This would lower the market prices of the shares, have negative implications for competition in the dairy processing sector, with further detrimental implications for sector productivity and consumer prices, the report claimed.
The restructure plan, which has received an 85 per cent vote of support from Fonterra's farmer-owners, still needs government approval because the dairy industry is regulated.
Invited to respond to Heuser's statement, Fonterra said: "We disagree with a number of Castalia's conclusions and have nothing further to add to our previous statements". (Reported again below.)
Jarden head of institutional research Arie Dekker has also questioned aspects of the Castalia report.
Castalia's Heuser said the negative impact on processing competition would result because Fonterra played a dominant role in the sector and "its milk price effectively sets the default price floor for milk that the independent processors then must at least match".
"Fonterra is also a co-operative owned by the suppliers of its costliest input. This means Fonterra has wide leeway to allocate its total return to its input costs (which is paid to its supplier-shareholders) or to dividends (also paid to supplier-shareholders).
"It will always be quite difficult to ensure that a co-operative sets fair prices when competing with investor-owned (or iwi trust-owned) milk processors. This difficulty was somewhat lessened due to market disciplines from FSF (Fonterra Shareholders' Fund) unitholders and FCG (Fonterra Cooperative Group) investors trading shares in a
liquid market. The capital restructure removes these disciplines, and leaves the Fonterra board with much more leeway to return capital to farmers through the milk price."
The data and information offered in Castalia's report discussed Fonterra's track record in this regard, Heuser said.
"Based on sound logic and the information before us, we are convinced that the restructure will have a negative impact on competition and harm, rather than benefit, a vibrant dairy processing sector. It may also lead to higher consumer milk products."
Heuser said the exact share valuation was very difficult to predict. Castalia's analysis showed how "very powerful" factors would depress the share price of the farmer-only FCG shares.
Those factors included: potential sellers of dry shares would vastly outnumber the parties required to buy "wet" shares; most dairy farmers were cash-constrained and would weigh up buying additional (illiquid) shares against other options to spend money such as repaying farm debt, improving on-farm productivity, and compliance. On balance, buying additional illiquid FCG shares would rank low, he claimed.
Also, the listed unit fund would be capped, ending this option to crystallise value.
Heuser said the restructure shifted the balance of incentives on Fonterra to return capital to its farmer-owners via the milk price payment, rather than via a dividend, which increased the riskiness of any dividend cashflows (and therefore changed the discount rate one should apply to any dividends).
"The sum of these effects is that the market price of Fonterra shares on the farmer-only market is likely to fall relative to where it was prior to the restructure being announced. The price will tend toward a simple function of the expected cashflows only. The shares will essentially become illiquid financial investments, akin to a bond that is hard to sell," Heuser said.
Fonterra chairman Peter McBride has said the Castalia report's main points "are not consistent with our expert advice, which has the benefit of utilising our internal data, not assumptions".
"It's important to keep in mind that Fonterra is a co-operative. We are an extension of our 10,000 farming families and a strong and sustainable co-operative of scale is good for farmers and for New Zealand communities. Because we're owned by Kiwi families, our profits go to New Zealanders," he said when the report was first published by the Herald.
In a following statement to the NZX, Fonterra said it disagreed with the report and a number of its conclusions, "including the assertion that protection for a fair milk price will be eroded and that the restructure will cause Fonterra's milk price to increase".
The co-operative challenged Castalia's estimates on Fonterra's future share price.
"Fonterra also notes that Castalia estimates Fonterra's future share price on the basis of possible dividends up to 2020 but appears to assume that Fonterra has zero value at the end of 2030. Fonterra considers this to be a misleading approach to valuing its shares."
The capital restructure proposal will make it easier, and cheaper, for farmers to join the co-operative and supply it with milk.
Fonterra, created in 2001 from an industry mega-merger under specially-written legislation, today collects around 80 per cent of the country's raw milk (it started off with 96 per cent.) But with national milk production forecast to remain flat or fall, the co-operative is seeking to ensure its future viability and to keep its tanks full.
