To allow its farmers to have open conversations and consider all options during consultation, the cooperative said it is temporarily capping the size of the Fonterra Shareholders’ Fund (the Fund) by suspending shares in the Fonterra Shareholders’ Market (FSM) from being exchanged into units in the Fund.
It said the temporary cap will be effective once the current trading halt is lifted when the market opens tomorrow and will remain throughout the consultation process.
Chairman Peter McBride says the capital structure review seeks to ensure the sustainability of the cooperative into the future.
“The coop’s future financial sustainability relies heavily on our ability to maintain a sustainable New Zealand milk supply and protect farmer ownership and control.
“The decisions we’ve already taken in response to the findings of the review – like temporarily capping the size of the Fund – haven’t been made lightly. We appreciate they will have come as a surprise, but they are necessary to keep all our options open while the coop’s farmer shareholders have a free and frank conversation about our capital structure,” McBride said.
Some of the options the cooperative is asking its farmers to consider include buying back the Fund. If the temporary cap was not in place, anyone holding ‘dry shares’ – those shares held in excess of the ‘wet share’ requirement linked to milk production – would have been able to exchange them into units in the Fund during consultation. This could have more than doubled the size of the Fund and made the option of buying it back unaffordable in the context of the cooperative’s current balance sheet targets.
The Fonterra board said it has spent a significant amount of time looking at a wide range of options, including staying with the current structure. Some of the alternative structures considered include: dual share structures, which would move from the current single cooperative share to a compulsory supply share and a separate non-compulsory investment share; unshared supply structures; a traditional nominal share structure; and a split cooperative model.
After its analysis to date, and to help give the conversations with farmers some structure, the board said its preferred option is a “Reduced Share Standard with either No Fund or a Capped Fund.”
“We believe the best option for our coop is to move to a structure that reduces the number of shares a farmer would be required to have and either removes the Fund or caps it from growing further, to protect farmer ownership and control,” McBride said.
Under this option, the minimum requirement for farmer owners would be one share for every four kgMS supplied to the coop, compared with the current requirement of one share for every kgMS supplied. At the other end of the scale, farmers could hold shares up to a maximum of four times their milk supply.
Fonterra said farmers will be encouraged to share their views on these and other features.
“This would make it easier for new farmers to join the coop and give more flexibility to existing farmers who may want to free up capital or who are working through succession,” McBride said.
“A key outcome of this change is that shares would be bought and sold between farmers in a farmer-only market. I want to be clear that these changes could impact the price at which shares in our coop are traded, and there may not be as much liquidity in the market. Ultimately the price for farmers’ shares would be determined by the performance of the coop and trading between farmers.
“We believe this is a more sustainable proposition over the longer term than the alternatives we are confronted with.
“This is the board’s current thinking, but we are open minded about adjusting that direction based on farmer feedback on any of the options. We want to hear from as many of our farmers as possible. I strongly encourage all farmers to consider the information provided and participate in the consultation process that started today and continues over the coming months.”
Fonterra said the environment it is operating in has changed over the past 10 years. Its current structure was put in place when milk supply was growing rapidly in New Zealand.
It said it now needs to be prepared for flat or potentially declining milk supply as a result of factors such as climate change impacts, regulatory changes, and alternative land uses.
“Our coop’s financial performance will always be the main determinant of our share of New Zealand milk. But we also know that a more flexible capital structure, that caters for the diversity and different aspirations within our coop, would support a sustainable future milk supply. This is critical for us to deliver our strategy, which prioritises New Zealand milk.”
Fonterra says declining milk volumes or more flexibility for farmers’ shareholding requirements could cause the Fund size to grow significantly. That would mean the thresholds put in place to help protect farmer ownership and control could be exceeded within the next few seasons.
“To stay within the Fund size thresholds, our coop would need to take action – such as buying back shares or units or increasing the thresholds to allow a greater degree of external investment. We don’t think either of these are ideal outcomes. Buy-backs create an uncertain demand on our capital, potentially impacting our ability to invest in strategy and growth. Under the scenarios that we’ve modelled, buy-backs could cost shareholders up to NZ$1.2bn (US$870m) over the next 10 seasons.”
Over the coming months, the cooperative’s farmers will have the chance to share their views through meetings, webinars and other opportunities – and if the appetite for change remains – the board will do further work to refine the preferred option or options and have a second round of consultation. If the board decides to seek change to the cooperative’s capital structure, it would likely aim for a farmer vote around the time of the annual meeting in November and the approval of 75% of votes from voting farmers would be required.
If the preferred outcome is to buy back the Fund, it would also require the approval of 75% of votes from voting unit holders.
As some aspects of Fonterra’s current capital structure are reflected in the Dairy Industry Restructuring Act 2001 (DIRA), any vote is likely to be conditional on any necessary changes to legislation being passed. The DIRA enabled Fonterra to be formed so an efficient cooperative of scale could lead New Zealand into global markets.
“I appreciate there is a real sense of optimism in the coop with our improving financial performance and how we are traveling generally. But the issues raised through this review need to be addressed early. Waiting for the problem to be at our feet will limit our options and likely increase the cost of addressing them, at the expense of future opportunities for us,” McBride said.