KEY POINTS:
Dairy giant Fonterra appears to have been locked into a long-term pattern for calculating the cost of its raw milk, in the wake of a successful Supreme Court appeal by the Commerce Commission.
As well, the decision released today by a bench of five judges in the nation's highest court has effectively given the Commerce Commission an intrusive power to intervene in such commercial decisions, unless Fonterra does things in a particular way.
Today's ruling overturns a series of lower court decisions, including in the Court of Appeal, in the dairy co-op's favour.
The 2001 mega-merger which created Fonterra escaped the scrutiny of the Commerce Commission, but the Government set regulations requiring it to supply limited amounts of milk to rival processors, and laid down a formula for the price which could be charged for that milk.
The rules were intended to create a level playing field for the independent processors in terms of their raw milk price, in a market where the Supreme Court said Fonterra controlled 98 per cent of the milk produced in New Zealand.
The dispute was about how Fonterra calculates the price of milk sold to independent rivals, but also canvassed whether the commission had power to dictate Fonterra's calculations.
Many things fed into the milk price in Fonterra's first season, in 2001-2002 season, including the value of farmers' shares in the co-operative and how much Fonterra topped up the payout from reserves.
The commission appealed on the issue of whether Fonterra used a "cost of capital" rate to set the price of farmers' shares in the co-operative. Fonterra used a weighted average cost of capital rate to calculate the value of its shares -- and successfully fought for that interpretation all the way through to the Court of Appeal.
For the year to May 31, 2002, Fonterra directors used funds from reserves -- equivalent to 4.5c/kg milksolids -- to prop up a debut payout of $5.33/kg milksolids, or a total of $5.9 billion. They then posted a loss of $50 million from turnover of $13.924 billion, instead of a forecast $13 million surplus.
The commission has fought a series of court actions since then, revolving around the allegation that in the 2001/2 season, Fonterra charged independent producers more for raw milk than the cost-price, because of the artificial inflation of its costs through the transfer from reserves.
In a May 4, 2006 ruling, the appeal court said the case was of public importance: the commission -- which is the regulatory watchdog monitoring the Dairy Industry Restructuring Act -- said the concept of the raw milk regulations was that independent processors should pay the same price for raw milk as Fonterra, so they could compete.
But on the issue how the price of milk should be calculated, the court said to rule in favour of the commission would not only lock Fonterra into a long-term pattern for the cost of milk, but would mean the commission had an intrusive power to intervene unless Fonterra did things a particular way.
It upheld an earlier High Court ruling in favour of Fonterra.
Today, the Supreme Court said the regulations cannot have been framed to allow Fonterra to adopt any of the three cost of capital rates it used in valuing its shares.
"Although the weighted average cost of capital was the rate used to calculate enterprise value, Fonterra's debt was 'backed out' before the share value was assessed on the basis of net present equity value.
"The weighted average cost of capital rate -- while used for calculating enterprise value -- was not used to calculate share value".
The capital referred to in regulations calling for calculations to be based on the cost of capital rate "must be equity capital".
The return to farmers on their shares was the cost to Fonterra of its equity capital: "The discount rate must therefore be a rate applicable to equity capital," the Supreme Court said.
- NZPA
