Have your say: Fonterra abandons NZX listing option; will raise cash from farmers instead

Fonterra announced on Saturday that it had withdrawn the option of an NZX listing as part of its capital reform discussions with farmer shareholders. "Many of our shareholders have made it clear they want to retain 100% farmer control and ownership of their Co-operative," Fonterra Chairman Henry van der Heyden said. Under Fonterra's constitution, 75% of votes must support any change to capital structure. "Taking a public listing off the table is a pragmatic, commonsense approach which reflects how our shareholders feel. It would be a waste of time and money to debate the merits of a public share listing when there is no prospect of securing a 75% vote," Henry said. "The Board, with the unanimous support of the Fonterra Shareholders' Council, will discuss with farmers possible solutions around a three-step process that, if accepted by farmers, would take care of Fonterra's capital structure issues for the immediate future. This is all designed to address redemption risk and to secure capital for the Co-operative. "At present Fonterra's shares relate to milk production and are redeemable. This means at times of falling production, significant amounts of equity are lost from the balance sheet, affecting debt-to-equity ratios." Fonterra said the consultation process with shareholders would begin on September 18. Henry said that, if farmers supported the first three steps, there were a number of options not involving public listing that they could consider for any fourth step. What I think New Zealanders generally don't trust the stock market anymore so it's understandable that farmers remain distrustful of an NZX listing, particularly given their punts on land prices in the last decade have proved so spectacularly profitable. Fonterra has bowed to the inevitable and decided to push ahead because it is determined to find some form of structural reform that gives it access to new equity. Fonterra needs to reduce its own debt, probably by up to NZ$1 billion over the next couple of years to drag its debt to debt+equity ratio down under 50% from 53% currently. It also needs at some stage to fund some overseas growth in the consumer brands and fresh milk areas. Fonterra's other risk is redemption risk. This is where a bad season could see farmers pull hundreds of millions of dollars of equity out of Fonterra because Fonterra's equity structure is based on farmers buying or selling an extra share for each extra/less kilogram of production every year. In the 2007/08 year of a big drought there was a net withdrawal of equity of NZ$600 million. Fonterra could not afford another big drought or some form of longer term farmer exodus. This could be triggered by an aged farmer base retiring or by high debt levels and low milk prices encouraging others to sell out. By choosing not to go with an NZX listing Fonterra has effectively decided it will ask its farmer shareholders for more equity. Most farmers will be able to afford it given their equity levels are high in farms that have more than doubled in value in the last 5 years. Some more recent entrants or those who have bought out neighbours with high debt levels may struggle. Fonterra estimates about 5% of its farmers who produce 10% of supply are stressed with high debt levels. What this means is that farmers will simply borrow more from their banks and hand it over to Fonterra, who will then pay back some of its debt, sometimes to the same banks. Some of Fonterra's debt repayment will however be to overseas lenders. This will mean New Zealand Inc's net debt levels would increase and the banks' exposure to the dairy farming sector would expand at a time when the Reserve Bank of New Zealand is warning banks not to lend too much to farmers. However, this simple act of asking farmers for more cash doesn't immediately solve the redemption risk. Fonterra may look at some sort of 'dry' shareholding option for farmers who hold 'excess' shares above their production amount or possibly retired farmers could own shares. Your view? We welcome your comments and insight below.