Creating Fonterra 11 years ago was possible only because farmer-shareholders and their leaders showed great courage and ambition – and they have had to keep making brave but sensible decisions to make their co-op the success it is today.
But, in common with all business owners, their work is never done. As the world changes, so must they and their co-op. Initiating share trading among farmers and bringing in non-voting external capital are the next steps.
These initiatives will help them to respond to two huge forces dramatically and rapidly reshaping their global industry.
One is the abundant opportunity created by burgeoning demand for dairy products. The other is a sharp and permanent increase in volatility of prices, supply and demand of commodities created by scarcity of resources; and volatility of financial markets created by the increasing inter-connectedness of the global economy.
To maximise these opportunities and minimise the risks, farmer- shareholders and their co-op have already developed some new tools and disciplines. The most beneficial so far has been GlobalDairyTrade.
The internet auction has brought price transparency to global dairy commodity trading, helping the co-op to maximise its return from commodity products and establish premiums for products and services it does better than its competitors.
Similarly, the NZX has pioneered dairy futures to help producers of commodities and their customers better handle price volatility. The exchange is pushing hard to establish its product as the world leader over a rival one from the Chicago Mercantile Exchange. If it succeeds, local financial markets will gain a global role, helping to reinforce New Zealand’s position as the world leader in dairy trade.
Every new tool brings benefits, but also uncertainties and risks. Even building up understanding of challenging new concepts takes a lot of time and debate. So it is no surprise that shareholders are heavily debating share trading among farmers. Although 89.85 per cent of shareholders voted in outline form for TAF two years ago, some of them have since become deeply fearful of it.
One problem was the time it took to develop the complex trading system and the legislative changes needed to implement it. Only in the last few days have shareholders finally got the detailed proposal from their board, on which they will vote on June 25.
TAF is designed to deliver two benefits: the co-op gets permanent capital; and its shareholders get a new source of capital and additional ways to manage it.
Under the long-standing capital structure, farmers have to buy from the co-op one share for each kilogram of milksolids per season it processes for them. If they increase production they have to buy more shares, if they cut production or exit they sell the shares back.
As a result, the co-op’s capital ebbs and flows with production. At times of drought, for example, the co-op loses capital and has to scramble to replace it from other sources.
In contrast, permanent capital would give the co-op a more stable balance sheet, which would help it invest in opportunities here and abroad. It can do this by creating a private market in which farmers wanting to increase their milk supply buy shares from those reducing theirs. The co-op would also sell new shares into the market to cover growth in total supply, thereby raising funds to help build more processing capacity.
But the market needs to be liquid, transparent and efficient to ensure farmers get a fair price for their shares. For example, it would be better to spread trading through the year rather than leaving it bunched as now in the two months before a new season starts.
To facilitate this, Fonterra is proposing a fund open to outside investors. They buy units in it, which are backed by co-op shares. A structure of custodian, firewall and safeguards and active management by the co-op will preserve farmers’ rights and absolute control of the co-op.
The market gives farmers more flexibility in how they manage their capital. For example, they can spread their entry into and exit from the co-op over three years.
The fund will improve the quality of the market and give farmers an additional source of capital, other than resorting to short-term loans from micro-managing bankers.
For example, farmers can sell some shares into the fund and use the proceeds to invest in their farms. But they keep the processing rights, milk payout and voting rights while the outside investor gets the dividend. Later, if they choose, they can buy the shares back and regain the dividend.
TAF critics argue that this is the thin edge of a wedge and will allow outside investors to eventually wrest control of Fonterra from farmer-shareholders. But the comparison they draw with Kerry and Glanbia in Ireland is false and alarmist. In both cases those co-ops became listed companies in which outside investors had voting rights. In TAF outside investors have absolutely no voting rights and no route to them.
Critics also argue that outside investors will try to maximise dividends by pressuring the co-op into paying farmers less for their milk, or by curbing investment in processing.
Again, that’s false and alarmist. The investors will get a steady rise in dividends only if the co-op thrives by investing in its future and by rewarding farmer- shareholders for investing in their on-farm businesses.
Fonterra’s competitiveness would erode rapidly if it skimped on either.
Crucially, farmers should want high dividends too. These are paid from the profits the co-op makes above the commodity milk price. So the faster Fonterra moves up the value chain, the bigger the reward for farmers. Any farmers who think they can survive on the commodity payout alone are ignoring the steady rise of low-cost commodity competitors overseas.
Ensuring TAF and the fund will fulfil their potential will take excellent design, governance and fast accumulation of experience by the co-op, farmer-shareholders and outside investors.
The board has helped that process by setting a number of key measures such as a maximum value of the fund at 20 per cent of the value of «wet» shares (those linked to processing).
It has also set a target trading range for the fund value of 7 per cent to 12 per cent of «wet» shares’ value and it has the tools to achieve that.
Crucially, farmer-shareholders retain the ultimate power: they can ditch TAF and the fund if the negatives outweigh the positives.
But voting against them from the outset would be a sure sign farmer- shareholders have lost the courage to step up to the opportunities the world is offering them.