Secret talks on farmers' trading plan

Fonterra CFO Jonathan Mason led the talks. Photo / Mark Mitchell

Fonterra's bold plan strikes hurdles, writes Jonathan Underhill.

Fonterra executives led by chief financial officer Jonathan Mason held secret talks with leading institutional investors to win support for the company's proposed trading among farmers' plan.

The plan - commonly known as TAF - will only function if it succeeds in selling rights to the shares in a secondary market.

Mason has put a proposal in front of investors in both Auckland and Wellington tweaking the terms of the rights which outside investors can buy. Among those canvassed were Auckland-based Brian Gaynor of Milford Asset Management and Wellington-based funds like Harbour Asset Management and the Accident Compensation Corporation.

Gaynor said he had to sign a confidentiality agreement and couldn't discuss what was offered, though he expressed some optimism the proposal could get over the line.

In his submission on a Ministry of Agriculture and Forestry (MAF) discussion document, Gaynor said investors should be better rewarded for ceding voting rights. The outside investor holds the rights to the dividend stream and any capital gain. But the right to vote remains with the farmer who signs the shares over to the fund.

Outside investors want the securities that will be traded through the fund to be like equities, which would typically have voting rights, disclosure rules and wind-up clauses. One institutional investor said: "Fonterra is caught between a rock and a hard place."

Fonterra's Mason says fund managers were made to sign confidentiality agreements because of the awkwardness of the situation where the company is effectively negotiating terms for a new class of investor.

"There's stakeholders - the Government, investors and farmers," Mason said. "The difficulty is we have to talk to investors about the detail of the structure but we can't have the media reporting before we tell our farmers - hence the confidentiality."

Failure to win over fund managers could scupper plans for farmer trading in the medium term. Agriculture Minister David Carter says the window of opportunity to get the enabling legislation before the Parliament before the election is closing rapidly. That risks losing further momentum for the changes, which Fonterra's farmer-suppliers overwhelmingly voted for in June last year.

"The chances of getting it through are getting slim," Carter said. While the Government had assured Fonterra it would push through the legislative changes before the election, that's now not looking achievable.

Political support isn't assured. Labour, the Maori Party and Act have yet to form caucus positions on what's proposed. They want to see the draft legislation, which Labour agriculture spokesman Damien O'Connor said he understands is being worked on "frantically" by MAF "no doubt with Fonterra managers".

O'Connor claims MAF may not be up to the task. "MAF doesn't have the depth of experience to analyse this correctly but I'm not sure there are any other objective advisers who could put something together either," he said. "Fonterra has very deep tentacles throughout New Zealand."

His comments suggest Fonterra has more work to do in winning political consensus in Wellington, even though CFO Mason says New Zealand's biggest business doesn't have political baggage.

"It is not a hostile environment for Fonterra in Wellington," Mason said. "We don't believe this is just a National Party initiative. Parties across a big part of the spectrum want a vibrant dairy sector."

Wellington-based advisory firm Cameron Partners, which had a hand in devising the original concept of the farmers' market and related fund, and works closely with Fonterra, declined to comment.

Of 23 submissions on the MAF discussion document, many are against the plan. The Commerce Commission said though it supported market mechanisms to sort out pricing, there was a risk the farmer share market could fail from lack of liquidity, making it harder for farmers to exit when they want and therefore making it harder for competitors.

The antitrust regulator wants the Government to adopt a MAF proposal that rules be agreed for governance of the milk price and disclosure measures to ensure sufficient liquidity.

Independent dairy companies echo those concerns. "There's a serious risk that the TAF platform will be illiquid, volatile and unstable due to the closed nature of the exchange," says the response from Miraka, a Maori dairy factory start-up building its own drier and with a Vietnam-based shareholder. Miraka refers to the rights as derivatives and says the combination of shares and rights exposes rival processors and the dairy industry as a whole to "an unacceptable level of risk".

Others are more blunt.

"It's a turkey - a really bad compromise," said John Shaskey, executive director at Global Dairy Network, a shareholder of Miraka and a broker of deals to trade dairy products. "You have got split obligations to investors. They are going to have obligations to non-farmer investors that will have some sort of priority."

Shaskey was managing director of Fonterra GlobalTrade until he resigned in 2007. He believes farmers "will become a little bit more trapped" by the new structure.

MAF was hoping to get the legislation passed into law by November. The Government is awaiting its recommendation but has concerns of its own and wants to hear directly from Fonterra how it will address its worries.

"We've become more concerned whether the original proposal delivers what we want around an efficient dairy industry and the price of milk being transparent," said Carter, who has met CEO Andrew Ferrier to discuss progress.

"We must have an efficient dairy industry that allows entry and the original TAF was around redemption risk. Now we're not convinced we're not in danger of locking farmers into Fonterra."

The draft legislation would amend the Dairy Industry Restructuring Act 2001, Fonterra's enabling law. It required Fonterra to provide open entry and exit for farmers so they could leave the dairy company when they wished. It also faced a regulated share price in that it had to issue and redeem co-operative shares at the same price in any given season.

A requirement to supply rivals with up to 600 million litres of raw milk has helped foster the rise of independents - though that is subject to a separate review and unaffected by the TAF proposal, according to MAF.

"The milk price is the milk price," said Simon Couper, chairman of the Fonterra Shareholders' Council. "It's a reflection of commodities. Anyone who set up in competition would have to pay that milk price."

Couper argues that by their nature, Fonterra's small start-up rivals lack the economies of scale to be successful dairy companies. "Small companies set up small driers. The model is not competitive," he said. "Some of those companies have been running at a loss."

Couper says the milk price is "non-negotiable". There is "no scope to negotiate that milk price away from farmers to investors".

Fonterra has successfully argued the lack of long-term equity and costs of redemption would hamper its growth and prevent it growing as much as it could. Permanent share capital means Fonterra could "invest with confidence in long-term opportunities that build on our global competitive advantage and maximise the returns for your milk", chief executive Ferrier told farmers at the meeting last year to vote on the changes.

Supporters say there's too much "white noise" being generated on the potential for the market to be dysfunctional.

They say the debate about a suitable pool size - $500 million? $900 million? - misses the point. Fonterra has no motive for wanting an illiquid market. In reality, said one industry adviser, a pool as little as $200 million would be sufficient in the New Zealand market though Fonterra is likely to opt for a bigger size.

"What they are trying to do here is make sure they create one class of voting rights," the adviser said.

"The difference is the farmers have the votes, people who trade them will have none. It may look complicated to people who are not familiar with capital markets but the market will work very smoothly and efficiently together and the same price will be traded in both markets," he said.

Analysts are also likely to get on top of the technicalities of the market quickly. Farmers will become marginal price setters and move fluidly between the sharemarket and the fund, supporters say.

Mason disputes that outside investors and farmer-shareholders are "totally misaligned" and says the share structure will create "some positive feedback loops."

"There's potential tension in certain situations," Mason said. "But in most cases are the interests aligned? Yes."

Opponents aren't just writing submissions. They're preparing for the parliamentary process with lobbyists lined up. Miraka argues that the horse bolted last year when Fonterra changed it share valuation methodology to account for the "restricted" market the shares trade in - a "value destruction" of $1.20 a share or more than $1.5 billion all up slashed from farmers' wealth.

The part-Chinese owned Synlait Milk says the downward revaluation has already been felt by Fonterra's rivals in the market for fresh milk, which is "characterised by over-easy entry and sticky exit" to the co-operative. Moving to TAF will "merely institutionalise this problem."

Jonathan Underhill is a BusinessDesk journalist.