Shock waves from Silver Fern Farms will now pulsate through the meat industry says Keith Woodford. The key question is how farmers will respond

Shock waves from Silver Fern Farms will now pulsate through the meat industry says Keith Woodford. The key question is how farmers will respond

By Keith Woodford*

Five months ago I said that whatever happened at Silver Fern Farms, it would be like an earthquake within the meat industry. Given that Silver Fern Farms is New Zealand’s largest meat company, and with the status quo unsustainable, it could not be any other way.

The offer that has now come forward from Shanghai Maling is remarkable. This offer, once regulatory approvals are received, will change Silver Fern Farms from being large but financially very weak, to being large and financially very strong. 

Apart from mid-season working capital, Silver Fern Farms will be debt free and with cash in their war chest to ‘take it’ to their competitors.

Shanghai Maling’s proposal to stake $261 million for a 50 percent share of the company is well outside most people’s expectations.  They have totally burnt off all other competing bids.  To now get a return on that investment, they will indeed have to make the value-add part of the business hum.  

Existing shareholders and employees must surely be ecstatic. CEO Dean Hamilton has truly ‘brought home the bacon’. Shares that were selling at 35c are now being valued by the bid at close to $3. But elsewhere in the industry, there will be lots of concern.

At Alliance, in particular, there will be some long faces. A year ago, they were confident that Silver Fern Farms was on its last legs. It seemed a reasonable assumption. Now it is Alliance which looks under threat.

The key reason for concern at Alliance is that they will now be the most vulnerable of the large meat companies with the least room to manoeuvre. Over-capacity is much more of an issue for sheep than beef, and it is in sheep that Alliance is ‘Number One’. In the long run, plant closures within the sheep industry are inevitable. Where will they come from?

The big question now is how farmers will respond, particularly in the South Island where co-operative principles have traditionally been regarded as important. Will some farmers now shift from Silver Fern Farms to Alliance?  Alliance will be desperately hoping this occurs. 

Co-operative principles are particularly valued by Meat Industry Excellence (MIE) farmers.   This group will be particularly incensed by the Shanghai Maling proposals.  If these farmers truly value co-operative principles, then they must surely now shift their allegiance to Alliance. If they don’t, then in the long run there will be no co-operatives in the meat industry. 

It seems likely that at Silver Fern Farms there will still be a supply co-operative. But let there be no doubt, regardless of the precise legal structure, the new Silver Fern Farms will not in practice be a co-operative.

Some people will ask whether or not it matters if there are no meat co-operatives. I think the answer is that, at least in the South island, it is the co-operatives that underpin prices at the farm gate.  In the North Island, where there is more competition, the influence of the co-operatives is neither as strong nor as needed.

Putting the co-operative issue aside, there is much to recommend about the Shanghai Maling proposal. Given their supermarket strengths, they are the ideal partner.   The strategic fit is much stronger than would have been the case with Brazilian company JBS, the most likely of the non-Chinese suitors.

There is need to clarify the financial structure of Shanghai Maling. Silver Fern Farms has described it as a subsidiary of Bright Foods, but has also said that Bright Foods only owns 38 percent of Shanghai Maling. I note that another report has said 58 percent.

Update (12.30pm 16 September 2015) I am now advised by a knowledgeable source in China ( Ivan Kinsella from NZTE) that Shanghai Maling is owned 32% by Yimin which is itself wholly owned by Bright. Also, Bright has a 6% direct share in Shanghai Maling. Under Chinese company law, a company is regarded as a subsidiary in situations where a shareholder can exert considerable influence even if the shareholding is less than 50%, and apparently this is the situation with Bright and Shanghai Maling. A lot of the other investors are government-owned investment trusts and the like.

Bright Foods has both previous and current experience in New Zealand.  It was Bright which became the cornerstone shareholder at Synlait Milk when capital was desperately needed, and at one stage Bright had just over 50 percent shareholding. But with the Synlait deal they never sought governance control, which in itself is remarkable.  Apparently they wanted majority ownership which gave them access to all the figures, but they wanted to stand back from management and overall control, and to learn from observation.  Subsequently their shareholding has declined to about 39 percent as other shareholders have come in, including FrieslandCampina.

My understanding is that the Japanese majority owners at ANZCO, New Zealand’s fourth biggest meat company, have also always left the New Zealand managers and directors to make the key operational decisions. 

Of course at this stage nothing is certain at Silver Fern Farms. There could be regulatory holdups. Also, at least in theory, there is an opportunity for New Zealand interests to match the Shanghai Maling bid.  However, no New Zealand interests, even if they had the finance, could make this particular investment work.  It needs a Chinese partner to manage the within-China supply chain.

In the absence of a local bidder, it is difficult to see the New Zealand regulators turning down the Shanghai Maling proposals. Without this Chinese partner, Silver Fern Farms slips back into the abyss. And that puts 7000 meat industry jobs at risk. No regulator would want to go there.

Nevertheless, the Shanghai Maling proposal will inevitably be very controversial. That is always the way with anything relating to Chinese investment. And with Bright Foods itself controlled by the Shanghai Government, some politicians, plus other groups and individuals, are going to have a field day.

Turning back to the overall New Zealand sheep industry, this coming year has the potential to be challenging both for farmers and processors.  For farmers, the lower exchange rates will cushion low prices in international markets. But for processors, the reduced kill compared to last season is likely to lead to intense competition for stock.

This highlights that the last twelve months have been atypical for the processors, with abnormally large kills of sheep due to drought and also large kills of dairy cows. For beef, whether or not the high kill rate will continue in 2015/16 will depend on the milk price and the season. But for sheep, a considerably lower kill in 2015/16 is already locked in due to less ewes and lower lambing rates.  Even without regard to the changes at Silver Fern Farms, the coming season will therefore be very challenging for the sheep processors.

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Keith Woodford is Honorary Professor of Agri-Food Systems at Lincoln University. He combines this with project and consulting work in agri-food systems. He will be writing a regular column here. His archived writings are available at http://keithwoodford.wordpress.com

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16 Comments

When will Fonterra follow SFF's path?

Is SFF a cooperative? Who will buy the shares if farmers abandon SFF in favor of Alliance, safe in the knowledge that med/long term SFF will only pay what they have to to secure supply, where as if Alliance remain true to undiluted co-op principles, will maximise return to supplying shareholders?

Putting the cooperative issue aside, is consigning farmer suppliers to where processing investors want them...the bottom of the heap.

It all stinks of backdoor politics!!! Either way farmers will be played.......

Peasant farmers scratch a living while the masters light cigars with $100 bills!

"Without this Chinese partner, Silver Fern Farms slips back into the abyss". What utter nonsense! SFF have signalled that they will have debt down to $140m by years end from $388 two years previous. There is absolutely no reason at all to be recommending this course of action given the long term consequences of losing control of the value chain. The truth is that the banks have stepped in to sort the overcapacity issue out given that industry leadership have continually kicked the can down the road. The one thing that Keith is correct about is the peril for Alliance, who's board have been arrogant and strategically inept .

Our wish? That Allan Richardson & Co. bring the co-ops together, with the interest shown by Shanghai Maling is converted to:
1. take-off contracts of 25 year plus, where they take volumes of product (sculpted for production cycles), at a minimum price/price range plus escalations.
On top of this would be a 50/50 jv that sales/markets/trades product to China.
- supply contracts backed to farm gate supply (like ss to a milk processor)

2. the cash element could take out term debt for all the co-ops.

Notes:
The terms of trade would be similar to other resources export contracts e.g. gas. Generally speaking selling resource/commodity by long term take-off contract with price flex is better than spot price and a sales relationship.

Point is, a buyers strike (like what has happened with wmp since the China change of policy Jan this year) must be avoided

As an aside in terms of Fonterra / Beingmate funny how the money went the other way. :)

For folk against "industry-wide arrangements", look at the China D20 Dairy Group and the way the China dairy industry is being shaped/directed.

Will the other companies now get the same acess to Chinese markets or will they be cut out by SFF?

of course not, my mate first. apply every where in this world.

If this is the case, with a many of the companies selling 40% sheep meat to China it could get interesting.Meat company reps say lamb prospects not looking that good, Chinese and European economy not looking good. Interesting timing for this sale. Beef looking like a better bet at the moment? Some big changes being pushed through by this government. Chinese city investors with big ideas buying average land in our area for big money it's all getting a bit silly considering world economy looking shaky.

many moons ago - I think it might have been during the reign of muldoon, was just getting interested in the stock market at a time when the NZ Stock Exchange was twice the size it is now, my boss who was a smart and patriotic Finance CFO person, preached to me that I should invest in agri businesses, because what is good for the agri-sector is good for new zealand and thus will be good for me. I went through the entire list of stocks, where, apart from R&W Hellaby and a couple of other freezing works, there was only 1 listed agri-pastoral-farming company. So I bought some shares in it. It was so stunningly un-sucessful I cant even remember the name of it. I think I lost most of it. The company is no longer around - gone

Now today,
how many listed agri-farming companies are there available that I could go and get patriotic with?

Has much changed in 35 years?
And this is New Zealand's backbone?
And this is where it's at so many years later?

LOL - if it was around 1978 - there were massive tax breaks against other business income to capitalise farm infrastructure? Many Public Trust farms were bought by family trusts where the controlling trustees were the principal partners of city stockbroking firms - hence the term Queen Street farmers. Waitaki NZR could be the name you are looking for.

I don't think this is the issue, does this deal give SFF a monopoly on sales to China? Or do our laws protect against this?

Better ask the Boss

His [President Xi Jinping] exhortation to maintain basic food security is embodied by this mantra:
"The food bowl of the Chinese people must always remain firmly in their own hands."
http://dimsums.blogspot.com.au/2015/09/study-xi-jinpings-rural-thought.html

Well we see this thinking in the wmp buyers strike (fta what) from January this year, knowing this SFF must be pressing for committed volume off-take, non?

Well quoted, Henry. Food security is a critical issue in maintaining Party control. And the Party has no intention of paying New Zealand or anyone else restaurant prices.

We will see the value chain in every agricultural purchase (notwithstanding a palatable 50-50 agreement to start) pass 'firmly [into] their own hands'.

We're told that investment in here provides capital for New Zealand companies. In truth it rescues debt-laden firms. Which means it pays out the banks.

China has no interest in being a source of capital to build New Zealand businesses. It is unwaveringly determined to secure its own interests in internal stability and external compliance and cost-control. The same strategy is evident in every other global commodity sector.

Yes.
And it may not just be restaurant price.
Who would have thought that once you got an FTA, and more to follow (Oz), you'd stop buying (preferring to pay 30% plus more).
In the material posted ex China, we found nothing about FTA, NZ supply, all references to non-local dairy, as imports, or local firms following the old "go global" theme, taking their operations off-shore..

http://www.interest.co.nz/rural-news/77513/keith-woodford-says-our-dairy....

Aside from Bingmate, Fonterra with its local farms didn't make the cut for the D20.

What matters in this phase of investment for China is ensuring it has sources of supply in the bank. Fully exploiting these sources of supply is another, secondary issue.

The process is the same in minerals and other resources. Securing agricultural supply is no different from securing mining rights. Once secured they can be parked.

The pressure to exploit its agricultural investments, which means controlling supply, with its costs and prices, is however somewhat more pressing. Barely a generation ago, most Chinese grew their own food. They were largely self-sufficient. Life in tower blocks, of course, makes this impossible.

In China's accelerating urbanised world, food security at acceptable prices is essential to political and social stability. In New Zealand's case there is no Chinese strategy to obtain and pay for premium food products (and it's questionable if we have any at scale). It is about getting hold of a value chain and being ready to plunge its costs.

The Chinese calculation is simple. Chinese consumers earn so much. New Zealand agricultural earnings (costs, wages, profit, etc) are at this other level. Which of these is the easiest to move?

So how have the trade policy heads and old hands from the China desk seem to have missed it thus?

Oh for just last year....
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=1122...
It confirms that the advantage bestowed when New Zealand became China's first partner in a free trade agreement in 2008 remains intact. This was re-emphasised when President Xi confirmed that he planned to accept an invitation to visit this country shortly before or after the G20 in Brisbane in November.

There is, obviously, huge potential for New Zealand in the new trade goal. Historically, it has run a deficit with China, but last year it sold almost $2 billion more to China than it imported. The respective populations of the two countries suggest that gap should increase much further in New Zealand's favour over the next few years. China will have to, as Mr Key suggested, "drink a lot more milk, and they're up for that".

or shall we be saved by those same Policy determinators and their stunning Plan B.