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Jamie Gray

Jamie Gray is a business reporter for the New Zealand Herald and APNZ wire agency

Farmers face Fonterra D-Day today

Dairy farmers vote today on a proposal to open the gate on the economic fortress that is Fonterra. Photo / Mark Mitchell
Dairy farmers vote today on a proposal to open the gate on the economic fortress that is Fonterra. Photo / Mark Mitchell

Dairy farmers will decide today if they will lower the drawbridge on New Zealand's economic fortress - Fonterra.

If successful, the vote will allow trading in Fonterra shares among farmers and allow outside investors exposure to the dairy sector.

Trading Among Farmers' (TAF) proponents say it will eliminate redemption risk and allow the cooperative to move forward.

While the proposal has broad support, its detractors fear it will dilute farmer ownership.

As it stands, dairy farmers are required to buy shares in the co-operative when they set up shop and when they sell, Fonterra has to pay them out.

This is called redemption risk.

While redemption risk has always been part and parcel of Fonterra's make up, it was not until 2008 that it came into much sharper focus.

Back then, Fonterra was grappling with the effects of drought and the global financial crisis.

Many farmers opted out, which meant Fonterra had to write cheques to the tune of around $600 million.

For Fonterra it was a wake-up call and a reminder that redemption risk was a potential chink in its otherwise formidable armour.

TAF's proponents say redemption risk still hinders Fonterra's ability to expand its already large global footprint.

They say it will allow farmers flexibility to "share up" or increase their holdings when their cash flow is stronger, and will let them to "share down" when cash flow is tight.

Fonterra is responsible for about 30 per cent of the world's dairy exports and is New Zealand's biggest company in revenue terms.

It will be Fonterra's second stab at a major revamp of its capital structure.

TAF has two main components.

The proposed Fonterra Shareholders' Market will be for farmers only and the Fonterra Shareholders' Fund will be open to both farmers and investors.

The fund will be worth a minimum of $500 million. The board intends to represent between 7 per cent and 12 per cent of Fonterra's total shares on issue, with a ceiling of 20 per cent.

A "firewall" between the two markets has been designed to ensure that share ownership will always remain within the Fonterra cooperative, even though the economic benefit will transfer to units in the shareholders' fund.

Today's vote will be in two parts.

The first part requires a simple majority, although chairman Sir Henry van der Heyden says it will not go through if the vote shows only marginal support.

The second part involves changes to Fonterra's constitution, which requires 75 per cent support.

The problem for farmers trying to evaluate TAF is that it is unique. There is nothing like it here or overseas, so there is nothing to compare it with.

It's not the first time Fonterra has had a serious look at its capital structure.

In 2007, the board proposed a capital restructuring option which involved putting the business operations in a separate listed company, with the co-operative maintaining a controlling interest. Farmers, fearing it as being a first step towards demutualisation, didn't like it and in 2009, the plan was abandoned.

The latest proposed change has has its detractors, many of whom fear a loss of farmers' 100 per cent ownership and control.

Canterbury farmer Leonie Guiney said it would lead to a more volatile share price that would add an incentive for farmers to leave the cooperative if it became too high, or if it fell too low.

"This is a step change away from cooperative logic and collective thinking to opportunities for individuals and for short-term gain," she said in an interview with Radio New Zealand.

And the previous Shareholders' Council chairman Simon Couper last month resigned because he said he was not convinced farmers were sufficiently protected.

But TAF has unanimous support of the Fonterra board and 94 per cent of the 35-member Shareholders' Council.

Van der Heyden said the scheme would strengthen the group by providing permanent capital while allowing some flexibility.

Van der Heyden has been at pains to point out that TAF is not about Fonterra raising fresh capital.

Another hurdle is the successful passage of the Dairy Industry Restructuring Act Amendment Bill.

Market conditions will also need to be right before the Fonterra Shareholders' Fund is unleashed on the share market.

While TAF will represent a major departure from Fonterra's existing structure, ratings agency Standard and Poor's is relaxed about the proposal.

"We expect this move to end the historical swings in equity from flows 'in and out' of the capital base, eliminating redemption risk for Fonterra," S&P analyst Brenda Wardlaw said.

Farmers already gave their thumbs up, in principle, on TAF in their first vote in June 2010, but some misgivings have arisen as more detail has emerged.

At today's vote, the fund's ceiling will be lowered to 20 per cent from a previously sanctioned 25 per cent, reflecting their concern.

Former Dairy Board chairman Sir Dryden Spring said Fonterra was such a "priceless asset" for dairy farmers and for New Zealand that it needed to lift its game if it was to compete internationally.

If TAF fails, then the status quo will remain. But van der Heyden says the issue of redemption risk will still have be dealt with at some time in the future, one way or another.

How the Fonterra share scheme works

Fonterra's 11,000 or so farmers will hold meetings around the country on Monday to vote on the co-operative's controversial Trading Among Farmers (TAF) scheme.

There are two main components to the scheme - the Fonterra Shareholders' Market and the Fonterra Shareholders' Fund.

The shareholders' market will be available only to farmers and the shareholders' fund will be open to farmers and the investing public.

The fund will sit alongside the co-operative, not inside it.

A "firewall" - in the form of a Fonterra-farmer owned custodian - will exist between the two markets to ensure share ownership always remains within the co-operative.

When a farmer places a share with the custodian, that will release a unit within the shareholders' fund, which can then be traded.

In other words, the share will remain with the co-operative, but will split out an economic right on the other side. An outside party cannot have legal title to a share in the co-operative.

The units will give investors access to the dividends arising from Fonterra shares.

A so-called market maker, or registered volume provider, will sit within the shareholders' market to ensure sufficient volume exists between the two markets.

The shareholders' fund will operate along similar lines to a unit trust. It will be listed on the NZX and is expected to be worth not less than $500 million.

If the scheme is approved and can complete the necessary regulatory hurdles, it is expected to be a reality by November this year.

The market maker, like farmers, will be able to trade between the unit market and the Fonterra shareholders market.

Farmers and the market maker can buy units from the unit market and bring them back into the Fonterra shareholders market.

That is expected to be popular among farmers who are in a growth phase - taking on newly converted land, who want to sell down their shares to better manage their capital.

As it stands, farmers who retire have to sell their Fonterra shares on exit. The scheme will allow them to retain an exposure with the industry through the Fonterra unit, without having to exit the industry completely.

A due diligence report on TAF released in May said the initial fund unit price and subsequent trading price would be important to the success of TAF.

"A price materially below the current fair value share price of $4.52 may not be viewed favourably by farmers," the report said.

"Conversely, a higher unit price may put pressure on the co-operative's ability to attract new suppliers," it said. The final unit price price will be determined during the fund launch process.

- APNZ

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