What Would Synlait Be Worth to Fonterra or a2 Milk?
Speculation of a possible joint move by Fonterra and a2 Milk to buy Synlait raises a much bigger strategic question, says agribusiness expert Dr Nic Lees.
Additionally, in the case of the co-operative a capital structure cannot be at odds with the co-operative structure and put that structure under such pressure the cooperative is lost. On this basis alone Fonterra's capital structure needs to evolve.
Go back 20 years when Trading Among Farmers (TAF) was put in place. We had very strong milk growth, mostly coming from the non-traditional dairying regions. That necessitated new (costly) stainless stell. The 'value add' part of the then payout was getting diluted by needing to be divided by more and more milksolids.
The logic at the time was "growth funds growth". It was correct and it meant Fonterra received the capital it needed to cater for that milk growth. Fast forward to the current day: the most optimistic forecast would be static milk, with a high likelihood of a falling milk supply, an organisation that has squandered billions of our dollars on multiple poor decisions, and a new group of directors and senior management now in charge. Against that backdrop strategy and by implication capital structure has to evolve.
Like no other time before, Fonterra needs to be competitive in the sourcing of milk. An entry price (share) is an obstacle when the competitors require no capital from farmers. Australia, over the last ten years, provides a good template of what happens when milk supply falls. Stranded assets - with little/no milk going through them - is commercially painful. Co-operatives can fail and Westland Co-op is our most recent example. Should New Zealand's milk supply fall then some current processors will fail.
The board needs to act decisively and fast to get the changes needed to be able to compete in this new world, just as it did 20 years ago.
It's a bitter pill to swallow having a $3 share price on our balance sheets. Apportioning blame typically achieves little, but as I see it, the new guard can't be held to account for that. It's largely a result of actions that happened well before they arrived. The new strategy appears to be way better aligned with our comparative advantage and also is way less capital hungry - a pragmatic solution to our current state by the board, as I see it.
I have thought about what's proposed a lot. It may not be perfect, liquidity and the number of non-milk shares that it will create is a concern. That does however put pressure on Fonterra to perform. The dividend will need to be solid to ensure there is sufficient liquidity (buyers and sellers). Fonterra could also buy shares back in the future if it needed to.
Many of these matters can be worked through over time should there be a problem. What I believe overrides almost all else is a capital structure that is attractive in the market and ensures that Fonterra, as it enters the next phase of its evolution, can compete equally for milk.
We will never all agree on every piece of detail in the proposal.
It's not that detail that will define us but it is that overall change that will ensure we remain competitive and therefore keep our cooperative.
Greg Gent is a Ruawai farmer, agribusiness leader and former Fonterra director.
