Fran O'Sullivan sat down with Fonterra's John Wilson and Theo Spierings to talk about their China position.
Fonterra's news that it was writing down its $774 million investment in Chinese infant formula company Beingmate by $405m inevitably dominated news headlines after the dairy co-operative announced its 2018 interim result to the NZX.
But that was eclipsed when chairman John Wilson announced the seven-year reign of his chief executive Theo Spierings was in its final phase.
It was a brutal press conference.
But after news media (including this columnist) had put both men on their mettle it was time to talk about the big picture — why the co-operative stays invested in China.
Fonterra estimates its Greater China operations accounts for $4.7 billion of its overall $16b-plus enterprise value based on current share prices, and, China itself, $3.4b of annual sales revenue.
Beijing laid three conditions on Fonterra as the price of accessing what is becoming the world's largest middle-class consumer market. "We have to farm at scale, have to have consumer brands in the market and a Chinese partner," says Wilson.
Clearly both men have been frustrated by Beingmate's performance. They have faced questions about the level of due diligence Fonterra performed before the acquisition.
But there is also the matter of the ropey financial information which led to several directors, including two appointed from Fonterra, taking issue with their integrity. And an opaque governance structure at Beingmate.
Wilson says the reality is that the company must access the China market. Other — perhaps easier markets with better governance structures — also have hefty trade barriers.
"We're very grateful for those opportunities to invest significantly alongside the dairy industry in China and drive significant revenue and earnings out of China," says Wilson.
"It doesn't come without risk and we have to continue to balance that risk."
Beingmate's issues have been well-canvassed. In February, it reported a loss of about $208m. Founder Sam Xie has been guided to step back in and the company is on the hunt for a new chief executive.
Its business has been disrupted by the rapid transition to e-commerce in China. But it has also succeeded in registering its brands under stiff new conditions.
What is notable is that the Chinese Government expects Fonterra to stay invested in Beingmate, and, together with Xie and another key shareholder, sort it out.
"The Chinese Government, when they laid down the rules they did for us, had three requirements," says Spierings, "They never change them. They never want to compromise."
Wilson places great store on the relationships Fonterra has built with their key Chinese ministers and government and commercial leaders.
He freely admits Fonterra has faced a number of what he prefers to call "roadblocks" in China including biosecurity scares.
"To be absolutely respectful, they have dealt with all those issues very, very well. They recognise what we do with it, a lot of others don't, or haven't.
"We have to think what our responsibilities are. It's a privilege to operate in that market."
Wilson says the biggest gain is in the underlying milk price. "That's the biggest gain for our farmers, being able to sell to that market at scale. Shift volume off our farms in New Zealand of high quality ingredients.
"That's what this entire discussion actually underwrites, and over time, maybe our lifetime, maybe not, it will be an entirely different product that's sold up there, and that's the direction of travel, but this stuff takes time."
Turning round Beingmate
Fonterra has an 18.8 per cent stake in Beingmate and just two directors on the Chinese company's board. This gives it influence but not control.
Fonterra directors Simon Israel and Clinton Dines — who Wilson says is experienced not only in China but also in when things don't go well in China — have been deputed to assist.
Wilson concedes there are always a few risks when investing with a very successful entrepreneur with a very successful business as to what happens next.
Spierings and Xie formed a strategic committee after Fonterra made its investment.
Spierings says there were initially very good and solid discussions.
"But it is difficult to convince a founder who has created massive success with his recipe that the cook or the chef has to change the recipe, when that's being told by a Dutchman working for a Kiwi company.
"So that's not an easy conversation to have. But that realisation is definitely there at the moment when the company's almost in distress.
"Because we all have a like interest to protect our value."
Spierings explains the relationship with Beingmate was formed because "Sam was a key customer for us and growing fast. At that point the relationship naturally was good and the strategic partnership was quite clear. But when the market shifted, we had to really embrace change in a drastic way. His and my opinions started to differ.
"So, the biggest shift in my opinion is the acceptance that the change needs to happen quickly; that management capability needs to be added very quickly, because he is also aware that there is another shift, to omni-channel. And he is clearly saying to us right now, 'I should not lead this transformation'."
Both Wilson and Spierings are convinced the initial decision to invest in Beingmate remains the right one. They point out that in 2013, Beingmate was the leading local infant nutrition brand and its founding shareholder had been crowned Entrepreneur of the Year.
But they have learnt a valuable lesson — that China evolves very quickly. "Having 18.8 per cent in a publicly-listed company in China with regulations increasing pretty quickly is not the easiest, to say it mildly," says Spierings.
"The other learning is really that the market changed so quickly away from sales in normal retail. The kind of stores that were full of people three years ago now are empty.
"So the market has shifted.
"The channels have shifted to e-commerce very rapidly, and if there's a management and a founder who is not recognising that shift early enough ... that's a learning that with 18.8 per cent these changes are not made easily.
"Now, the situation is what it is, and these discussions are much better and are accepted.
So, we definitely have learned."
The focus on the Beingmate debacle should not obscure the relative success of Fonterra's other China businesses.
But what excites the Fonterra duo is the new opportunities to forge a partnership with Alibaba, for example, to leverage omni channels.
Wilson points to the ability to use milk produced by Fonterra's China farms to sell into the developing "super fresh" market.
Then there are the ingredients and foodservice businesses.
"Because of the sheer scale of what we do, we're always attempting to think well out into the distance and having to invest accordingly," says Wilson.
"None of us like to be in the position that we are at the moment with Beingmate but those other key strategic and tactical investments are really starting to pay dividends.
"The only way that we can have the sort of conversations that we are having with the likes of Starbucks and Alibaba to really accelerate is because we have 400 million litres of milk — probably the finest fresh milk in China," he explains.
"To build a 35,000-cow, highly efficient, dairy farming enterprise in China, takes time. If you talk to the very best New Zealand dairy farmer and ask them how long it takes them to build a dairy farm down the road in Canterbury or Southland or Central Waikato, it takes time.
"And we've done this in China. And that now gives us a footprint to do a whole lot of other things to support our business out of New Zealand, and that's important."
Spierings is excited by the visionary stuff — "to go super-fresh".
"What we can do extremely well in China is we can milk a cow. And if we have a factory or a box factory close by, we could be having that milk in bottles in four hours.
"If you can have it with the consumer in, let's say 24 hours, and, you have daily fresh milk with seven-day bottles, then you have a maximum 48 hours cold milk. So, super-fresh and super-safe. I don't think there's anybody else that can do that.
"And then 400 million litres sounds like a lot of milk, but it's not."
Spierings says the Chinese are highly demanding when it comes to fresh food, seafood and meat.
"Nowhere else in the world would you have the super fresh concept."
"It's expensive to ship water, fresh air, and packaging from New Zealand to the world. That will always be our constraint," he adds.
"We're shifting fresh milk into that market, and, you can see us being a lot more enthusiastic about what we're doing with Alibaba with fresh milk from our farms out there. It's hard to do.
"The point is right now we have multiple touch points. We have created the Behavioural Hub. There is Alibaba's interest in blockchain development. And the interest in the fresh milk."
Spierings says he is now talking with Alibaba CEO Daniel Zhang about taking a holistic approach to the two big companies doing stuff together. "He is extremely interested and was blown away when I actually explained what we're doing, especially in the innovative field. We're moving extremely fast."
Wilson says in the meantime the noise over Beingmate is not helpful.
"We enjoy a number one reputation in China in dairy which is an extraordinary privilege to hold. But it gets knocked around a little bit and it tends to happen from here, rather than up there.
"That's our reality."