Dryden Spring: Give law a few tweaks and TAF is the answer for farmers and Fonterra

Photo / APN

Opinion

As a retired dairy farmer, co-operative ownership of our industry from cow to customer remains deeply embedded in my DNA. Not because of any abstract philosophical belief but for sound commercial reasons.

It is a tough, competitive world out there, and my business experience, both in and outside of the dairy industry, tells me that businesses invariably work in the interests of their owners.

That is entirely natural, there is nothing wrong with that, but we do need to understand that only farmer-owned co-operatives will work solely, or even mainly, in the interests of their farmer shareholders.

With 95 per cent of our milk exported to markets usually far distant, New Zealand dairy farmers must compete in the markets of the world against the very best farmers, co-operatives, corporates, and governments (who seek to frustrate us at every opportunity through tariffs and trade restrictions). Many of our competitors, be they corporate or co-operative, are huge and among the best performers in the world.

It has been the strong co-operative structure of the New Zealand dairy industry, integrated as it is from cow to customer, which has enabled us to compete effectively against the best in the world so the industry has been able to grow and prosper.

In Fonterra, New Zealand has something which is for us rather rare, a business of global reach and world-class scale. It has significant influence in the "accessible" global markets, and is respected as a leading "world class" business.

Farmers in many parts of the world envy New Zealand farmers their ownership of such a formidable commercial enterprise.

Fonterra is a priceless asset for dairy farmers and for New Zealand.

It is central to the global competitiveness of the dairy industry and also that of New Zealand, because if it ever ceased to be owned by farmers it would almost certainly have a different core purpose than that of adding value to New Zealand milk.

But Fonterra must also continuously lift its game if it is to compete on a playing field where the competition is also getting better. If it does not do so it will lose competitiveness and relevance.

There can be no "stand still" on improving performance. So Fonterra must continue to improve its processing and logistics efficiency.

It must innovate and lead the world in product and process development. It must explore the new frontiers in the unique biologic and nutritional properties which milk has. It must have marketing capabilities which enable it to capture the imagination (and the wallet) of consumers of different cultures and dietary patterns, in many different countries right around the world.

In short, it must not only be a leader but it must be the world leader, in dairy-based nutrition. That will require investment.

When Fonterra was created it was given one serious flaw in its structure, not by industry choice but by government decree: the "fair value" share.

Because Fonterra has an obligation to resume or buy back shares when a shareholder leaves or reduces production, its share capital is not true equity but instead effectively a contingent liability which it must always be able to repay.

This limits Fonterra's ability to invest as it needs to, if it is to continue to perform at the highest level.

It must find a solution which means its share capital becomes permanent capital, to remove uncertainty from its balance sheet and enable it to invest as it must if it is to perform to the standard farmers (and New Zealand) expect it to.

But farmers clearly want this done in a way which ensures continuing co-operative farmer ownership and control. The current debate reflects a concern to ensure that in finding a solution which removes redemption risk and provides permanent capital, something worse does not occur - eventual loss of farmer co-operative ownership and control. That is an understandable concern.

Is TAF (trading among farmers) the answer? It will clearly remove redemption risk and ensure share capital is permanent capital which Fonterra can then invest in improving its performance.

Does TAF pose a threat to farmer ownership? I have been impressed by the thoroughness of the work Fonterra has done to find a solution which avoids or minimises such a possibility. TAF has been subjected to what I regard as very rigorous due diligence and stress testing.

Under TAF farmers will not sell shares in Fonterra to non-supplying farmers. Farmers will be able to sell an "economic interest" (right to dividend) in some of their shares to the Fonterra Shareholders Fund.

Importantly shares in Fonterra will continue to be owned only by supplying shareholders who alone will continue to have voting rights and control. External investors in the fund will not own Fonterra shares.

Given that structure and with:

•A reduction in the number of "dry shares" on issue;

•The modest limits limits on the proportion of "dry shares";

•The limits on the proportion of total shares which can be sold into the "fund", my view is that any perceived risk is manageable.

The other critical issue is the milk price. Fonterra's profit and dividend can only be determined after paying farmers the "true value" for their milk. Profit can be increased or decreased by paying farmers less or more for their milk.

So farmers do not want a lower milk price to enable higher dividends. They want to be satisfied that they will receive "true value" for their milk. In an ideal world "true value" would be an "arm's length" value, determined by the market. In many countries it is actually determined by the Government.

The absence of such a mechanism has always been a disadvantage for us because it makes judgment of co-operative performance very difficult.

I believe that it is in the interests of farmers for the value of raw milk to be as transparent as possible, as that will enable co-operative performance to be measured, which in turn will drive improved performance.

Global dairy trade now appears to be of such scale and sufficiently well developed to provide an adequate proxy milk price that all parties can be comfortable with.

Finally, farmers should not ignore the risk of doing nothing. If Fonterra does not get rid of redemption risk and stabilise its balance sheet with permanent capital, then in my view it is probable that it will under-invest and consequently underperform through lack of investment. That will not serve farmer interests either. In fact it will eventually be an even larger threat to farmer ownership and control.

In my view, provided Fonterra obtains the amendments to the Dairy Industry Restructuring Bill it seeks, TAF as it is structured gives Fonterra the permanent capital necessary to enable it to invest in future performance, while continuing to ensure farmer ownership and control.

It is worthy of farmer support.

Sir Dryden Spring was knighted for his services to the dairy industry. He chaired the NZ Co-operative Dairy Co from 1982-89 and the Dairy Board from 1989-99.