The Fonterra Shareholders’ Fund does not have voting rights in New Zealand’s biggest business, but it does have influence, which is a form of control, says chairman Peter McBride.
“The greater the size of the fund, the greater the level of influence it can bring to bear on the co-operative’s leadership.”
Fonterra farmer-shareholders and unitholders had different ideas about risk and value, he said.
McBride was responding to an argument against axing or capping the $500 million Fonterra Shareholders’ Fund, in which the non-farming public can invest through buying units in farmer shares.
McBride and his board of directors have signalled their preference to get rid of the fund as part of their proposal for a major capital restructure of Fonterra in its quest to secure critical mass milk supply for the farmer-owned co-operative in a landscape of flat and likely shrinking milk production. Trading of Fonterra securities would be within the co-operative and therefore restricted.
The other part of the proposal, now in consultation with Fonterra’s 10,000 farmer-shareholders who must buy shares to supply milk, is to lessen their capital burden, attract more supply and make it easier for young farmers to afford entry by relaxing the share standard.
Jarden investment bank head of institutional research Arie Dekker has suggested removing or diluting the fund, which he calls “a demand pool for shares”, risks undermining Fonterra’s whole aim of securing critical mass milk supply.
“It creates issues because the capital base of the co-operative remains the same … at a time they’re putting something forward which will allow farmers to reduce the number of shares they hold,” he has told the Herald.
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McBride responded the biggest implication of trading in a farmer-only market is that farmers will set the price for shares through trading among themselves.
“This is likely to be different to how outside investors value units in the fund today.”
McBride has said because of the fungibility or near equal value of shares in the fund and Fonterra’s separate, farmer-only market, investors have tended to dictate share prices. The listed fund allows outside investors to buy units in Fonterra farmers’ “dry” shares – those not needed to cover milk supply. The units offer access to Fonterra dividends but have no voting rights.
McBride said under the proposal the future share price would be set by performance and farmer perception of share value “which may be different to how external investors may perceive value”.
“In a farmer-only market, there may be lower levels of trading (liquidity). While we would retain a ‘market maker’ – the registered volume provider who is active in making bids and offers on a minimum number of shares in the Farmers Share Market – the share price could move more on small volumes of trading in a farmer-only market.”
The fund, which the board proposes buying back, has hardly grown since its introduction under a 2012 capital restructure called Trading Among Farmers (Taf). Constitutionally it is capped at $500m – its current market capitalisation is $493m. Taf also introduced the separate farmers-only trading market for “wet” or milk supply shares.
The fund hasn’t grown because the share price impact of Fonterra’s disappointing financial performance hasn’t attracted farmers or outside investors. Farmers with surplus shares because of declining milk production have hung on to them.
Fonterra directors are concerned that as the company’s new business strategy turns around its performance at the same time milk supply flatlines or declines in coming seasons, the fund will press against its size thresholds. This would force Fonterra to allow more external investment, or buy back shares or units, placing uncertain demand on its capital and potentially affecting investment in strategy and growth.
There’s also the issue that in relaxing the share standard, farmers will be able to buy shares up to a maximum of four times their milk supply. Overarching all concerns is the need to retain farmer ownership and control.
Dekker has said in fact the fund is very small and only potentially large. He’s suggested Fonterra extend its potential size while keeping an eye on its actual growth.
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McBride: “It’s true the fund has no voting rights but it does have influence which is a form of control. The greater the size of the fund, the greater the level of influence it can bring to bear on the co-op’s leadership.
“Ultimately this comes back to the potential misalignment between the mindset of external investors versus farmers when it comes to perceived value and this could create conflict in relation to strategic decisions the co-op makes in future.
“The co-op looks at total wealth – farm, animals and shares. Unitholders may only look at the value of the units, so naturally we have different ideas when it comes to risk and value.”
Dekker has also suggested rather than lower the share standard so drastically – from one share per kilogram of milk solids supplied to one share for four kg – Fonterra return capital to shareholders by further divesting mature overseas assets and those not creating competitive value.
“We take his point,” said McBride.
“Nothing that we are suggesting prevents us from doing that in the future if we choose to.”
McBride said the board respected Dekker’s opinion and acknowledged there would be a range of different perspectives during the consultation debate.
He noted an S&P Global ratings commentary issued after the capital restructure proposal announcement, which said the agency considered “the preferred option balances the need for greater flexibility while maintaining farmer control”.
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