Fran O'Sullivan: Dairy move taps into successful formula

Bright Dairy is providing capital for cash-strapped Synlait to restructure its balance sheet and repay loans. Photo / Simon Baker

The plan by China's Bright Dairy & Food Company to buy a controlling stake in Canterbury's Synlait Milk for $82 million should easily get a rubber stamp from the Overseas Investment Office.

Unlike Hong Kong's Natural Dairy, which is endeavouring to get control of the Crafar farms portfolio and establish another new dairy processing rival to industry heavyweight Fonterra, Bright Dairy comes with plenty of street cred in the Chinese dairy market.

It's already the number three player in the Chinese dairy production market. Importantly, its shareholders also include the local Shanghai Government.

Any problems that emerge downstream can always be resolved in bilateral discussions at a political level - which is often how "business" gets sorted in China.

Bright Dairy is providing capital that will enable the financially-stressed Synlait to restructure its balance sheet; repay some bank loans and form a joint-venture with its Chinese partner to build a new processing plant on the Canterbury plains to manufacture various products - including premium infant formula - which will be co-branded and distributed within the rapidly growing Chinese consumer market.

There's plenty of upside for Bright Dairy.

It's a major move - the first time in fact that a Chinese milk producer has gone offshore with either a merger or acquisition deal.

Bright Dairy projects that bringing in Synlait is expected to raise the Chinese company's net profit by $1.84 million in the first year of the joint-venture to reach $10.82 million in three years.

There's plenty of upside also for Synlait's founders who broke away from Fonterra to form their own small rival operation.

The company has been cash-strapped. Its Japanese shareholder was not prepared to underwrite its growth.

After last year's abortive IPO, it's no wonder that Synlait chief executive John Penno believes his company has finally hit the "sweet spot" by getting into bed with its Chinese partner.

But instead of applauding the Chinese firm for bailing out another financially stressed NZ agri-business, Greens co-leader Russel Norman is reacting in a xenophobic fashion by saying the Government should make sure NZ retains the ability to "block companies like Chinese Government-owned Bright Dairy from controlling our dairy industry".

It's difficult to see how the Government could do this given that the free trade agreement that New Zealand signed with China in April 2008 clearly envisaged cross-border investments would occur.

Realpolitik dictates if this particular bid was to be turned down - there would have to be very strong grounds.

But the deal has obviously been carefully structured so that Synlait's existing cache of Canterbury farms remains within the parent company's ownership and - despite some fogginess on what will happen in years to come - it is obvious if Bright was ever to seek OIO approval to acquire shares in the parent company it would have to go through an approvals process again.

That said the Bright acquisition is also a classic example of the Golden Rule - He who has the gold makes the rules - a reality that Penno conceded when pressed on why the joint venture has not been structured as a 50:50 investment. As Bright Dairy's parent company announced to the Shanghai Stock Exchange this week some of the $82 million purchase price will be used to repay bank loans. While Bright Dairy and Synlait's parent company have a shareholders' agreement to cover many facets of their relationship, it is obvious Bright's $82 million investment has bought the Chinese company the controlling say in what really matters. It gets four seats on the Synlait Milk board - although the Synlait parent company will appoint the chairman.

Bright will retain the right to maintain its 51 per cent stake when shares in Synlait Milk are floated in three to five years.

Given these circumstances it is important both parties work hard to ensure a win-win result.

The plan is to ultimately sell NZ-originated and manufactured infant formula on the Chinese market.

Federated Farmers is sceptical that will occur pointing out it would be cheaper to package the product in China using cheaper labour.

But that's the sort of defeatist talk that has resulted in far too little premium dairy brands being exported from New Zealand.

Bright Dairy's marketing vice-president Li Ke maintains there is a big market for premium New Zealand-sourced infant formula.

Li contends Chinese - who in reality can draw on six people to financially support each baby because of China's one child per family policy - will offer a high price for formula. Already imported product is retailing for twice the price of domestically sourced formula.

Renewed scares over melamine contamination have also driven up the security price for safe foods.

Given these realities Bright Dairy and Synlait should be encouraged to make sure the production is scaled up appropriately here.

What is tiresome is to hear the erroneous claim that Synlait Milk is passing into Chinese control because Kiwis have an infatuation with property investment and will not back productive investment. Frankly, that is a fatuous proposition.

The problem is many investors in prime NZ agri-businesses such as PGG Wrightson and Uruguay Farming systems - now the subject of a 100 per cent takeover offer from Singapore's Olam International - have already had their fingers badly burned in the past couple of years.

Such companies gobbled up too much debt as "visionary" leaders set them on fast expansion paths. The upshot was inevitable once the Global Financial Crisis struck and international markets turned down.

Others lost cash in the finance companies bust.

But it's important not to lose sight of the fact that many Kiwi companies, including dairy co-operative Fonterra which sucked up $800 million of retail bonds last year, did manage to successfully recapitalise themselves from the domestic market during the credit crunch.

Others, such as Fisher & Paykel Appliances and PGG Wrightson, have acquired foreign cornerstone shareholders.

This pattern is not new.

In 1990, New Zealand had to begin a global hunt for equity as so-called blue chips fell below investment rating. Much of that foreign investment wave was US sourced.

In the latter 1990s, Australian companies snapped up a huge raft of prime New Zealand firms which occupied dominant positions in their sectors. But there was little protest at the Aussie takeover.

What is different this time round is that much of the equity for distressed New Zealand assets is coming from an expansionist China which is on the takeover trail seeking to buy undervalued assets worldwide.

Kiwis need to show a bit of common sense here.

If we get it right we do have the ability to cement markets.

But we could also use the NZ Super Fund and/or KiwiSaver funds in a more adroit fashion to back our long-term strategic interests.

That is the discussion Norman should be urging - not a return to Fortress NZ.