Cablegate: Fonterra - New Zealand's Largest Company Plans To
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FM AMEMBASSY WELLINGTON
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UNCLAS SECTION 01 OF 05 WELLINGTON 000847
EAP/ANP, EEB/TPP/ABT, STATE PASS TO FAS KHALIKA MEARDY -
OCRA, PAUL KIENDL - OGA, JIM DEVER - OFSO, COMMERCE FOR
ITA/MAC/AP/OSAO, PACOM FOR JO1E/J2/J233/J5/SJFHQSTATE
E.O. 12958: N/A
TAGS: EAGR ECON EFIN ETRD PREL NZ XV
SUBJECT: FONTERRA - NEW ZEALAND'S LARGEST COMPANY PLANS TO
FLOAT FIRST INITIAL PUBLIC OFFERING
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1. Note: This is a joint Foreign Agricultural Service and
State report. End note.
2. Summary. Fonterra Co-operative Ltd, New Zealand's
largest company is beginning a two-year consultation with its
farmer shareholders whether to approve a preferred capital
restructuring option. If approved, Fonterra would transfer
its assets, liabilities and operations to a separate company
that would be listed on the stock exchange in 2010. Outside
investors could purchase up to 20 percent of the shares,
which would enable Fonterra to raise capital for planned
expansion into overseas markets, primarily China, other
countries in Asia, and South America. Fifteen percent of the
shares would be provided to existing farmer shareholders and
the remaining 65 per cent would be held by the co-op.
Fonterra controls nearly 40 percent of global trade in dairy
exports, and its 2007 assets of NZ$12.6 billion (US$10.1
billion) and revenue of NZ$13.9 billion (US$11.2 billion)
mean it could eclipse the currently largest listed company on
the New Zealand Stock Exchange - Telecom. While potential
investors have responded positively to the plan, Wall St.
expressed cautious optimism but the initial reaction of
farmer shareholders has been mixed. End summary.
Who Is Fonterra
3. The Fonterra Co-operative Group was formed by the merger
of New Zealand Dairy Group, Kiwi Co-operative Dairies, and
the New Zealand Dairy Board in late 2001. The group is owned
by its 11,000 dairy farmer shareholders and is the world's
largest exporter of dairy products, exporting 95 percent of
New Zealand's production. Fonterra controls about 40 per
cent of world dairy trade and exports to more than 140
countries with 32 per cent going to Asia, 25 per cent to the
Americas, and 21 per cent to Oceania. With its 2007 assets
amounting to US$10.1 billion and revenue of US$11.2 billion
Fonterra could eclipse the currently largest listed company
on the New Zealand Stock Exchange - Telecom. Fonterra is
considered a "partnership model" because of the growing
number of foreign companies with which it has established
partnerships. This strategy enables it to access dairy
markets where dairy demand is met by local supply.
Partnerships, such as joint ventures, give Fonterra market
access without major capital investments and financial risks,
while providing mutual benefits to both companies.
4. In North America, Fonterra has already teamed with Dairy
Farmers of America, the largest farmer-owned dairy
cooperative in the U.S. The resulting partnership,
DairiConcepts, produces and markets milk protein
concentrates. Fonterra has also entered into an agreement
with Dairy America, a federated marketing cooperative, to
serve as the marketing agent for the nonfat dry milk received
from its members (seven U.S. farmer-owned dairy
cooperatives). In the U.S. market, Fonterra is a buyer and
an exporter of U.S. nonfat dry milk to other foreign markets.
Its other partnerships include joint ventures with Nestle
through Dairy Partners Americas in South America, Arla Foods
in the United Kingdom, Clover Industries in South Africa, and
Britannia Industries in India. Fonterra is the world's
largest dairy ingredients company, but is also a supplier of
consumer branded products, such as its Anchor brand butter,
Anlene brand milk powders, and Mainland brand cheese
products. Fonterra has a major stake in the Australian dairy
company, Bonlac Foods Limited, and has undertaken the formal
merger of both companies' consumer products operations in
Australia and New Zealand.
Fonterra Announces IPO
5. On November 15, 2007, Fonterra, the largest company by
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turnover in New Zealand and the world's fifth largest dairy
company by revenue, presented for consideration to its
members, six options for a fundamental capital restructuring,
including the Fonterra Board's preferred option that would
result in the co-operative listing its business operations in
a separate company, while maintaining a controlling interest.
Under the preferred option, initially farmers would own
about 80 per cent of the listed entity, 65 per cent through
the co-operative and around 15 per cent through their own
shareholding in the listed entity. The remaining 20 per cent
would be available to the public. Fonterra wants to change
its capital structure to address three pressures on its
current structure - redemption risk, investment choice for
farmers, and the need for a secure and expanding capital base
to implement its growth strategy. The preferred (i.e.,
announced) option was the only one of six the Board
considered that would achieve all three goals.
6. Two years of consultations and two rounds of shareholder
voting will be required in order to implement the initial
public offering (IPO). In May of 2008, Fonterra's 11,000
shareholders will vote on whether to allow Fonterra to change
to the two-entity structure and to adopt a more transparent
milk pricing system. The milk price system will be used to
determine the price by which the co-op transfers milk
produced by shareholders to the new company. The second
vote, which will probably be around May 2010, will determine
whether to let Fonterra list on the stock exchange in order
to generate external capital. In both ballots, 75% of
shareholders must vote to approve the measures.
7. Of the six options presented to members by the Fonterra
Board, the preferred option was the only one that would
achieve all three goals of implementing growth strategy,
reduce risk, and create flexible investment choices for
farmers. The start of the consultation process comes two
months after Fonterra announced a record payout to suppliers
of NZ$6.40 (US$5.12) per kilogram of milk solids. "While
NZ$6.40 (US$5.12) is good for farmers, it doesn't give the
Co-operative the capital to implement our strategy," said
Fonterra's Chairman, van der Heyden. "It may lessen the
redemption risk for a while, but that is debatable because
our shareholders can choose to redeem their shares regardless
of the level of payout. And NZ$6.40 (US$5.12) does nothing
to address shareholder investment choice," per van der Heyden.
Pre-Conditions for Fonterra Listing on Stock Market
8. The following conditions must be met before the IPO can
- 75 per cent farmer shareholder approval to create parent
co-op and operating subsidiary and a transparent milk
pricing system (to be voted on by 11,000 Fonterra farmer
shareholders in May 2008).
- A competitive milk pricing mechanism.
- Superior business performance across Fonterra.
- Acceptable share market conditions.
- Acceptable listing value for current shareholders.
- Acceptable legislation to support necessary changes.
- 75 per cent farmer shareholder approval in second vote
(expected around 2010) of listing and raising external
Floating Fonterra: Process, Structure, Safeguards
9. The process calls for two years of consultations and two
shareholder votes. The first vote is scheduled for May 2008.
Fonterra farmer shareholders will vote on: splitting
Fonterra into two entities - a parent co-op and a separate
company with manufacturing and marketing responsibilities;
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and a milk pricing system that determines the price for
transferring milk from the co-op. The second and final vote
is expected around May 2010. Shareholders will vote on
listing on the stock market and raising external capital. In
both votes, 75 percent approval of shareholders is required
for the measures to pass. The two-year consultation process
will provide farmers with a chance to assess how the milk
pricing system is working before voting on the listing
10. Under the preferred option, the assets, liabilities and
operations of the current co-operative would be shifted to
the new company. The co-op and its farmer owners would
retain a 65 percent stake, 15 percent would be distributed to
farmers, and an additional 20 percent would be issued to
external shareholders. Farmers would have the option of
selling their shares on the stock market or keeping them.
11. The preferred option includes contractual,
constitutional and legislative safeguards to help ensure New
Zealand farmer majority ownership and New Zealand control.
- The new company will contract with the co-op to pick up all
milk produced by shareholders, maintain adequate processing
facilities, and adhere to a milk pricing agreement.
- Only the co-op will be allowed to own more than 10 percent
- The co-op will not be able to own less than 50.1 percent
without a 75 percent approval vote.
- The minimum co-op stake will be 35 percent.
- 50.1 per cent of shares must be held exclusively by New
Zealanders, even if the co-op's stake drops to 35 percent.
- The co-op will have a board comprised of eight farmer
directors and two independent directors.
- The co-op board will have the power to appoint the board of
the new company, which will consist of six farmer and four
- The two boards will share the same chairman and four farmer
- Fonterra headquarters will remain in New Zealand.
- Only New Zealand dairy farmers will be able to be
shareholders of the co-op.
Rationale: "Behind the Borders"
12. Of all of the options considered, the preferred option
reportedly best ensures that Fonterra will be able to raise
capital at a competitive cost. It is estimated that NZ$2 to
$3 billion (US$1.8 to $2.4 billion) could be raised through
the share offering, which would enable Fonterra to pursue its
growth strategy of expanding in the fastest growing markets
around the world, including South America, China and other
countries in Asia. In these markets, there is strong demand
for fresh milk and Fonterra's strategy is to supply this
demand by building profitable businesses in those countries
by using locally-produced milk. In New Zealand, this
strategy is commonly referred to as a "behind the borders"
13. The preferred option also enables Fonterra to address
redemption risk, which is significant. Farmers that supply
Fonterra must purchase fair value shares proportional to the
amount of milk supplied. These shares are fully redeemable
if producers decide to cease supplying Fonterra. Because of
the way the Fonterra cooperative was initially set up with a
fair value shares system, Fonterra has virtually no permanent
capital. The total value of all fair value shares represents
the entire equity capital of Fonterra. By issuing
non-redeemable, tradable shares that can be listed on the
stock market, Fonterra would be able to minimize redemption
risk. However, that solution opens them up to the risk that
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the market could drive down the company's value.
Wall Street Reaction
14. Following the news of the planned restructure, Fitch
Ratings announced it retained a negative outlook for the
dairy giant and assigned its AA- (minus) credit rating.
Standard & Poor's has reassessed Fonterra's rating and
downgraded the outlook to a slightly negative, continuing the
rating agencies' declining assessment of Fonterra begun a
year ago based then on merger problems. Fonterra wants to
maintain the highest positive ratings, but the rating
agencies said the risks created by the co-operative's new
proposals have slightly weakened its positive profile. In a
worse case scenario in a share market arrangement, market
analysts posit that farmer-suppliers could be "left in the
cold," i.e., standing last in line of potential creditors to
be paid. Currently, the annual milk payments are Fonterra's
single biggest business cost. Under a revised capital
restructure Fonterra would be able to raise capital to fund
growth, rather than rely on debt, and would reduce redemption
risk (more outside shareholders to hold risk). A Fitch
analyst warned that while the capital restructuring has
credit-enhancing features, it also requires a restructuring
of the milk supply arrangements - potentially leading to a
significant diminution in Fonterra's financial flexibility.
15. According to newspaper reports, a listed Fonterra would
be worth between NZ$8.6 (US$6.9) and NZ$10 billion (US $8
billion), making it the largest company on the New Zealand
stock market. (The next largest company is Telecom valued at
NZ$7.7 billion (US$6.15).) Many in the industry expect the
fair value share of Fonterra stocks owned by current
shareholders to go down by approximately 35 percent because
the cooperative's equity will be distributed - 15 percent to
farmers and 20 percent to new investors.
Initial Reaction by Dairy Farmers
16. Despite the safeguards in the proposal and reassurances
from Finance Minister Michael Cullen that Fonterra's plan
would be in New Zealand's best interests, the initial
reaction from farmers is mixed with most indicating that they
need more information before they can make a decision. How
the milk transfer price between the co-op and the new company
will be determined is a key concern as this will determine
how much of the operational subsidiary's after costs revenue
will be passed on to producers in the form of higher milk
prices and how much will be passed on to investors in the
form of higher profits. The new board will be in the
unenviable position of trying to balance the desires of
farmers, who will want the highest possible milk price, and
external investors, who will want the highest possible
dividend. Under the current system, virtually all of
Fonterra's revenue is passed on to dairy producers in the
form of higher milk prices.
17. A team in Fonterra is working on a system to calculate
the milk transfer price and aims to put a proposal before
farmers in the next couple of months. Because there's no
open market determined price for milk in New Zealand, coming
up with a suitable mechanism that is transparent, competitive
and fair will be tricky. According to Fonterra, the new
system will build on the approach used by Duff & Phelps, the
company that calculates the fair value of Fonterra shares.
Farmers will need to be convinced that this system protects
their interests before they vote to approve the listing plan.
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18. Another concern among Fonterra shareholders is the
issue of non-farmer dominance and encroaching foreign direct
investment. While the scheme presented to stakeholders would
have contractual and legislative safeguards to protect farmer
control, along with New Zealand farmer majority ownership,
many farmers are questioning whether these safeguards are
adequate. While the proposed governance structure is
intended to ensure farmer concerns are addressed, many see an
inherent conflict of interest in the way boards are set up.
Others have expressed concern that the co-op will still be
exposed to significant redemption risk and capital management
issues, which, in the minds of some could lead to a sell off
of shares and increased external control, especially if there
is a drop in the milk pay out price. (Note: If the milk pay
out price drops and there is a loss of supply, the co-op
would potentially be forced to sell shares to fund the
farmers exiting the system. End note.) Another frequently
heard complaint is that the Fonterra announcement was "big on
spin" but "short on hard facts."
19. Comment: Fonterra's IPO, if successful, will have a major
impact on the New Zealand economy but its impact on the
global dairy market is not expected to be that significant.
The success of the Fonterra IPO proposal depends largely on
New Zealand milk producers being persuaded that Fonterra's
"behind the borders" approach is the appropriate way forward
and that their search for capital should extend to the
riskier equity market. In the minds of many analysts, access
to the capital markets through an IPO to expand Fonterra's
overseas markets and maintaining exclusive domestic control
of Fonterra are two mutually exclusive propositions. The
interests of NZ dairy producers may ultimately be at odds
with outside (international) shareholders. Throughout the
early planning stages of the IPO proposal, New Zealand
government officials from the Ministry of Agriculture and
Forestry along with the Treasury had been in close
consultations with Fonterra's Board in order to ensure
national interests were adequately considered. New Zealand
dairy farmers are yet to be convinced that the plan is in