Fonterra’s shareholders not obliged to save the country

Recent articles on Fonterra’s capital restructuring proposal have suggested shareholders are missing a big opportunity by retaining complete control of their co-operative. Opinions in the NZ Herald and Sunday Star Times include Brian Gaynor who reckons 51% of a well capitalised company provides more certainty than 100% of a more highly leveraged one, Rod Oram who considers farmers are short-changing themselves, their co-op and the country, and Deborah Hill Cone who thinks a listed Fonterra would be sexier than a farmer-owned co-operative.

 

Gaynor is correct, although shareholders now have the chance to acquire more equity, Oram’s contention is supported by logic, while Hill Cone’s comments are more entertaining, if lacking in depth. They all make a good point, but they have forgotten to ask farmers whether they feel an overwhelming responsibility to save the economy just because they represent over 20% of New Zealand’s exports. Dairy farmers only have a financial responsibility to themselves and their families, while their primary business obligation is to supply milk produced in an environmentally responsible way for the tanker to collect.

 

To listen to commentators and politicians, you would think farmers had accepted an obligation at the time Fonterra was formed to ensure their co-operative earned maximum returns for the country as a whole. Dairy farmers are variously seen as the engine room of small town New Zealand and ultimately the salvation of the economy. I can find nothing in the Dairy Industry Restructuring Act to suggest they were expected to take on this responsibility which the Government now seems to think was implied by the merger of NZ Dairy Group, Kiwi and the Dairy Board.

 

Commentators ignore the fact dairy farmers’ on-farm investment is seven or eight times bigger than their shareholding in Fonterra. They also question how Fonterra can possibly become a global food giant capable of competing with Kraft, Danone and Nestle under the capital constraints of co-operative ownership.

 

Alex Duncan, Fonterra’s General Manager Strategy and Corporate Finance, says the company’s prime focus is to process the highest quality raw material for its international partners rather than build a global consumer branded food business in it own right. In his words Fonterra is “the only game in town” for these global food businesses which need consistent, high quality raw material supply.

 

He also says Fonterra will have enough capital, if shareholders approve its capital restructuring proposal, to be able to achieve vertical integration of its investments downstream to the farm gate and upstream to the consumer where control of the value chain is seen as necessary and to pursue joint ventures where these make sense. Vertical integration is an approach generally restricted to Asia and Australasia, while JVs are generally preferred in the rest of the world, like Dairy Partners Americas with Nestle.

 

The justification for creating Fonterra back in 2001 was accompanied by exaggerated claims about what the combined company could achieve and people, both inside and outside the company, believed a lot of the hype. I recall the engagement of an international marketing guru for whom the colour yellow was the most important aspect of any proposal (he had been responsible for the Lipton’s Yellow brand) and who was convinced he could make Fonterra a branded consumer foods business. That ambition now seems to have been tempered by a realisation the company’s strength lies more in business to business relationships, borne out by the proportion of added value business in the payout.

 

So Fonterra has concluded it should concentrate on expanding what it already does well, working in partnership where it makes sense, reducing debt levels through a more appropriate retention policy, strengthening its share structure to avoid excessive redemption risk and reducing share valuation volatility. Working with partners at different points of the value chain makes it possible to take advantage of other parties’ capital at a lower cost, while ensuring those partners have an investment in the success of the business.

 

If Fonterra’s shareholders accept the challenge of increasing their investment in their company and recognise the importance of retaining funds for investment, there should be sufficient capital to follow the present business strategy. I don’t think they should be expected to do any more.

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