Q+A - Craig Norgate and Lachlan McKenzie

Sunday 24 June, 2012

Greg Boyed interviews Craig Norgate and Lachlan McKenzie

Former Federated Farmers Dairy chair - still a Fonterra supplier - Lachlan McKenzie doesn't think the Trading Among Farmers scheme will go ahead.

But the company's former boss, Craig Norgate, sees it from the other side and is absolutely confident farmers will give it the green light.

Fonterra's farmer vote will ultimately lead to overseas investors and shares going offshore, says former Federated Farmers Dairy chair Lachlan McKenzie.

But former Fonterra chief executive Craig Norgate says Fonterra's constitution is designed to protect farmers.

McKenzie says farmers already take huge, significant and calculated risks, but argues this risk isn't the right one.

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Q + A
Greg Boyed Interviews Craig Norgate And Lachlan Mckenzie

GREG Fonterra is our biggest company this week, and it’s having the biggest vote in its history. The result will be known tomorrow. The company wants to introduce something called trading amongst farmers. Right now, Fonterra shares are held exclusively by farmers. Fonterra wants to raise capital by creating a shareholder fund where non-farmers can buy shares that return a dividend but don’t have any voting rights. Critics are calling the scheme the start of New Zealand’s other asset sale, preparing Fonterra for privatisation. Former CEO of Fonterra Craig Norgate wants the trading to go ahead. Lachlan McKenzie, a Rotorua farmer who used to be head of Federated Farmers’ dairy section, thinks it’s a bad idea. Welcome to you both. First of all, Craig, why does this have to happen at all? Why does there need to be a change?

CRAIG NORGATE – Fmr Fonterra Chief Executive
Yeah, well, there’s been debate on this now for over 10 years, since before Fonterra was formed, and it’s holding the company back quite significantly. The strategy that they released just last year is very similar to one that was in place when it was formed, but the directors really can’t afford to pursue that strategy with vigour because they’ve got the spectre of redemption risk in terms of having to redeem farmers’ capital at the drop of a hat. And you can’t run a sustainable business like that.
GREG Why—? Does that point to a fundamental mistake with how it was set up in the first place?

LACHLAN MCKENZIE – Fmr Federated Famers Dairy Chair
Fonterra’s got a share valuation problem. As a cooperative, it is the most efficient way of getting export dollars down to provincial New Zealand and to farmers, so that’s how New Zealand benefits. What this scheme is looking about is changing the capital structure of Fonterra so a percentage of the profits from Fonterra, instead of flowing to farmers, flow to outside investors, and that will inevitably lead to, you know, investors from offshore. So at the moment, 100% of the milk price, 100% of the profits flow back to provincial New Zealand and it benefits New Zealand. No other structure provides that benefit to New Zealand.

GREG Craig, how do you do that? We’ve heard about firewalls, we’ve heard about safeguards, but you are getting outside money, non-farmers in. How do you prevent them having a say on things like milk prices?

CRAIG Well, at the moment, the milk price is very transparent. It’s codified. It can’t be changed at the drop of a hat. So if you look at the overseas models that people are concerned about, they’re independent people that actually could dictate what happened with our milk price. Farmers can be very comfortable with the current proposal. It cannot be changed. You know, there’s things enshrined in constitution to protect farmers in respect to the milk price, and that is the core of it. And it’s not actually outside investors that’ll decide whether they can invest in New Zealand; it’s actually farmers themselves. Farmers have to decide that they do not want the returns from their shares, and those farmers that don’t want those returns have to have a mechanism to be able to sell them, and so that’s what this is about. It’s how can we set up that mechanism without creating a run on the co-op, which is actually a far greater threat to what Lachlan’s concerned about than anything else.

GREG Lachlan, I see you shaking your head there. You obviously don’t buy into that.

LACHLAN Well, if you look around the world, it doesn’t matter whether it’s Kerry in Ireland or the grain groves in Australia, it’s always been about six or seven votes that the owners of the cooperative demutualise their business. So this is, I believe, the first step. You mention that Fonterra needs the capital. This is not about raising capital for Fonterra. Fonterra’s balance sheet has gone from about 60% debt in 2007 to only 39% debt now. It’s got a very strong balance sheet in that regard, and, in fact, the debt has shrunk. This is all during a world economic crisis. No other business in the last two years – there’s about $925 million of capital came in from farmers in New Zealand into Fonterra.

GREG Craig, on that point, there’s enough in the kitty to borrow around a billion dollars. Surely that’s enough to get overseas and buy whatever’s needed to make this whole thing go forward.

CRAIG But no prudent director in the current environment is going to take the risk of actually spending that balance sheet capacity when you’ve got a situation that is as fragile as it is.

GREG But if it’s a risk and it’s fragile, why is anyone else going to buy into it?

CRAIG Well, the reality is there’s a huge appetite for what is deemed to be safe investments, and so what you’ll find here is that for most investors, they’re not interested in this Fonterra fund. But for some, just a very small proportion, they’d like some of their money to be sitting in that space. That is money that the farmers themselves can put to work on the farm and producing more for New Zealand, so this will release a lot of energy for farmers in terms of being able to invest in our businesses.

GREG Okay, there’s term that’s central to all this, and we’re going explain very very quickly— that I think is central to it as well. One of the main reasons this is happening is redemption risk. In layman’s terms this means stopping farmers wanting out and basically taking their money with them and out. Is this going to stop redemption risk or not?

LACHLAN No. All it does is it’s like a big merry-go-round. All we’re doing is shifting the redemption risk, because there’s capital redemption and milk redemption risk to a manufacturing processor like Fonterra. All we’re doing is shifting it from the company, for the co-op, a selective of the co-op, on to individual farmers. In the process we’re allowing outside investors to have an equity. If they just so choose to exit, then that redemption risk is still there, so it’s a big merry-go-round. All we’re doing is shifting it from the collective of co-op. In the process, though, what we’re doing is taking it from a core cooperative which has maximised the benefit back to New Zealand to a farmer-owned business which then has the risk of outside investors and some of the profit that comes back to New Zealand now flowing to outside investors.

GREG Craig, on the other side of this, if you’ve got farmers who are unhappy and want out whichever way this vote goes, you’re going to have a big redemption risk anyway, aren’t you?

CRAIG I don’t think there will be very many farmers that leave for this reason, and, frankly, they’d be gone already if that was the case. I think there’s a red herring. I mean, Lachlan talked about the Kerry example. I know it very well. I’ve studied it for over a decade. Part of the reason why we structured Fonterra’s capital structure the way we did was to avoid the Kerry situation. This is not the first step in a Kerry-type environment. This is not about taking the Fonterra business and listing part of it. The previous proposal did that, and the shareholders spoke and delivered a real message to the board, and, frankly, that’s the biggest strength and protection that farmers have got.

GREG What about the simple thing, Craig, of farmers losing control. Heard a great quote from a farmer just the other day – I forget who he was – saying that people are going to buying in whose only relation to milk is the froth on their cappuccino. They’re not going to know about farming, and farmers are going to lose some control.

CRAIG But you’ve got to ask what they’re buying into. They’re not buying into Fonterra. They are buying into a derivative of Fonterra where they can get access to part of the dividend flow. It is not selling shares of Fonterra.

GREG But is this the first step to selling shares in Fonterra and they are going to be able to buy in Fonterra in four, five, six, 10 years’ time, whenever it’s decided this didn’t work that well?

CRAIG No. I mean, there is no connection between the current proposal and what is required to actually create that sort of situation, and that is where some of the misgivings about the proposal are misplaced.

GREG This is a very divisive issue. There’s 10,500 farmers in it. What is enough of a yes vote for this to go ahead, in your opinion?

LACHLAN Well, normally— well, the constitution of Fonterra says a 75% vote to change the constitution, and that’s there for a very good reason. Cooperatives by their very nature have a diverse shareholder base, and so to change the constitution from basically a cooperative as it is now to a farmer-owned business, there should be a vast majority – in the constitution now, a 75% vote.

GREG Craig, 75%?

CRAIG Yeah, 75% of farms already voted for the principles of the scheme. What we’re now talking about is the detail, and Fonterra have agreed to go back to farmers to make sure that they are comfortable with the detail. I don’t believe that a 50% endorsement would be enough, but I don’t think we can also be religious that it has to be 75%, because you can’t have 25% of farmers holding the rest of them to ransom.

GREG Let’s talk about these firewalls. What firewalls are actually there that are going to stay there to stop the people who do buy in not having a vote on things like milk prices and so on?

CRAIG Well, the constitution, for a start, so Lachlan’s 75%. You’d need 75% of farmers to actually change the constitution to move away from the scheme that is now proposed to one where those outside investors have any say at all.

LACHLAN But it’s farmers that will vote for change going forward. There’ll be economic drivers. With the sheer fluctuation in share price, it’ll be those economic drivers, and we’ve seen throughout the world it’s those economic drivers that then determine for farmers the change and to vote for change going forward. This in itself is not going to create that, except for we’ve now gone away from a focus of long-term sustainable milk price to an investment company. So that step in itself is the first step to change the focus. Farmers are ringing me up and saying, ‘What is the share price going to be? What do you think the share price is going to be?’ rather than, ‘How is Fonterra going to maximise my milk price?’

GREG Is a no vote more about a fear of change, and is it going to hold Fonterra from going forward?

LACHLAN Absolutely not. We are not risk-adverse people. We take huge risks. We borrow a significant amount of money. And you’ve seen the growth in dairy in particular over the last few years, over the last decade or so We are a growth industry. We take risks, and we understand those risks, but we do significant analysis and we take calculated risks.

GREG Okay, a couple of quick questions for both of you. Are you confident this is going to not go ahead, or you think it will go ahead? What’s your gut feeling?

LACHLAN That most of— 70— 80% of the farmers have already voted. I think that’s a good turnout. There will be more voting on Sunday. I don’t think it’ll go ahead.

GREG Craig?

CRAIG I think farmers through time have always proven that when it comes to the crunch, they make the right decisions, and I’m absolutely certain that they’ll support this one.

GREG Fonterra’s the biggest dairy company in the world. If this doesn’t go ahead, is that going to change?

CRAIG Yeah, I think there are real risks to the future of Fonterra. It has been 10 years of constant debate around capital structure, and that is holding the organisation back. It has not delivered on what was promised a decade ago, because it has not been able to make the investments that it needs to. And it will have to go back to the drawing board again if this vote doesn’t go through.

LACHLAN There are cooperative solutions, though.

GREG All right, to both of you, thank you very much for your time.

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