Dairy giant risks losing the PR battle over problems at Beingmate.

If Fonterra has a game plan to deal with the growing debacle at Beingmate, it is keeping its cards close to its chest.

Last week I wrote that Fonterra had run out of lip gloss to apply to its $774 million investment in Beingmate, which has smoked a huge amount of shareholders' cash since CEO Theo Spierings led the acquisition of a stake in the Chinese company three years ago and formed a joint venture with its charismatic founder Sam Xie.

Since last week, Beingmate shares have continued to drop, reaching below 5 Chinese yuan when the Shenzhen exchange opened yesterday. That's well down from the 18 yuan a share Fonterra paid when it bought an 18.8 per cent stake in March 2015 and significantly lower than the 6.7 yuan a share that the stock was trading at before the company's shock January 21 announcement that forecast losses for the December 31, 2017 year had greatly increased.

My sources tell me the issue has caused considerable behind the scenes debate among Fonterra shareholders.

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There is growing concern that Fonterra's due diligence on the acquisition may have been rudimentary. And that Fonterra's mantra that this was a "strategic investment" rather than a financial one, has now worn thin when it was obvious that the company would book losses of over half a billion dollars if it sold out at today's prices.

The company's PR yesterday said "you can be assured that all the right people" in Fonterra are giving the matter their urgent attention.

In response to questions from this columnist, Fonterra responded that the board meets regularly to discuss important strategic matters, such as its investment in Beingmate.

"Of course, it continues to be senior management's highest priority to see this investment on the right track.

"We don't publicly discuss the details of corporate strategy, but what we can say, is that while we are disappointed Beingmate hasn't maximised the opportunity created by the new registration rules (for infant formula in the Chinese market), the strategic rationale for our partnership with a leading local infant formula brand still stands.

"China's infant formula market has strong fundamentals and is growing rapidly. Within five years, forecast demand for infant and baby food products in China will be more than all other countries. It is one of Fonterra's largest global markets, accounting for NZ$3.4 billion of our sales revenue. Our integrated business in China comprises Ingredients, Consumer and Foodservice, our China farms and our strategic partnerships."

In other words: "trust us, we are on the right track - we are keeping our nerve."

The problem is, Beingmate appears to be mismanaged. Four of its directors - including the deputy chairman, the chief of the audit committee and Fonterra's own two directors on the Beingmate board - have as much as said so in damaging revelations on January 21. But in the absence of full briefings in New Zealand - not simply responses to Chinese regulators and media queries - Fonterra risks losing the PR battle both within New Zealand, but importantly also in China.

Chinese media have begun to raise the spectre of a war between Beingmate and its second largest shareholder, which has the potential to be as damaging as the 2009 stoush between Danone and Wahaha, which resulted in the French company packing its bags and selling its stake.

Then there is the apparent misinformation.

Case in point, the report in the Beijing News which claimed that Beingmate had written a letter to regulators blaming Fonterra for a failure to reach a "mutual understanding" that was seriously affecting the development of the company.

"We have never seen this letter," was Fonterra's response yesterday. "Our only insight into its potential existence is the Beijing News article."

Fonterra went on to point out that the Beijing News article mentioned that it had not confirmed the authenticity of the supposed letter.

But Fonterra did confirm it was highly concerned about false rumours regarding the market and Fonterra's investment in Beingmate, and had sent a letter to the company, requesting it to investigate the source of rumours that it wants to take over Beingmate, so as not to disrupt the market and damage the interests of the listed company and all shareholders.

Fonterra's comments do not change my own view that there is a serious governance issue to address at Beingmate. The company has reiterated that Beingmate's formal forecast earnings downgrade announcement outlined four specific factors that have driven its recent losses:

Intense competition and heavy discounting that has followed in the wake of the new infant formula regulations

Costs resulting from the Product Purchase Agreement with Darnum Dairy Products

Higher levels of inventory write-off - more than originally expected

Less accounts receivable payments than anticipatedBut there are also concerns that Beingmate's statements do not address other influencing factors.

Sources close to the Fonterra Shareholders Council are concerned that the results of a report that was commissioned by the council on the Beingmate investment was not directly conveyed to shareholders.

The report by Ward Associates is dated late 2016 and came after growing concerns that Fonterra's investment in the 18.8 per cent stake was ill-judged.

Ward Associates' own investigations in China were aided by Chinese researchers.

The report does not make pretty reading.

Here's one snippet: "It is alarming that profits in the past two years largely reflect government subsidies received for various expansion projects and investments.

"Beingmate received government subsidies of 83.1m RMB in 2014 and 123.8m RMB in 2015, adding a total of 382.1m RMB to their 'non operating income' over the past five years.

"Subtracting these subsidies from their income calculation, net profits for both 2014 and 2015 turn negative and continue to worsen.

"The deterioration in performance follows their peak result in 2013 where sales revenue expanded by 14.2 per cent year on year to 6.12b RMB and net profit after tax totalled 721m RMB with the net profit margin at 11.8 per cent."

Charles Whitehead, then chairman of the council's performance committee, maintains that questions were put to Fonterra and satisfactory answers were received.

Whitehead was relatively sanguine about the Ward Associates report.

"It's no different to the Harvard Business School study," he said.

There has long been a contention that in Asian countries, foreign companies frequently have to "pay to play" - that is, invest in domestic production capacity within market to smooth the way for their exports.

The debacle at Beingmate suggests this truism should be challenged.