Fonterra’s broadcast to farmers on Friday was pretty impressive I thought. Henry Chairman, Andrew CEO and Blue Farmer were interviewed by Dan Journo (“some of you may remember me from Country Calendar”). The broadcast was interesting from several perspectives: economics, sociology, and dairy farming.
Lets start with the economics.
The co-op has too much debt. Previously acceptable gearing ratios are now considered excessive, and in a debt constrained world equity matters. Fonterra is asking farmers to approve issuing up to 20% extra shares, to be non-voting “dry” shares, and then to buy them. Based on current data these would pay a dividend of 11%, so there should be good uptake.
On the equity side, well there really isn’t any, at least not in the normal sense of that term. Fonterra stands ready to repurchase shares from any farmer at any time, but it would collapse if enough farmers tried to cash out at once. Under current arrangements, you must hold shares to cover all production. So if production falls eg because of drought, farmers have to sell back shares and the co-op has to buy them. $740m was paid out last year on share redemptions, some of which was initiated by farmers gaming the co-op.
So Fonterra argues that it needs to (a) get equity capital into the business and (b) protect the co-op against opportunistic gaming by its members.
I agree.
There are two ways to do this. One is to withhold revenue. Cut the payout, retain the cash and use it to pay down debt. That forces all farmers into the same structure. Issuing shares to those that want them allows greater flexibility and seems more efficient. It also helps to open the door to other sources of equity.
Brian Gaynor makes a defensive argument for getting some pure equity into the co-op, on the grounds that currently, as suppliers, farmers rank behind debt holders and ahead of equity holders. Its an OK argument, but the situation it applies to must (hopefully) be a very low probability event. The situation would need to be bad enough to involve capital loss, but not bad enough to ruin the whole co-op.
Now for a couple of sociological observations:
1. Well, um, Henry um Van der Hayden um didn’t um seem terrribly um sure of himself at times.
2. Why was I surprised that Blue Read has red hair? The obvious nickname really.
And what about the farmers?
I’d imagine there’ll be some grumbles about share prices. Henry said that shares are currently valued on the assumption that anyone could buy them. And that since the board clearly ruled out an IPO, the pool of potential buyers is smaller, so the shares must trade at a discount (reflecting that constraint), so they are worth less than we all thought. Hmmm. So all of the periodic share valuations since Fonterra formed in 2001 have formed been on a basis that was incompatible with the apparent belief of farmers that non farmers could not buy in? Well yes, admitted Henry, but that was in the context of something to do with “two proud co-operatives”. Not a good look.
More generally, I just hope they back the concept and don’t get too hung up on the fact that external capital will eventually be needed.