Yili bid for Westland Milk raises questions about dairy co-operatives – and Fonterra’s ownership

On  the face  of  it, it’s  a  no-brainer.  Weighed  down  with  debt,  Westland  Milk,  based in   Hokitika  is financially  on  its  knees.  Riding  to  its  rescue,  Chinese  dairy  giant  Yili  has come in with a  $588m buyout deal   which  will yield  $3.41  a share   to the co-op’s  farmer shareholders,  and, as well,   absorb  Westland’s debt and liabilities.

According to  Westland, the  nominal value of its shares  has ranged  from  70c  to $1.50  per share. For the  average-sized  Westland farm, the  share offer translates to  about half a  million dollars cash.

The offer  looks even  more attractive since  Westland had to  cut its  milk payout  forecast, while other  companies’ forecasts  are rising.  Westland, which has  grown out of  the West  Coast’s  150-year  dairy heritage, hasn’t paid  a  competitive milk price   for  several years.

The conditional  deal comes with extra  sweeteners. Yili has committed to collect all  milk  supply. It  will  also pay  a  competitive  price of at  least  as  much as  the  Fonterra  farmgate milk price   for  10  years.

But why  would   Yili   go that distance?

Dairy  farmers  outside  the  Westland   supply  region   are  asking themselves that question.   What are  the long-term ambitions    of   the  Chinese   giant?

Inner Mongolia Yili Industrial Group   first  entered   NZ   with  the  purchase  of the assets of Oceania Dairy in early 2013.

It then  began development of a $236m infant formula milk processing plant on a 38ha block of land at Glenavy, near Waitaki River.That is Yili’s first major offshore acquisition and was undertaken,  it is said,  to enhance Yili’s “competitiveness”.  Production from the Glenavy plant goes primarily into Yili’s supply chain.

As  the largest company in the dairy food market in China and one of the fastest growing dairy companies across the globe,  will  Yili’s  ambitions be  satisfied with the  acquisition of   Westland?

That’what dairy farmers in  other  regions   are  pondering.

News outlets  like  the  NZ  Herald  have been raising  the  wider issue  of  whether  the  co-op   model  is   still  up  to  the  job. Increasingly,  it’s  been tough   for  the big  dairy  co-ops  to strike the right balance between  what  farmers  are paid  and how  much is  retained.

Investment  guru  Brian  Gaynor  in  the  NZ  Herald has  argued  the proposed   sale of  Westland   to  Yili  should be a  warning  to  the industry.   He   contends the  co-op structure may  be  “on  its  last legs  as Westland’s  and  Fonterra’s  performance illustrates  that these farmer-owned structures are struggling in a  highly competitive  consumer market environment”.

Mark Brown, from Devon Funds,  believes  co-ops  are  “somewhat archaic”  corporate  structures.  In theory   their growth is limited to the cash  they retain after paying out  dividends. In Fonterra’s  case  the co-op  had  global  growth ambitions  but has been held back   by the lack of access to  capital.

Once they have exhausted  their  debt facilities, access to  equity is limited to  the minority  non-farmer share pool, given that farmers—the majority shareholders— have no appetite  to recapitalise the company”.

In Westland’s  case farmers have been simply unable to put up the capital  the co-op  needed. Brown  says  Fonterra’s suspension of its interim dividend “gives me no confidence  they  are in significantly better  shape”.

That’s  not  a  happy  outlook,  either,  for  the country  which was once led to believe  Fonterra  would  become a “national champion”  or  for  individual  farmer-suppliers,  however strong  their  faith  in   the  co-op  structure  may be.

Co-operatives   which have evolved   into  limited  liability  companies  are generally  more  profitable, as shown by  Kerry Group listed on the Dublin  Stock Exchange.  It has a sharemarket value of  17bn  Euros.  By comparison  Fonterra   has an effective sharemarket value of  $7bn.

Gaynor   wonders whether   Fonterra  will heed  the  warning  signal from   Westland’s fate. He suggests that if Fonterra doesn’t, is it then a  question  whether  the country’s  dairy sector  will end  up  in  foreign control just as has happened to our banking, insurance, forestry and pulp & paper  sectors?

No   wonder   there  are  dairy farmers  asking themselves   just what  Yili’s  intentions  could  be.

And there’s  the issue of  the  key  feature   in the legislation  which  established  Fonterra   (and is   currently  under  review).  It is the stipulation  that  Fonterra    must  accept   all the   milk   which is   offered  to it.

On that basis   many  farmers   have  borrowed  heavily  to  finance   their operations.   If the assurance  they  have a  buyer for  all the  milk they produce is removed,   who might they  supply?   Overnight  the valuations  on  which   they borrowed  could  collapse.

Not a  pretty  prospect.


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