overnight.

Fonterra's $500 million sharemarket offer has attracted intense interest, requiring brokers to heavily scale back applications and forcing some investors to miss out entirely, say market sources.
The "book-build" for broker allocations is complete, so brokers now know how many units they may pass on to clients. There is no public pool.
..... The offer has been heavily promoted offshore and funds management sources said demand from overseas investors alone could have filled the offer several times over.....

More news from the front....
Fonterra, SCA test moribund market... ex
The year's two biggest initial public offerings, Fonterra and SCA Property Group, will find out just how bomb-proof their floats are with raisings set down for the coming week ...
Note to self: How did this become an Initial Public Offering??
Both management teams have had to pedal hard over the past month, spruiking their respective companies' yields and defensive revenue streams in a bid to defy the choppy markets....
Not to self: Why are we selling into such a poor market???
...... It's a similar story over at fonterra, which is seeking to raise $NZ 500million (AUD$393million) for ist Fonterra Shareholders Fund.
The dairy giant's management returned home on Friday after marketing throughout Australia, New Zealand, Asia and Europe.
But their rosashow is far from over. Fonterra will host a group of investors this Thursday, showing them around some of the company's North Island production sites, ahead of the bookbuild early next week.
Up to 70 per cent is expected to be allocated to institutions. Bids will start at $NZ 4.60 a share , which represents a 6.8 times forecast 2013 earnings before interest, tax, depreciation and amortisation.
Fonterra's best chance of getting to the $NZ 5.50 maximum price will be if Asian investors decide to play the dairy thematic.
It will be interesting to see whether Australian investors buy it. While most seem to agree it has been priced resonably, there are some concerns among Australia's bigger funds that the units are only in a shareholders fund and do not carry voting rights....
mmmmmm. so it sounds that rather than the investors they want, (OZ super funds) they will rely on Asian investors - if they decide to play ...... - so thats alright then ..... 

The research firm gives a 'do not subscribe' recommendation for the fund's initial public offering, saying Fonterra Cooperative Group lacks pricing power over its dairy commodities, generates low returns compared to its multinational peers, and investors won't know the price they are paying until after the bookbuild process is completed on November 27.
A reliance on whole milk and skim milk powder and a lack of branded products means the dairy exporter has smaller margins than its global competitors. It will probably face "significant competition from companies like Nestle and Danone" as Fonterra moves to sell more higher-value products, Moghe said.
"Multi-national food companies on the other hand have well diversified operations in relation to sales and raw material procurement. They also mainly sell branded products which enjoy better pricing power than commodity products," he said.
"As a result we think the valuation discount is warranted," Moghe said.

Link to the report:
We don’t believe Fonterra possess an economic moat.
While the company is the world’s largest exporter of dairy products, its business is driven by commodity products like whole milk powder and skim milk powder which make up 60–65% of its operating  earnings. Consequently the vast majority of the firm’s business has no pricing power and generates mid-single digit operating margins.
This pales in comparison to mid to high teens generated by some of the other multinational food companies. Fonterra aspires to sell more branded products to move up the value chain and boost returns. However we think it will face significant competition from companies like Nestle and Danone given their well entrenched positions in several key markets and geographies. A good example of this is ANZ where margins and earnings on branded products have taken a knock because of significant competitive pressures.
It is what it is...

The Fonterra Shareholders Council's reason for not supporting a farmer resolution at next month's annual meeting is an "affront to farmers' democratic rights", say the remit's promoters.
Fonterra shareholders Lachlan McKenzie and Ann Jones said the council, a 34-member farmer-elected watchdog of Fonterra's performance, had made a "hasty" decision in not supporting their resolution aimed at maintaining the current number of farmer directors on the Fonterra board, and "enshrining into our constitution what is normal good practice within co-ops".
The resolution, which will still be put to the vote at Fonterra's annual meeting next month in Hamilton, seeks to write into the dairy giant's constitution that there should be a minimum of nine farmer directors and that only farmer directors can elect the chairman, who must be a farmer.

Affidavits alleging political interference in the Fonterra election process have been sent to the co-operative's board and will be discussed at its next board meeting.
Rotorua based dairy farmer and former Fonterra director candidate Trevor Hamilton has sworn the affidavits which detail times, dates, meetings and conversations that took place prior to and after the 2011 director elections.
Hamilton is supported by a group of 20 farmers who have written to Fonterra's board calling on Fonterra chairman Sir Henry van der Heyden to stand down as a director once he relinquishes his role as chairman at the annual meeting in December.

NEW ZEALAND: Fonterra Set For Initial IPO
Fonterra, the world’s largest processor of dairy products, is reportedly looking to raise at least NZ$500m this month, by selling units in the Fonterra Shareholders’ Fund. According to reports, the farmers co-operative could price the units in a range of NZ$4.60 to NZ$5.50, which would give it a valuation of NZ$7.9bn at the upper end.

The proceeds of the sale are expected to go towards expansion into branded dairy products and building an integrated business in China, but could lead to tensions with its farmer members. The group insists it is launching the Shareholders’ Fund to improve its capital position and provide greater liquidity for its farmer-owners.

Currently, Fonterra must buy farmers’ shares when they choose to sell, but by letting them trade shares among themselves or with the fund, the group will not face any ‘redemption risk’. The units, which will be listed on the Australian and New Zealand stock exchanges, will not carry any voting rights but will pay a dividend from company profits.
NamNews - Tuesday 20th November 2012

Coles-Woolworths milk price war sparks Queensland's biggest off-season clearance of dairy cattle.
The Queensland Dairyfarmers' Organisation (QDO) said 50 farms had closed since the milk price war started in January last year.
Livestock agent John Cochrane warned the industry was on its knees. "I'm 57 and I've been in dairying all my life and I've never seen this volume of sales in November, ever," said Mr Cochrane, who said he organises most of the dairy cow sales in Queensland.

Fonterra has said that it does not intend to permanently retain the resulting equity.
Fonterra will put in the bulk of shares required for the Fonterra Shareholders' Fund following a muted response from its farmer members.

The dairy co-operative said farmers had taken a "wait and see'' approach in the supply phase of the fund, which will list on the NZX next week.

Fonterra said about 260 farmer shareholders had offered to sell economic rights of around 5.5 million Fonterra shares into the fund.

"It is clear that we have seen limited interest from farmers at this time,'' Fonterra chief executive Theo Spierings said in a statement.

Buy bye:

Fonterra fans thirsty for subscriptions
26 November 2012 | The Australian Financial Review | Sarah Thompson and Anthony Macdonald
PRINT: 26 November 2012 | The Australian Financial Review | PAGE 14 | Fonterra fans thirsty for subscriptions
Fonterra, a $10 billion company whose shareholders are mostly dairy farmers, will look to raise $NZ525 million ($413 million) for its Fonterra Shareholders Fund when the bookbuild kicks off in Auckland today.
According to its prospectus, Fonterra originally sort $NZ500 million.
But it seems an additional $NZ25 million of subscriptins on offer for Australian suppliers and Friends of Fonterra has also been snapped up.
Bids will start at $NZ4.60 a share, which represents 6.8 times forecast 2013 earnings before interest, tax depreciation and amortisation, with the top end range pegged at $NZ5.50.
Sources told Street Talk last night the number of fund managers who had indicated their support suggested the deal would be pricied above the midpoint range.
Fonterra's management wound up an exhaustive investor roadshow throughout Australia, Asia and Europe with site visits to processing plants and dairy farms in the North Island at the end of last week. Roughly 40 fund managers were present, with joint lead managers, Craigs Investment Partners-Deutsche Bank, UBS and Goldman Sachs crossing fingers that Asian investors, in particular, will choose to bet on the dairy thematic today.

Ex Oz AFR:
Fonterra's $NZ525 million equity raising closed well oversubscribed at $NZ5.50 a share, the top of the bookbuild range.
The dairy giant briefly considered re-pricing the deal, but decided it was better to have an oversubscribed offer than up the price and irrate investors....
Note to self: Think of this as value shift from old shareholders to new friends....

For completeness
At the offer price of $5.50, demand outstripped supply by a long way and there was a clear expectation that anyone who got their hands on some stock would make a killing.
Days before the stunning arrival of the Fonterra Shareholders Fund on the NZX, Chalkie heard grumbles about how little stock had been allocated to New Zealand retail and institutional investors.
Who got what was a closely guarded secret, but overall numbers released by Fonterra showed overseas institutional investors had received 42 per cent of the $525 million of units on offer. The balance went to local instos, clients of NZ brokers and "friends of Fonterra" who included staff and Australian milk suppliers.
At the offer price of $5.50, demand outstripped supply by a long way and there was a clear expectation that anyone who got their hands on some stock would make a killing.
And so it proved as buyers piled in on day one, pushing the price up to $6.85 at the close, on huge volume. The day's gain added about $125m to the value of the fund and about $2.2 billion to Fonterra's implied market capitalisation.
In just two hours, the value of trading in Fonterra Fund units exceeded the typical value traded on the entire NZX in a whole day.
This was a stockmarket debut with knobs on.
For comparison, Trade Me's first day on market a year ago generated about half as much volume, while Chorus, which opened a few weeks earlier, was a relative yawn at less than $20m.
In these situations, the upshot is what some people describe as a "transfer of value" - ie, the people who pay $5.50 get more value than those who pay $6.85. The question is, does it matter if 42 per cent of the value - about $50m, say - is transferred to foreigners?

Overall, farm prices are still around 25 per cent down from their historical highs recorded over 2007-8.
The introduction of Fonterra's Trading Among Farmers (TAF) share trading scheme has added a new dynamic to the market for dairy farms, and has potential to put downward pressure on farm values, Real Estate Institute of NZ rural market spokesman Brian Peacocke said.
"If the value of the shares increases, in our view that does not make the value of the whole asset increase in value," he said. "It simply puts downward pressure on the land value," he said.
We agree, the farm supply as a business is worth x (75% of 2008x) so as fonterra shares increase, so the value attributable to the farm goes down.
The units passed value from existing shareholders to new ones (by the amount of the listing premium - that invesntment banking advice was money spent.....)
The increase in fonterra share price once the unit mechanism in place has transferred value out of farms and into Fonterra.. Blessed are the executive........