Why Synlait has nothing to fear from a2 Milk's foray into infant formula

A2 Milk is in talks to take a controlling stake in Mataura Valley Milk. Photo / Supplied

A2 Milk will soon try its hand at infant formula making if it is successful in buying the debt-laden Mataura Valley Milk, but its supplier - Synlait Milk - has nothing to fear.

The dual-listed a2 Milk is in talks to buy three-quarters of the China-owned Mataura Valley Milk in Southland for $270 million.

A2 Milk has made a non-binding indicative offer to acquire a 75.1 per cent interest in Mataura Valley, based on an enterprise value of about $385m.

Mataura Valley had agreed to provide a2 Milk with a period of exclusivity to conduct due diligence and documentation.

The moves are supported by Mataura Valley's majority shareholder, China Animal Husbandry Group, which would retain a 24.9 per cent interest.

Chief executive Geoff Babidge said a2 Milk had in the past 18 months been looking at opportunities to diversify its supply and risk management.

Synlait, just under 20 per cent owned by a2 Milk, in a statement to the NZX, said it was well-positioned to continue to support a2 Milk's growth aspirations.

"You can't assume that we are going to take all our production in house - that's not our strategy," Babidge told the Herald.

A2 Milk chief executive Geoff Babidge. Photo / File

"The strategy is about complementing our existing supply arrangements that we have in place with Synlait and Fonterra," he said.

Mataura Valley has the capacity to produce about 35,000 to 40,000 tonnes of milk powder, most of which will go into infant formula manufacturing.

As a marketer of dairy products and infant formula, a2 Milk, which employs just 300 or so people, has a light capital structure.

"We are a low capital-intensity model, so this is simply about supplementing our existing supply arrangements. It's not about replacing them."

Mataura Valley has struggled since setting up shop in 2018 and was last year put up for sale.

Gore-based Mataura Valley said last year it needed an additional $12m in funding to cover expected production and operational costs.

It reported a $47m loss in that year, and faced funding shortfall of $26m this year.

Babidge said Mataura Valley had been keen to address its funding arrangements, which were put in place originally as part of developing the business.

"We came to a view that the Mataura Valley opportunity presented the most attractive opportunity going forward."

A2 Milk's investment in the company would effectively retire all the debt in the business.

"The plant is really state-of-the-art and is capable of producing the highest quality nutritional products," he said.

China Animal Husbandry is owned by the a wholly owned subsidiary of China National Agriculture Development Group, which is also the parent company of a2 Milk's strategic partner in China, CSFA Holdings Shanghai, or China State Farm.

A2 Milk plans to invest further to establish blending and canning capacity at Mataura's facility to support setting up a fully integrated manufacturing plant for infant nutrition.
Discussions with MVM were "ongoing and remain incomplete".

Any transaction that results from the current discussions is expected to be settled towards the end of a2 Milk's cash reserves.

At its annual result this week, a2 Milk said its cash balance was $854m. If the deal went ahead, it would be settled from existing cash reserves, it said.

Shares in a2 Milk last traded at $20.27, up 35c, while Synlait dropped seven cents to $6.62.