How Fonterra sells structural change

The eight months of consultation and debate about Fonterra's capital structure has delivered a template that will be used to deal with other big constitutional changes, says chairman Henry van der Heyden.

This round of capital structure change ended on Thursday when shareholders turned out in record numbers to approve proposals aimed at simplifying the group's structure and providing some flexibility about how much capital farmers need to invest.

Van der Heyden told shareholders at the special meeting in Christchurch that more change to the co-operative's capital structure was inevitable.

The changes made this year were part of an evolutionary process, he said.

"To build our business and our cooperative we must continue to evolve."

The painstaking consultation process that Fonterra went through to canvas farmer opinion on the topic appears to have paid off.

About 62 per cent of Fonterra's 12,000 shareholders turned out to vote on Thursday.

At the co-operative's first AGM three years ago just 18 per cent of farmers turned out to vote.

At an AGM two years ago, where similar changes to the capital structure were rejected by farmers, just 32 per cent of shareholders voted.

Fonterra Shareholders' Council chairman John Monaghan described the turnout as "a vote of confidence in Fonterra".

There was no easy way to approach the capital structure issue, van der Heyden said.

"Fonterra is unique and we have to develop our own unique solutions. There is no off-the-shelf package or silver bullet that provides ready answers."

The co-operative held three rounds of farmer consultation meetings before last week's vote.

Its management dedicated hundreds of hours to working through farmer concerns and balancing them with the needs of the company.

A number of farmers have raised concerns that the capital structure changes did not go far enough.

They say the changes do not address the real issues - the rising value of the share price.

Van der Heyden is adamant that those farmers represent a vocal minority. Most farmers were able to see that the money they pay for shares in Fonterra is an investment not a cost, he said.

The alternative to farmers investing their capital in Fonterra was for the group to look for outside investment. That was just not palatable to the majority of farmers, van der Heyden said.

He was confident that when the contract milk system was up and running most farmers would not want to use it, because they would be able to see that an investment in Fonterra was providing them with best return they could get anywhere, he said.

Monaghan agreed.

"There is a lot of noise from a section of the supply base, but given the opportunity it will be interesting to see whether that materialises into tendering for a contract. Most farmers I talk to do see that share as a vehicle for equity appreciation," Monaghan said. "The pendulum has swung," van der Heyden said.

"There has been an overwhelming change in thinking. There is just a better understanding of what our capital structure is.".

* THE CHANGES

Contract supply:
Farmers will be allowed to supply up to 15 per cent of their milk to Fonterra on a contract basis - without having to invest in additional shares. There are fears that the rising cost of shares could limit milk supply growth and this measure should help avoid that.

The contract system will be phased in with 3 per cent of production being accepted on a contract basis in the 2006-07 season.

Peak notes scrapped:
Peak notes were a way of reflecting the greater cost to Fonterra of processing milk at the season's peak. Farmers who supplied more at the peak were required to hold more capital in the company.

The system meant farmers had to keep complex accounts and were often faced with big one-off bills.

The notes have been replaced with a capacity charge by which the price of milk will be seasonally adjusted up or down. Farmers who produce a lot of their milk at the peak could receive as much as 3c/kg less for milk solids. There will be a transition to the new system so Fonterra can avoid buying back peak notes in a lump sum at a potential cost of about $1 billion.

SRRs scrapped:

Fonterra used Supply Redemption Rights to assist suppliers in managing downward fluctuations in production. The system has been replaced with Excess Shares. Farmers can now choose not to surrender shares when production drops. They can hold up to 20 per cent of their production volume in Excess Shares. They can also opt to supply extra milk without buying corresponding shares during a short-term seasonal increase. If the increase is repeated, the corresponding shares must be bought.