Farmers vote yes to internal share trading

Fonterra’s suppliers have overwhelmingly supported the dairy giant’s third stage of capital restructuring.

With an 80% participation rate, 89.85% of voters supported stage three – Trading Among Farmers after giving the green light to the first two stages last year.

Fonterra chairman Sir Henry van der Heyden said farmers voted in record numbers. Those who voted represented 77.77% of the company’s total milk solids.

“I am delighted with this because, for me participation in the co-op is as important as the outcome and it is something that the board has made a priority,” he said.

Sir Henry said the move to Trading Among Farmers would be a lasting solution that would remain at the core of the cooperative’s capital structure for many years.

“Effectively our vote today… will, together with the co-op’s new retention policy, take capital structure off the table for the foreseeable future.”

He said support for the change showed a clear awareness and understanding among farmers of the need to evolve and further strengthen Fonterra’s capital struture.

“We knew when Fonterra was formed nine years ago that we would need to evolve our co-op’s capital structure and develop a durable solution to address redemption risk.”

In a statement, Fonterra Shareholders’ Council chairman Blue Read said shareholders have delivered a strong and decisive mandate that will give the business certainty.

Trading among farmers is the vital third stage of a three step plan that removes share redemption risk from Fonterra.

Today Fonterra chairman Sir Henry van der Heyden repeatedly reiterated to shareholders his commitment to ensuring the company was 100% controlled by farmers.

In a speech made before results of the vote were known, Sir Henry touched on the embarrassing failure in 2007, when the board floated an idea about a partial listing on the stock exchange.

The concept never made it to the vote after farmers vehemently voiced their opposition against such a proposal.

Removing the risk
Out of that, a new phase of consultation was developed to change the company’s capital structure in a way that would retain its total farmer control and also strengthen its balance sheet, without the injection of fresh capital from outside investors.

Last year farmers agreed on the first two stages of the proposal, which set a new share price structure and also allowed farmers to increase their shareholding beyond 100% of milk production.

The final third stage proposal farmers voted on today removes the redemption risk of the company.

This was really the most important feature of the planned changes. Stages one and two gave farmers more flexibility in terms of managing their shares.

Because the shares were linked to milk production, when the final tally was completed at the end of the season, farmers were either required to buy more shares reflecting a boost to their production, or Fonterra had to cut them a cheque – essentially buying back the shares that weren’t required reduced milk flow.

This proved to be a massive problem during the 2007/08 season when a near-nationwide drought led to plummeting production levels. The net result was a $600 million hit to Fontera’s equity when it had to redeem shares.

Exclusive farmers' sharemarket
However, the redemption risk was already reduced slightly with the decision last year to allow farmers to hold more shares, up to 120% of production.

While farmers could still have opted to redeem shares if their production fell, the new 120% cap meant they did not have to. Essentially, the shares linked to milk production would have fallen, but they would have been left with the remainder in “dry shares.”

These are essentially the same and still attract a dividend, but have no voting rights.

This means the increased share cap can be used as a type of buffer at the end of the season, especially if production falls.

If an individual’s production increased, shares would still be needed to cover that. However, those who already bought extra shares would have a similar buffer and might not have to shell out more.

To completely eliminate the redemption risk, Fonterra’s Trading Among Farmers concept, once enacted, means farmers will have to buy and sell their shares on an exclusive market to other shareholders.

Risky times
Fonterra has already identified the risks it sees in the future.

Sir Henry said today that New Zealand’s milk supply couldn't keep growing the way it has been.

“Also there are physical limits to the expansion of dairying and alternative land uses may take some land out of dairying in years to come,” he said.

“If there’s a limited pool of milk, other processors will always want a slice of the action and we may see some well-capitalised competitors over overseas competing with us for milk.”

This threat is a clear and present danger with the well-publicised plans of UBNZ and Hong Kong-listed company Natural Dairy (NZ) Holdings and their $1.5 billion plan to buy up farms and milk processing capacity in New Zealand.

Russian company Nutritek already has a foot in the door with its ownership of New Zealand Dairies in Canterbury and Open Country Cheese has been increasing its production base at Fonterra’s expense for years.

Using its global muscle
Opponents of the plans such as Open Country have suggested to Fonterra shareholders that they will be locked into the company with the stage three proposal and will find it more difficult to exit supplying the company if they choose.

This month, that theme was reiterated by the US Dairy Export Council, which wrote to Agriculture Minister David Carter about its concerns the move would further strengthen Fonterra, which dominates global dairy trade at the expense of other exporters.

But, Sir Henry is unapologetic about the proposal and it is no secret that Fonterra wants to use its global muscle to further improve its prospects.

“The cold hard reality is that there’s every chance our co-op will have periods of lower growth in our milk supply at some stage in the future. And, with the current capital structure – and the need to pay cash to farmers reducing supply or exiting – Fonterra’s balance sheet would come under acute pressure,” he said.

“This could happen quite quickly and it would be very difficult to fix our capital structure while Fonterra was facing this sort of financial crisis.

“None of us want to see that,” he said.

Funding strategies
Fonterra chief executive Andrew Ferrier said permanent share capital would allow the company to invest, with confidence, in long-term opportunities that build on its global competitive advantage.

Mr Ferrier said opportunities and plans under each of the company’s strategic themes, many of which have “hefty price tags and require significant chunks of capital.”

“That’s partly a reflection of our scale. If we want a project to be meaningful in terms of our own business and that of our customers, it’s usually got to be a certain size to be even worth considering.”

Mr Ferrier said with the confidence that comes with having permanent share capital, the company can do more, sooner.

“Which should mean better shareholder returns, faster.”

2 · Got a question about this story? Leave it in Comments & Questions below.

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2 Comments & Questions

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Could this lead to suppliers being price takers, or reduced returns at the expense of those holding shares in the export sales?

This is a strong possibility, with a collection of 5% shareholders being able to have a significant input on its board composition & future decisions.

While this may not happen in the short term, I'd put money on this being an eventuality. Mark my words, a few big players will be dictating the terms of the split in distributions within a ten year period.

The next big questions is will they be local?

Sad to say it, this model has been designed for future overseas interests!!!

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Richard S has hit the nail on the head but NZX control of the information to the farmers and a great PR job has distracted farmers from the dangers that lie ahead. Aggregation of the influence of a few 5% players will dictate the direction of the company and an undervalued share structure is difficult to sustain.
It will be up to those who are designated "farmer shareholders"

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