• Who Will Own The Dairy Industry?

    It is a brave outsider who would claim to understand Fonterra’s proposed capital re-structuring, let alone try to explain it to others. Yet the issues raised by these proposals affect us all; if Fonterra gets it wrong, the country’s economic future – and not just that of our dairy farmers – could be seriously at risk.

    Most people understand that Fonterra is a farmer-owned co-operative that manufactures and sells a range of milk-based products into international markets, and pays farmers for their milk out of the proceeds.

    The farmers’ income therefore depends on the milk price (and there is currently some interest in how that price is determined). But farmers are owners as well as suppliers; they provide Fonterra’s capital by buying shares, (so-called “wet” shares) according to the volume of milk they supply. If they supply more milk, they have to buy more shares, and Fonterra’s capital increases. The converse happens if the milk supply falls – the so-called “redemption” risk – though this has happened only once, in the annus horribilis of 2008, when a drought coincided with the global financial crisis, and Fonterra warned that the share price could fall in the following season.

    There is of course an inherent conflict between the interests of farmers as milk suppliers on the one hand, and as investors in a manufacturing and trading enterprise on the other. As suppliers, they want a high milk price; as investors, their goal would be maximum profits, meaning raw material (that is, milk) prices are kept low.

    That conflict does not arise in a true cooperative, since milk suppliers and investors are the same people. But this could be about to change, if new Fonterra proposals mean that farmers and owners become separate groups with conflicting priorities.

    The 2008 wobble in the capital base, coupled with the Sanlu debacle, gave renewed impetus to a push for change in some quarters. How, it was asked, could Fonterra finance a drive for increased market share worldwide if it had to contend with such uncertainty?

    The initial suggestion was that Fonterra should cease to be a cooperative and become instead a listed company; the stock market would provide (it was hoped) a buoyant source of new capital. But this was quickly rejected by farmers, who saw the danger of conflicting interests with outside owners.

    A second proposal was then put forward. In addition to the shares that farmers were obliged to buy in line with their milk volumes, it was proposed that they should be able to buy additional shares (“dry” shares) – and they could trade shares (or “securities”) amongst themselves.

    This had the advantage of increasing Fonterra’s capital base and increased the banks’ willingness to lend, thereby largely overcoming the “redemption” risk. Farmers would still retain complete control over the cooperative since only they would own the voting rights. This proposal, in principle, was approved by a ballot of farmers.

    Alarm bells began to ring, however, when more detail of what was proposed began to emerge. The proposal now before farmers (and on which they will vote on 25 June) is that shares should be tradable, not just with other farmer members of the cooperative, but more generally; non-farmer purchasers will acquire the right to the dividend stream, but – it is claimed – the voting rights will remain with the farmers. And this is where the real worries begin to surface.

    The inherent conflict between two distinct interests – milk suppliers and investors – will no longer be mediated in house, but will be out in the open. There will be no going back. Once traded, the price of shares may rise to a point where farmers cannot afford to buy them back.

    For how long in these circumstances will the new owners (and their top lawyers) allow economic ownership and voting rights to be separated and the value of their investment to be determined by the milk suppliers? And when those new owners use their clout to drive down the milk price, farmers’ income in the long term will have fallen for the sake of a short-term capital gain.

    And it’s not just farmers at risk. Who can doubt that the shares will inexorably pass into the hands of foreign owners who are already salivating at the prospect, so that a large part of the dividend stream from our most important export industry – just like bank profits – will go overseas, imposing an additional burden on our precarious balance of payments and driving up our overseas borrowing requirement?

    Why should we (or farmers) be happy with this? We’re told that we can achieve a stronger stock market if these “securities” can be traded. But when will we realise that a prime reason for our weak capital markets is that most of our assets of any value are sold off and traded offshore?

    When farmers decide these issues in June, they will no doubt bear in mind the government’s apparent lack of concern over increased foreign control, as witness the partial asset sales, the concessions made to overseas corporations like Warner Brothers and Shanghai Pengxin, and the special protection given to foreign investors under the Trans Pacific Partnership. Do they want to see Fonterra next on the chopping block?

    Bryan Gould

    16 May 2012