Brian Gaynor 's Opinion

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor: Fonterra's triumph marks big week for NZX

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Dairy farmers will be able to realise cash for the economic interest of their shares while maintaining full control of Fonterra. Photo / Mark Mitchell
Dairy farmers will be able to realise cash for the economic interest of their shares while maintaining full control of Fonterra. Photo / Mark Mitchell

It has been a landmark week for the NZX with the passing of the Mixed Ownership Model Bill, by 61 votes to 60 votes, and the approval of Fonterra's Trading Among Farmers scheme with 66.4 per cent of votes cast in support.

The only real surprise is that 33.6 per cent of votes were cast against Fonterra's scheme, even though it is a fantastic deal for dairy farmers and the co-operative.

The big question is whether Fonterra's proposed Shareholders' Fund will be attractive to non-farmer investors on a long-term basis.

The first point to note about the mixed-ownership model (MOM) is that it does not involve the sale of assets by the Government.

It is the sale of minority shareholdings in state-owned enterprises to the public, with the Crown continuing to hold a minimum 51 per cent controlling stake.

MOM is completely different to the 1980s and 90s assets sales - it is much more similar to the sale of minority stakes in Vector, Port of Tauranga, Lyttleton Port and Ports of Auckland.

It is a huge contrast to the wholesale flogging off of the Bank of New Zealand, Telecom, TransRail and other state-owned enterprises two decades ago.

Minority stake sell-downs have worked extremely well as far as investors, ratepayers and beneficiaries of the trust that holds a controlling stake in Vector are concerned. There has been little criticism of this model or any concerns that the major shareholders will sell their controlling stakes.

This is because the majority shareholders - the Bay of Plenty Regional Council in the case of Port of Tauranga and Christchurch City in Lyttleton Port - have recognised the benefits of having a minority stake in private hands with the company listed on the NZX.

The two most important issues, as far as the partial privatisation of Crown-owned enterprises are concerned, are the distribution of shares and the issue price.

Two decades ago the government sold 100 per cent of the companies to offshore investors and a select group of New Zealanders. The distribution policy this time should be something like this:

* The Crown maintains a 60 per cent shareholding.

* Nine per cent is distributed through a public pool to New Zealanders who don't have broker accounts.

* Nine per cent is sold to New Zealanders who are clients of brokers.

* Nine per cent is distributed to non-KiwiSaver New Zealand funds, charitable trusts and so on.

* Six per cent goes to KiwiSaver funds.

* Four per cent is distributed to overseas fund managers who have at least $100 million invested in New Zealand.

* Three per cent is sold to iwi.

The Crown may be best advised to sell 40 per cent or less at the initial stage because if a share price rises, as Port of Tauranga's share price did, then the Crown would receive a higher price for the sale of its remaining minority stake.

The other important issue is the initial public offering (IPO) price, which will have to be struck carefully to ensure that it is neither too high nor too low.

The Government doesn't want a Facebook, where the share price went from its IPO price of US$38 to a low of US$25.52 ($32.30).

This would discourage investors from purchasing any further shares from the Crown.

It also won't want another Trade Me, whose share price went from its IPO price of $2.70 to a high of $4.09 before the additional sell-down by Fairfax. Under this scenario, politicians would be accused of having short-changed taxpayers to the benefit of IPO participants.

The ideal situation is an IPO price that leads to a total return (share price plus dividends) of between 8 per cent and 18 per cent per annum over the first three years of listing.

To achieve this return there could be a loyalty bonus scheme at the end of three years for individual investors. A long-term loyalty scheme, in the form of a one-for-12 or one-for-15 bonus issue, is preferable to a discounted IPO price because the latter will encourage investors to sell out and take a quick profit.

Mighty River Power, which will be the first state-owned enterprise IPO, will be extremely popular, partly because of the huge publicity it has generated. In addition the company has a low-risk business model and should offer a fairly attractive dividend yield. This is an ideal investment in the current low interest rate environment.

It will be a major disappointment - and a poor reflection on the Government's communications skills and the finance industry's distribution capabilities - if Mighty River Power doesn't attract more investors than the 225,000 who purchased shares in Contact Energy's 1999 IPO.

Fonterra's Shareholders' Fund is a fantastic deal for dairy farmers because it offers them a number of ways to realise cash for the economic interest of their shares while maintaining 100 per cent control of the co-operative. In addition it will strengthen Fonterra's balance sheet.

Unfortunately the Trading Among Farmers scheme is incredibly complex as it involves wet and dry shares, a complicated milk price-setting process, a market operator and two distinct markets.

These markets are the Fonterra Shareholders' Market, which will allow dairy farmers to buy and sell shares amongst each other, and the Fonterra Shareholders' Fund, which will allow farmers to sell the economic interest of shares to the fund and receive vouchers in return.

These shares are then converted by the fund into units and sold to the public, although dairy farmers can also purchase units in the fund.

The units will be entitled to the dividends associated with the shares but the voting rights will remain with dairy farmers through the vouchers they receive.

The problem with the fund, from the point of view of outsiders, is that the farmer shareholders have driven a hard bargain as far as their own interests are concerned. They keep all the voting rights and can participate on both sides of the market and both sides of the fund, whereas outside investors can only participate on one side of the fund.

This gives farmers an arbitrage opportunity that is not available to outside investors. Farmers will have a huge advantage over outside investors but the fund could still be successful, as long as Fonterra's directors and management adopt best-practice disclosure and communications practices.

In other words the success of the fund will be dependent on the communication skills of Fonterra's management team, as this could compensate outside investors for their lack of governance rights.

Fonterra's management will probably have enormous demands, in terms of disclosures and face-to-face meetings with non-farmer investors, but this commitment will be worth it because the Shareholders' Market and Shareholders' Fund are positive developments for the co-operative and farmer shareholders.

These positives include:

* It will strengthen Fonterra's balance sheet as the co-op will no longer have to redeem shares.

* The size of the fund will be capped at 20 per cent of total shares.

* Farmer shareholders will be able to sell the economic interest of their shares for cash yet maintain 100 per cent ownership of the co-op in terms of voting rights.

* The board and management will be subject to far greater scrutiny, particularly in terms of domestic and international broker reports. This should help improve the performance of the dairy giant.

In view of these factors it was a major surprise that 33.6 per cent of votes were cast against the scheme at this week's meeting. Surely it wasn't because farmers were concerned that outsider investors in the fund would be deprived of arbitrage opportunities and voting rights?

Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the Financial Markets Authority (FMA) in 2011. He is also a Portfolio Manager at Milford Asset Management.

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