Dairy industry people call that “a tension” - and not a good one.
Here’s another.
Apparently there’s a culture gulf between people who are very good at running a raw goods manufacturing operation and the “shiny suits” who shift fmcg.
Dairy industry people say the ethos is quite different.
But Fonterra is deep in both.
All this is even before you get to the big question of whether Fonterra as a farmer-owned co-operative with constrained capital is a natural owner of a consumer business, which is inherently capital-intensive and risky.
The bottom line is that the consumer business isn’t performing.
It had one of its better years in FY24 but despite that, its return on capital was just 6.8%, up from 3.9% in 2023 and 0.2% in 2022.
Fonterra says it can’t justify investing more farmer-shareholder money into a business that generates returns lower than their opportunity cost of capital, while exposing them to more risk.
These commercial arguments in favour of Fonterra exiting the $3.4 billion business with its iconic brands probably won’t satisfy those still bemused as to what happened to New Zealand’s “we-must-add-value-to-our-products” mantra.
But Fonterra has an answer for that, too.
It says being freed up to concentrate on its core specialty ingredients and foodservice product activities, built on the quality provenance and reputation of New Zealand milk, will unleash a formidable competitive advantage.
These are also value-added products and Fonterra is arguably the most efficient in the world at turning them out. In the consumer business, it has no competitive advantage at all.
Next question is, assuming farmer-shareholders approve the divestment (and that can’t be taken for granted), what will the exit look like?
What curly questions are Fonterra’s leaders and advisers possibly wrestling with, and what will the company look like afterwards?
Confirming recently its intention to press on with a sale process, Fonterra said it was testing a potential initial public offering (IPO) and a trade sale.
Given what’s at stake - including a major capital return to shareholders - it’s unlikely New Zealand’s biggest business would’ve flagged an IPO if it wasn’t firmly on the table.
Fiduciary duty demands the sale route chosen will be the one that will fetch the highest price, but industry insiders favour an IPO for the New Zealand-Australia business, Fonterra Oceania, and trade sales for the other consumer businesses, including Sri Lanka.
They think the Australian manufacturing operations could be rolled into the IPO as Fonterra has been moving out of offshore milk supply since 2019.
An IPO of a brand new company with its own board and chief executive that Kiwis (and Fonterra farmers) could buy shares in may help settle feathers ruffled by the loss of beloved and decades-old brands.
The Anchor brand, for example, has a strong emotional and generational pull with farmers in the Waikato, where it was founded. However, a young farmer in Southland is unlikely to feel that pull.
As one industry supporter of the divestment observes, the biggest risk in this process is that the Fonterra board will be swayed by the emotional views of a few. Trying to appease a vocal 5% of members is a weakness of the co-operative’s philosophy, he suggests.
Next question is how much of a stake, if any, would Fonterra want in the new company?
Some in the industry suggest at least 49% to ensure control.
But that makes little sense given the co-op says it wants out of the consumer product business.
Sharemarket watchers suggest 19.9% would be enough to have a major influence on big decisions. Perhaps the strategy will be to sell down Fonterra’s stake in later stages?
It’s thought Fonterra will need to take some sort of stake to give the IPO confidence. But the bigger the stake it takes, the more the initial share price will be eroded.
Whatever the stake, Fonterra will have to maintain distance from the new company to protect other shareholders, though it would have a director or perhaps the chief executive on the board.
The new consumer goods company will need to source milk and ingredients with a guarantee of continuity and consistency.
Fonterra’s the biggest player in town - it has a 78% share of the New Zealand milk supply market - so is likely to get the job.
Or the new company could use Fonterra or some other consumer goods manufacturer as a “toll manufacturer” of its products. Before Fonterra sold the Tip Top ice cream company, it made ice cream for a supermarket chain. This is called toll manufacturing.
The new company might buy manufacturing assets from Fonterra as part of the IPO.
All these areas will have to be nutted out before an IPO.
Sharemarket watchers think the IPO will be attractive to retail investors, who will be willing to pay a higher price for the shares because they like the iconic brands. KiwiSaver funds would also be starters.
Industry watchers believe the divestment of the consumer business will massively strengthen the co-operative.
“It would look like a very focused business. It would be focused on the things it’s good at which is specialty ingredients for key customers around the world,” said one.
With possibly months still to go before farmer-shareholders and the sharemarket learn more, only one thing about the divestment proposal seems certain at this stage.
Fonterra’s share price will fall after a capital return to shareholders that Fonterra has indicated will be “significant”.
Andrea Fox joined the Herald as a senior business journalist in 2018 and specialises in writing about the $26 billion dairy industry, agribusiness, exporting and the logistics sector and supply chains.
