Fran O'Sullivan on business

Business analysis and comment from Herald columnist Fran O'Sullivan

Fran O'Sullivan: Synlait calls and investors jump

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Following company's success with Bright Dairy deal, its planned float is attracting significant overseas interest.

The Synlait milk processing factory near Dunsandel in Canterbury. Photo / Simon Baker
The Synlait milk processing factory near Dunsandel in Canterbury. Photo / Simon Baker

Full marks to Synlait bosses Graham Milne and John Penno for hanging tough in the post-global financial crisis environment and going offshore to find a significant stakeholder for the South Canterbury dairy firm after NZ investors shunned a plan to raise $150 million in late 2009.

Back then not enough Kiwi investors were persuaded that backing the New Zealand quality food brand story was a suitable investment. Synlait also had more runs to score.

It's a story that was played out with other key New Zealand brands like Fisher & Paykel Appliances and PGG Wrightson who also had to go offshore for equity after being caught short by the global credit crunch.

But an offshore investor, China's Bright Dairy & Food Co, injected $82 million into Synlait Milk in return for a 51 per cent stake, as it saw value where New Zealanders didn't.

Synlait Milk is now going back to the market again with an IPO designed to raise $120 million - $75 million of which will go into retiring debt and investing in new plant to expand the business and the other $45 million which will go to various shareholders including Synlait management (not Bright Dairy) who are selling into the offer.

What's interesting this time round is there is again considerable offshore interest in Synlait.

International media have positively spruiked the IPO, news agency AP describing it as "New Zealand deepening its economic ties with China" with plans for the first IPO of a Chinese company on the NZ stock market and the Wall St Journal writing that "investors keen to gain exposure to dairy in New Zealand - nicknamed the Saudi Arabia of milk - will soon have an opportunity".

In fact, Synlait can hardly be described as a Chinese company simply because Bright currently holds a controlling interest which enables it to consolidate the earnings of the NZ firm.

But it won't do the IPO any harm at all. Nor will the Wall St Journal's comments on the ability of investors to gain an exposure to the NZ milk story.

It won't just be the international investors who see value now. NZ institutional investors are also expected to want a slice of the action in much the same way they mopped up units in the Fonterra Shareholders Fund.

There are several driving factors. The Synlait prospectus outlines some compelling metrics.

The global dairy industry is on a roll with OECD forecasts that per capita consumption for milk equivalents will grow 22 per cent by 2021 in Asia Pacific. And in the burgeoning infant milk formula category, in the Chinese market alone this is estimated to be worth US$15 billion ($19.4 billion) per annum and "is expected to almost double in the next four years".

While Synlait makes an infant formula brand, Pure Canterbury, under contract for Bright Dairy to market in Shanghai at a valuable premium, what is notable from reading the prospectus is the fact that China is just one of Synlait's markets.

Synlait products also retail elsewhere in Asia and in high growth markets like North Africa and the Middle East where dairy protein is a valuable commodity.

At a site meeting two years ago, Bright Dairy executives told me that they were happy for Synlait to develop its own brands over time. But CEO John Penno makes it clear that is not part of the plan.

First, Synlait is concentrated on the business-to-business market. This means it makes particular products under contract for other firms who market them under their own brands.

Second, Synlait's customers do not want the NZ-based company to compete against them with their own brands.

Fonterra found itself in exactly the same position when some of its big customers protested against it building competitive brands of its own, but has since made a strategic decision to launch its own branded infant formula products in China later this year.

Penno has a point when he says Fonterra is a much larger company than his South Canterbury-based entity and has more capacity to spend the vast sums of money required to establish a brand.

This float ought to escape some of the xenophobic nonsense that has been sprayed at Chinese investment.

When Synlait went back to the drawing board in 2009 with the assistance of lawyers Minter Ellison Rudd Watts and its investment banking advisers First NZ Capital to come up with a new capital option, it was fortuitous that China's Bright Dairy & Food Co went for a deal where they invested in the processing arm, while Synlait retains majority ownership (77.5 per cent) of the company's farms business.

This was a very sophisticated deal as it neatly side-stepped public opposition to Chinese owning New Zealand farms.

There are a number of risks associated with the investment in the IPO. Drought, foreign exchange movements and so forth. But the biggest potential risk, which Penno considers is really a plus, is the shakeout in the Chinese dairy industry.

The Chinese Government is forcing a consolidation of Chinese dairy companies and is putting in place strict measures to control which companies make infant formula products.

Synlait will need to be licensed under the new rules. But Penno considers the Bright linkage will be a plus.

On the governance front, Synlait has received a dispensation from NZX listing rules so that Bright can in effect maintain sufficient control at board level to consolidate its NZ-related earnings after its own stake is diluted to around 40 per cent.

Former Finance Minister Ruth Richardson, who joined the Synlait Group board in 2004 as its first independent director, will now join three Chinese directors as a Bright appointee to the Synlait Milk board. As for Penno, he is constrained from leaving the company in the medium term, unless the directors consider someone else is better placed to take it forward. On the current growth trajectory there's fat chance of that happening.

- NZ Herald

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