Fonterra's growth to be decided by its capital structure. Allan Barber looks at the TAF reviews and vote prospects

By Allan Barber

The process of getting farmer and legislative approval for the introduction of Trading Among Farmers must seem frustratingly slow to Sir Henry van der Heyden, directors and management of Fonterra.

They have been working on it for almost two years now and even got just under a 90% vote from shareholders in favour of it when it was last put to the vote in June 2010.

They will now take it back to shareholders for a second vote in late June this year when they hope to get another resounding mandate for its introduction.

By then the company also expects the Select Committee will have completed its hearing and reported favourably, enabling the Dairy Industry Restructuring Act to be passed.

This will enshrine both Commerce Commission oversight of milk price setting and TAF in legislation, should Fonterra elect to introduce the scheme.

The objectives of TAF are very simple: first it will remove the threat of redemption risk destabilising Fonterra’s balance sheet and second it will generate an investment capital fund which will enable the company to invest in strategic partnerships and initiatives which exceed its present balance sheet capability.

As a pure cooperative it can’t guarantee to be able to do this, in the same way that Silver Fern Farms, from a substantially weaker capital base, found it necessary to introduce ordinary tradeable shares to replace rebate cooperative shares in 2009.

The sky hasn’t yet fallen in as a result of this change in SFF’s equity structure, but this was always less likely to happen in the meat industry which is nowhere near as desirable as an investment as the dairy industry.

However a vocal minority of Fonterra’s shareholders are now very suspicious of the proposal to introduce TAF because of a perceived risk of corporate or private investors being able to influence the ratio of dividends to the milk price the shareholders receive.

I get the impression the directors are surprised, not to mention disappointed, by the serious amount of noise this issue is generating.

But of course the issue is absolutely crucial for the future of Fonterra as a cooperative owned 100% by its farmer shareholders.

If the door opens even a millimetre to corporate ownership, there will be no chance of closing it again, so it is critical that they get it right first time.

Fonterra and the Shareholders Council are carrying out a due diligence process to ensure that certain pre-conditions have been met by the time the vote takes place on 25th June. At this stage the Shareholders Council has not yet given its unqualified support for the scheme, but only the process.

The major perceived threat to Fonterra’s long term existence as a farmer owned cooperative under TAF is the freedom to trade shares for which the dividend rights could be sold to private investors as units. However these units would not have voting rights which would remain attached to the shares in farmer ownership.

Opponents of TAF, notably Lachlan McKenzie, ex Federated Farmers Dairy Section head, and Damien O’Connor, Labour spokesman on agriculture, believe these dividend rights will be the thin end of the wedge which will enable outside investors over time to demand higher dividends at the expense of the milk price payout.

After yesterday’s Select Committee hearing, van der Heyden stated unequivocally that Fonterra would always be a 100% farmer owned cooperative and would not seek outside capital, while CEO, Theo Spierings, said there were plenty of other ways of structuring investments than increasing shareholders’ funds from new entrants or new production.

So Fonterra will have to convince the doubters that the dividend rights will not pose a risk to cooperative ownership in the long term, while answering those who doubt the company’s ability to fund new investments from its balance sheet without outside capital. It’s a challenging balancing act that the Board must tread carefully to achieve the desired outcome.

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Allan Barber is a commentator on agribusiness, especially the meat industry, and lives in the Matakana Wine Country where he run a boutique B&B with his wife. You can contact him by email at allan@barberstrategic.co.nz or through his blog at http://allan.barber.wordpress.com.