The Fonterra Shareholders' Fund has run its course and should be bought out, says fund chairman John Shewan, who believes Fonterra's model of trying to be both a corporate and a cooperative is not sustainable.
In his address to the annual meeting of Fonterra unit holders, Shewan said if even the small, 6.7 per cent of non-voting listed units held by the public in the fund is a "cause of significant concern" over protecting farmer ownership and control of New Zealand's biggest business, then it "really goes to the heart of the issue of whether Fonterra is a corporate or a cooperative".
Shewan said Fonterra chairman Peter McBride directly addressed this issue at last week's annual farmer-shareholder meeting of the dairy company.
McBride had said Fonterra trying to have a foot in both camps wasn't sustainable. Shewan said he agreed.
"The challenge with this lingering issue is that it perpetuates the perception in the minds of investors of potential conflicts between the interests of farmers, and the interests of unit holders.
"Buying the fund back is a logical and timely solution."
Shewan said the fund had run its course and the capital structure review "provides a natural break point in the life of the fund".
Fonterra has said it will not buy the fund out.
But it has modified its stand. Under the final capital restructure proposal approved by farmer-shareholders last week, the fund will now be capped at 10 per cent of the total Fonterra shares on issue rather than at the current size, around 6.7 per cent.
Shewan welcomed this change.
While farmers have voted 85 per cent in support of the capital restructure, it has yet to get the green light from Cabinet - and Agriculture Minister Damien O'Connor has made it clear he has reservations about the proposal. Fonterra is subject to the Dairy Industry Restructuring Act 2001.
Shewan said while the fund's independent directors recognised the strongly held view of the Fonterra board, now supported by a farmer vote, that the new "flexible shareholding" structure was critical to Fonterra's future success, they were very concerned at the impact the proposed changes had on the fund's unit price.
"...We remain of the view that Fonterra should have proceeded with its initial preference to make an offer to unit holders to buy the fund back at fair price."
Fonterra did a U-turn on that idea in September, opting to cap the fund size instead of buying it out.
Fonterra's capital restructure project and the uncertainty it caused saw the fund's market capitalisation fall by 16 per cent or $75 million between November 2020 and November 30 this year.
The price of the dividend-carrying, non-voting fund units prior to Fonterra's May trading halt and capital structure review proposal announcement was $4.60.
Since then the price had dropped by around 21 per cent based on the price of $3.65 on November 30. The price of farmer-owned Fonterra shares, previously closely aligned with that of units, fell by 32 per cent over the same period.
Shewan said numerous meetings between the fund's independent directors and Fonterra leaders had been respectful and constructive but on the central issue of whether Fonterra should offer to buy back the fund "we agree to disagree".
He said while it was disappointing the fund's argument had not "at least at this time" been accepted, there were positive aspects to the associated strategic plan and operating outlook plans outlined by Fonterra recently.
The Fonterra board was confident the interests of the cooperative would be much better served under the new proposed capital structure.
"If that proves to be correct then all Fonterra shareholders, and all unit holders will benefit. To that extent, there is an alignment of interests."
"Further as a result of the reduce capital requirement on farmers, there will now be a much greater number of farmer and retiring farmer-shareholders in Fonterra who, like unit holders, will be focusing solely on dividends and share value."
This was because they would now be required to hold around one share for every 3kg of milk solids supplied to Fonterra instead of one share for every kg.
"So, over the period that farmers continue to hold these shares, a number of them, for some farmers as many as three out of four, will be held for investment purposes," said Shewan.
"The financial return on these shares will be dividends and movements in the share price, which puts them in the same boat as unit holders."
Shewan said he was also positive about the road map and associated earnings outlook Fonterra is aiming to achieve over the remainder of this decade.
"If these targets are achieved then the substantially sub-par financial returns that unit holders have experienced should improve markedly."
Until the capital structure review process, Fonterra farmers could invest in the fund by converting shares they don't need to cover milk supply for units and vice versa.
The halt had the effect of capping the size of the fund, currently at 107.4m units.
When, at the early stage of the process, Fonterra directors said their preferred option was to buy back the fund, there was an immediate downward impact on the unit and share prices.
Shewan said year-on-year the most significant movement had been in units held by farmers, which reduced from 12 per cent to 9 per cent of total units on issue.