Gaynor: Small shareholders out in the cold

By BRIAN GAYNOR

Graeme Hart can certainly spot a good deal, and his purchase of a controlling stake in New Zealand Dairy Foods may be one of his more profitable transactions.

But the deal has left 6200 shareholders in an extremely difficult situation. Should they sit tight and take their chances as minority shareholders in an unlisted company? Or accept Hart's undervalued takeover offer?

Dairy Foods, which according to ACNielsen has approximately 40 per cent of the domestic retail dairy products market, operates under the Anchor, Primo, Fresh'n Fruity, Swiss Maid and Chesdale brands, among others. Its main competitors are Mainland, with 35 per cent market share, and National Foods, with 6 per cent.

Dairy Foods was 100 per cent owned by The New Zealand Co-operative Dairy Company (NZ Dairy Group) until 1999. As part of the merger between the Hamilton-based NZ Dairy Group and South Island Dairy Co-operative, Dairy Foods shares were distributed to NZ Dairy Group shareholders.

After the distribution NZ Dairy Group owned just over 50 per cent of Dairy Foods in the form of A shares. More than 6000 farmers held the remainder in the form of B shares.

PricewaterhouseCoopers established a mid-point valuation of $1.86 for the B shares.

Until December last year, only farmers could own the B shares. Trading in the shares was light, with most changing hands through private transactions at $1.86.

On October 16 last year Kiwi Co-operative Dairies and NZ Dairy Group merged to form Fonterra Co-operative Group, and the New Zealand Dairy Board became a subsidiary of the new dairy giant.

As part of the arrangement, Fonterra was forced to sell its shareholding in Dairy Foods by September 27 this year. This was a requirement of the merger legislation because Fonterra had a dominant position in the domestic retail dairy products market through its shareholdings in Mainland and Dairy Foods.

Last July, a sales process steering committee was formed and ABN Amro was chosen as the sales adviser.

Information was distributed to 135 organisations and more than 20 potential purchasers were visited on an international "roadshow".

Because of the Takeovers Code, any party wishing to buy Fonterra's controlling stake would have to make the same offer to all shareholders.

National Foods, a listed Australian company with annual revenue of nearly A$1 billion ($1.2 billion), expressed a keen interest but the Commerce Commission turned down its application on March 22.

The commission concluded that "the proposed acquisition would result in the merged entity obtaining a market share (in yoghurts and dairy desserts) that fell outside the commission's safe harbour guidelines".

National Foods, which is 18 per cent owned by Fonterra, had no time to appeal against the decision because the sales process steering committee had established April 2 as the deadline for firm offers.

On April 5, Fonterra announced that it had agreed to sell its 70 million Dairy Foods shares to Graeme Hart's Rank Group for $1.70 a share. Dairy Foods chairman John Storey was not happy with the outcome and was quoted as saying "the resolution of Dairy Foods' future ownership has been concluded within a shorter time frame and with less involvement by farmer shareholders than anticipated".

The farmer-backed Great Milk Company (GMC) claimed its $1.70 a share offer had not been treated seriously.

But Fonterra was dismissive of this bid and issued a statement saying it had received one letter from GMC containing two proposals that were subject to formal documentation and several conditions.

On April 24, Hart raised his offer to $1.75 a share and this week the takeover offer and a summary of Cameron & Co's independent report was sent to Dairy Foods' minority shareholders.

The overall tone of Cameron's report is depressing. Its basic message is that the price is not great but Hart is now in control and he will put his own interests ahead of minority shareholders.

Hart won't list Dairy Foods on the Stock Exchange, share liquidity will be low, the company probably won't pay a dividend, disclosure will be poor and individual shareholders have limited rights in unlisted companies.

Cameron values Dairy Foods at between $1.75 and $1.98 a share and suggests that those who reject the offer should have "a long-term investment horizon" and be "indifferent to the financial policies the company may potentially adopt".

There is little doubt that Hart is buying Dairy Foods for less than full value. The purchase price is 6.8 times forecast 2003 earnings before interest and tax (ebit) compared with the same-based takeover multiples of 8.6, 9.7 and 7.6 for Ernest Adams, Frucor and Nobilo Wines respectively. On this basis the offer should be above $1.95 a share.

The problem is that Fonterra's Dairy Foods stake, which is worth $122.5 million at $1.75 a share, represents less than 1 per cent of its total assets and the dairy giant wants to get rid of its holding well before the September 27 deadline.

But, given time, National Foods could have successfully appealed against the Commerce Commission decision and then there would have been two serious bidders instead of one.

(The commission ruled that Dairy Foods and National Foods would dominate the yoghurt and dairy desserts markets but their revenue in that segment is only $62 million and $21 million respectively, out of total domestic retail dairy sales of $1.1 billion. Either Dairy Foods or National Foods could have divested their yoghurt and dairy desserts operation, maybe to the GMC, and Fonterra could have sold its 18 per cent National Foods' stake.)

Another alternative would have been for Fonterra to exit Dairy Foods through a public float and Stock Exchange listing. Based on the issue prices and earnings multiples of the more recent food and beverage floats - Frucor, Nobilo Wines and Restaurant Brands - Fonterra would have realised between $1.40 and $1.80 a share. This is below Hart's offer, but Dairy Foods shareholders, who are also shareholders in Fonterra, would have been far happier.

Dairy Foods would be an ideal public float because it is big enough to attract institutional support, export prospects have increased since industry deregulation and the company is benefiting from the drop in milk prices. (Fonterra has signed a 10-year agreement to supply milk to Dairy Foods on the same terms as it does to Mainland.)

Hart is giving nothing away as far as his plans are concerned. He won't say whether the company has any potential synergies with Burns Philp in Australia and he hasn't made any official comment on a stock exchange listing. Cameron & Co's comments on Hart's aversion to a listing are based on a report in the Business Herald, and he may be trying to use media comments to persuade shareholders to accept his offer.

Dairy Foods shareholders have two choices. They can accept Hart's opportunistic offer and mutter under their breaths about Fonterra's quick acquiescence.

Or they can reject the offer on the basis that a group of shareholders is willing to advocate actively for minority shareholders' rights. This could be a group of farmer shareholders working together or with the Great Milk Company or the Shareholders' Association.

If farmers are unable to form an advocacy group then shareholders who reject the offer should join the Shareholders' Association and persuade Bruce Sheppard to take a strong interest in Dairy Foods.

There is a great deal of value left in the company but minority shareholders won't get their fair share unless they work together, are well organised and take a proactive stance.

* Disclosure of interest: none.

* bgaynor@xtra.co.nz