What will Fonterra come out with tomorrow for its capital restructure?

Fonterra’s capital restructure proposals, due to be revealed tomorrow morning, have been kept surprisingly watertight considering it has 10,000 heavily invested and involved farmer-shareholders, but its a safe bet the main thrust will be measures to stop milk supply loss by demanding less capital from its farmers.

This New Zealand’s biggest company and the world’s fourth largest dairy company by revenue could do by making it less costly to join and supply milk to the big farmer-owned co-operative.

It’s a measure new chairman Peter McBride signalled he was very keen on in a Herald interview back in December.

Another safe bet is that the proposals being offered tomorrow for farmer consultation (and presumably the board will show leadership by signalling its favourite) will seek to simplify Fonterra’s current complex hybrid capital structure.

As a co-operative, only farmers can own shares. But public non-voting, dividend-carrying units in those shares are listed on the NZX and the ASX, and farmer-shareholders themselves can trade shares in the market.Fonterra is in a trading halt until Friday morning to give farmers and the market time to digest the proposals for change.

Farmers must buy a share for every kilogram of milk solids they supply to Fonterra, unlike its growing dairy processing competition which generally doesn’t require this.

With those shares trading anywhere from $4-plus to $6 in their heyday, that’s a very expensive proposition for a young farmer juggling land and cow costs, or any other entrant to the industry.

All the while New Zealand’s milk production is flatlining, Fonterra’s market share of milk is eroding, while competitors like Open Country Dairy are getting bigger, attracting more milk suppliers and paying similar prices for milk – but without a dividend.

McBride signalled his concern about the compulsory nature of Fonterra’s capital in a Herald interview late last year after he took on the chair’s job.

He identified “structural issues” as needing attention.

“The compulsory nature of capital, the flexibility we can offer to farmers. I’m really hot on succession planning in this industry, how we facilitate young farmers into the co-operative and onto farms. If we don’t, where is the future?”

Asked if the cost of buying into Fonterra was too high, he said: “Yes. But it’s also about highly indebted farmers and the implications for them as well. And that’s notwithstanding [the issue of] the company’s performance as well in terms of its earnings per share, dividends and share value.”

While there’s speculation today that a significant capital restructure might torpedo the Fonterra Shareholders’ Fund which introduced listed units and trading in 2012 under the Trading Among Farmers (Taf) scheme, McBride in a Herald interview agreed the fund, which has its own board and administration, would be challenging to dismantle.

And as Jarden investment bank senior analyst Arie Dekker has noted, farmers own a big proportion of the fund anyway. And given the fund is capped at about $500 million, Dekker questioned where the money would come from to disestablish it.

Dekker will be closely reading tomorrow’s announcements.

In March in the Herald he said farmers had invested $8 billion over a decade in Fonterra for a disappointing return.

Future capital was looking scarce, he said. It would be helpful for Fonterra’s leaders to say why the business was retaining capital in overseas and mature businesses where it did not have a competitive advantage, or where categories were mature, against investment in priority areas which should provide better returns.

Fonterra may be more competitive and its farmers might be happier with a smaller capital base, Dekker said.

The choice was to shrink the co-operative or reduce the amount of capital invested.

“It’s difficult to see how they can hold on to everything and make it easier for incoming and outgoing farmers to hold less capital in the co-operative.”

Mechanisms already exit for farmers to enter Fonterra and get time to pay off the shares, but for existing farmers more flexibility could be offered on the share standard, Dekker said.

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