Brian Gaynor: Acquisition underlines market shortfalls

Bright Dairy is providing capital for cash-strapped Synlait to restructure its balance sheet and repay loans. Photo / Simon Baker

Two developments this week, the proposed acquisition of a 51 per cent stake in Synlait Milk by a Chinese company and the takeover offer for NZ Farming Systems Uruguay (NZFSU), underline the inadequacies of our capital markets.

The Synlait development shows that our companies are unable to raise sufficient expansion capital from domestic investors and the NZFSU bid highlights how overseas groups can make low-priced offers for our companies because they have been poorly governed.

These developments also indicate that foreign entities could gain control of major areas of our food and dairy sectors.

In the 1980s and 1990s Australian investors spotted the huge potential in our banking sector and purchased ASB Bank, Bank of New Zealand and the remaining 25 per cent of ANZ Banking Group (NZ). These offers were successful because we didn't have sufficient savings and capital to match the Australian acquirers.

The major Australian banks have made huge profits from these acquisitions and, as a result, there has been a significant wealth transfer from New Zealand across the Tasman.

In the mid and late 1990s overseas investors, particularly from Asia and North America, recognised the huge potential in our major commercial forests. Most of these forests are now overseas-owned and these owners are now making huge returns because of booming log exports to China.

Once again we sold these forests far too cheaply because we didn't have sufficient savings and risk capital to take a long-term view. New Zealand investors tend to panic and sell in a downturn and overseas investors, who take a long-term view and make low-priced, successful offers, make huge profits at our expense.

Asian investors have now spotted the massive potential in our dairy and food industry and, once again, we don't have sufficient capital to compete with them. As a result, we could see large sections of this industry acquired by offshore interests.

The solution to this problem is that we need far more domestic savings, capital and stronger capital markets.

In other words we should be looking at the reasons why New Zealand companies have to go offshore to raise capital instead of adopting a xenophobic approach when the providers of this capital want to take major interests in our companies.

Synlait Milk originated as a wholly owned subsidiary of Synlait Limited, a company established in 2000 to own and manage a group of farming businesses in the Canterbury region.

In 2007, Mitsui of Japan invested $30 million in Synlait Limited and a year later Synlait Milk's first milk processing facility was commissioned.

In November 2009, Synlait Milk sought to raise $165 million through an IPO although the prospectus was never registered. The proceeds would have been used for a number of purposes including the repayment of debt, the funding of a second milk processing facility and the buyout of Mitsui.

In simple terms Synlait was trying to raise sufficient capital from New Zealand investors to double its milk processing capacity, mostly exports. In addition, Mitsui would be bought out and replaced by New Zealand shareholders.

The IPO failed because of our shortage of capital and our institutional investors having limited knowledge and experience of the dairy sector. As a result they needed far more time to assess Synlait than was available and the IPO was pulled before the prospectus was registered.

The Synlait IPO would have been no problem in Australia because of the abundance of capital and major institutions across the Tasman that have far more analytical resources to respond quickly to an equity offer.

Synlait Milk announced on Monday that China's Bright Dairy & Food would pay $82 million to acquire a 51 per cent stake in the company. The funds will be used to build the second milk processing plant which was supposed to be funded through the IPO.

Under the latest proposal the Chinese will own 51 per cent of Synlait Milk with Synlait Limited owning the remaining 49 per cent. The latter is still 22.5 per cent owned by Mitsui whereas under the post-IPO structure Synlait Milk and Synlait Limited would have both been New Zealand owned.

The NZ Farming Systems Uruguay debacle can be summarised as follows.

In November 2006 NZFSU raised $115.6 million through the issue of shares at $1 each and a year later it had a one for two rights issue at $1.50 per share.

The company planned to purchase 24,000ha of farm land in Uruguay but by June 2008 it had acquired 36,300ha with the additional 12,000ha costing twice as much as the initial 24,000ha on a per hectare basis.

PGW Wrightson, NZFSU's management company, earned huge fees even though its stewardship has been woeful and the Uruguayan company has fallen well short of its prospectus profit forecasts.

The company's share price slumped to a low of just 37 cents in recent months and on Monday Olam Corporation of Singapore announced it intended to make a full takeover offer at 55 cents a share.

PGW Wrightson announced that it would accept in respect of its 11.5 per cent stake, which would take Olam to 30.0 per cent, and the NZ company would relinquish its management contract in return for the receipt of its unpaid fees and an ongoing supply contract.

Many shareholders are extremely angry with PGW Wrightson because the takeover offer appears to be extremely beneficial to it.

On the positive side, Olam will get rid of PGW Wrightson, NZSFU's share price is above its recent lows and shareholders don't have to accept the 55 cent offer. If Olam gets to 50.1 per cent, but doesn't reach the 90 per cent compulsory acquisition target, then NZSFU's share price could start climbing back towards $1 under foreign stewardship.

But the most important issue regarding NZSFU is that its poor performance has put another dent in investor confidence. This was a contributing factor to the poor response to the Synlait Milk IPO, another dairy company, and one of the reasons why the Canterbury company will have a 51 per cent Chinese owner.

The lack of savings and capital is a major concern for the dairy and food industry, as it was for banking and forestry in the 1990s, but there is no quick solution. In my 35 years involvement in the NZ sharemarket I have never seen so little interest and activity on the NZX or such a lack of IPO prospects.This is reflected in KiwiSaver statistics with only 13.1 per cent of total KiwiSaver funds invested in domestic equities, 38.8 per cent in other NZ investments (mainly cash and bonds) and 47.5 per cent offshore.

By comparison Australians have 46.7 per cent of their superannuation in domestic equities, 36.7 per cent in other Australian investments and only 16.6 per cent offshore.

Looking at it another way we have only $0.7 billion of KiwiSaver invested in domestic equities whereas Australians have a massive A$493.7 billion ($608 billion) of their superannuation invested in Australian equities.

Our capital markets need a dramatic quick fix but the only headline-grabbing mends are the partial float of Kiwibank or Fonterra.

These are both off the table because of fears they will be taken over by foreign interests.

Therefore the New Zealand investment sector is caught in a hopeless chicken-and-egg situation.

It doesn't have new and exciting IPOs to encourage investors because of fears that these companies will be taken over by foreign interests.

On the flip side there is little interest in our capital markets because we have so few IPOs and, as a result, more and more of our companies are coming under foreign control.

The worst response to this situation would be to restrict foreign investment because this would almost totally starve our businesses of badly needed capital.

Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management. bgaynor@milfordasset.com