Three-step process to strengthen capital structure

Three-step process to strengthen Fonterra's capital structure that retains 100% farmer control and ownership

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The Board of Directors of Fonterra have started consulting with farmer shareholders on a three-step process that, if accepted by farmers, should take care of Fonterra’s capital needs for about the next five years and would retain 100% farmer control and ownership of their Co-operative.

The capital structure review aims to stop large amounts of money washing in and out of Fonterra’s balance sheet each year as milk production fluctuates. It also seeks to ensure the Co-operative has the share equity needed to fund profitable business opportunities so as to drive a higher payout to dairy farmers.

The three steps suggested to evolve Fonterra’s capital structure are:

1. Strengthening the Share Structure. Farmers would be allowed to hold shares up to 120% of their milk production (for most farmers, the current limit is closer to 100%) and there would be enhanced incentives for them to hold shares even if their production falls. The rules about the pricing of end of season share transactions would also be tidied up.

2. Restricted Share Value. The way Fonterra shares are valued would be adjusted to reflect that share ownership is restricted to farmers only. As this would likely result in a lower share value, there would be a transition process to deal with any impact on the share price.

3. Trading Among Farmers. Fonterra would move to a system where farmers buy and sell shares among themselves, rather then transacting through the Co-operative.

Fonterra’s farmer shareholders will be consulted on the first two steps at meetings around the country over the next fortnight and throughout October. If feedback is positive, proposals taking account farmer feedback would be finalised and put to the vote at the Annual Meeting in Ashburton on 18 November. If the first two steps are approved, the third step could be discussed and voted on next year, with implementation possibly in 2011.

Fonterra Chairman Sir Henry van der Heyden said the Board had spent the best part of a year developing a completely fresh set of options on capital structure change, and had been discussing them with the Fonterra Shareholders’ Council since early 2009. The Board and Council had agreed unanimously to take the three steps out to consultation with farmers.

“Many of our shareholders have made it clear that they want to retain 100% farmer control and ownership of their Co-operative. They have also indicated they are prepared to support Fonterra’s ongoing growth by providing additional capital to fund profitable business opportunities,” Sir Henry said.

“The options we are discussing with farmers would strengthen the capital structure and make Fonterra more adaptable and competitive in the international marketplace. They seek to encourage farmers to maintain or increase their equity in the Co-operative.”

Sir Henry said each step of capital structure change would be considered by farmer shareholders separately and would only proceed with a 75% vote in favour.

He said the key to improving Fonterra’s capital structure was reducing and eventually eliminating redemption risk. Redemption risk occurs because Fonterra’s share levels are related to milk production and the Co-operative is responsible for buying shares back off farmers when they want to redeem them. After milk production fell during the 2007/08 drought, for example, Fonterra had to pay out $742 million of equity to farmers via redemptions.

“To be successful and achieve the best possible payout for farmers, Fonterra can’t afford to have hundreds of millions of dollars washing in and out of the balance sheet every time milk production fluctuates, for whatever reason,” Sir Henry commented.

“We need certainty in our equity base to invest in dairy processing operations so as to drive a higher payout. These investments require capital and are long-term commitments – the stainless steel of a new processing plant, for instance, has a useful life of more than 30 years.”

Sir Henry said the success of the suggested capital structure changes would ultimately depend on how much additional capital farmer shareholders were prepared to commit to their Co-operative. It was difficult to estimate how much new equity might be raised from farmers, but the Board believed it should be enough to fund Fonterra’s needs for about the next five years.

“The Board and management remain totally committed to the Fonterra strategy, as we believe this is the best way to ensure Fonterra shareholders receive the highest possible payout on a sustainable basis,” he added.

ENDS

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