Monday, September 21, 2009

The cow jumped over the moon… hopes Fonterra

The Board of Fonterra is about to try to get farmers to pay for the high cost of the two ideas farmers - that is, some farmers - have long claimed they would not give up at any price. We may be about to find out whether indeed there is in N.Z dairying - as there is in everything else in life - "a price at which".

The two ideas - that co operative ownership is the best model for the industry and that farmers will only ever allow farmers to own and invest in "their industry" - have become such motherhoods in New Zealand that the most hardened commentators have either (1) given up in disgust and gone home (2)become too scared to look at the guts of these arguments objectively or (3) worse - become convinced themselves.

So we are missing plenty....

First the entire house of cards which is monopoly supply of milk to farmers has to be supported by state coercion through legislation. No one else needs or gets that hand up. If this model is so robust why is force needed? This is anti smacking stuff for farmers. A large number of nursery rhymes about collective behaviour, weak selling and such like have circulated for years while the evidence says, unsurprisingly, that these people are price takers not price setters and no amount of collusion can stop competition for long - ask OPEC.

Second, farmers are already donkey deep into agriculture without the company they think they own forcing them to become even more undiversified, more exposed to the exchange rate volatility they hate, invested still further in a so called "value added" business which only provides them returns at the expense of the milk price they get, and further exposed to a company which is run primarily via a political process.

Third, "their" company is asking them to invest at a cost of equity about which little is known other than the fact that it's limited liquidity, its rules around ownership and the dependence of the model on state imposed monopoly all combine to drive risk higher than standard levels. Paying over the top for equity in a company you have a compulsory sales arrangement with in which the company sets the price is, at the very least, bizarre.

These are high costs to pay for the illusion that the form of "ownership" which keeping other investors out brings is of any value. Auckland International Airport - now safe from marauding herds of Canadian teacher pensioners is still struggling to structure its capital optimally. Silver Fern Meats whose latest capital raising efforts imposed restrictions to limit non farmer investment to 20% ended up with a shortfall in capital raised. They are currently looking at selling investment assets - ironically a bunch of shares in another agricultural venture - to raise capital.

The "rights" this ownership confers are a mixed blessing - essentially the right to vote for a farmer politician or two on the board, the right (well there is less choice than these words imply if you want to sell milk) to be part of the monopoly which prevents the competition which would bring the company to account - and of course the "right" to have to buy more artificially priced shares should the farmer be courageous enough to produce more milk.

One of the tougher decisions in dairy farming is when to stop producing lest you are forced to buy more shares which might be marked down in value. Far more prudent to stop producing than to buy.

Finally - the model itself - again a sacred cow (sic).

Investors in any company make money when costs, including costs of supply are driven down as far as possible. That is how farmer investors in Fonterra would or could maximise dividends - by driving down their supply prices.

Suppliers maximise returns by obtaining the highest possible prices for their product - not by leaving plenty on the table for dividends to the owners. High cost of supply to the company sits well with the supplier and poorly with the investor.

Who wins? Hard to tell - its far too opaque since prices are the product of advisor reports not markets - but we do know that farmers have a comparative advantage at being suppliers. Being strong performing dairy farmer suppliers - rather than some time minority capital investors - is their core business and they do it well. And anyway, creditors get paid out well before equity  investors.

This is very likely why in spite of Fonterra and before it the Dairy Board have been arguing the need for investment in "value added" businesses for years but significant actual returns to farmers have yet to be seen - as a supplier owner with expertise and a core business in supplying why would you want it otherwise?

In short - the model is schizoid. Thus capital comes and goes with redemption and growth fighting one another in a process which never sees a stable capital structure. The value of permanent capital was recognised by the Dutch and the English in the middle of the 17th century.

Just what price is "enough" for the rights to be a part of all this? We don't know but may be about to find out. What is for sure is that it's pointless looking for objective answers from farmer politicians who have everything to lose and nothing to gain.

It would be useful if a few more critics turned some serious spotlight on the political roadshows to come - after all, that monopoly is granted by taxpayers - not farmers, not by suppliers to Fonterra, not by Fonterra management and certainly not by farmer politicians. Taxpayers too are owed some accountability.


  1. Well said. As one in category 1 above - gave up arguing years ago - there is a certain satisfaction in seeing the cows come home to roost.

    The $740m redemptions last year almost bust the company and scared the hell out of the directors. But farmer politicos know how to spin the bull. They won't admit any flaws in the sacred co-op model, and just present this total reversal as minor change.

    The director selection process is Jesuitical. If the correct mantras are not chanted, no chance of election.

    And wise MPs (especially Nat MPs)do not argue with farmers. Give them what they want, and the quiet life is ensured. But not so good for the rest of NZ.

    Sorry to be so cynical and pessimistic. But seen it all before!

  2. Lets face it, within say 10 years Fonterra will probably be a really bad memory. Overstaffed with overpaid executive types,weak negotiators with unions, dictatorial with individual farmers,I couldn't jump ship quick enough.Farmers were racing blindly down the steep, slippery road to hell. These were the nouveaux riche.Money was no object, there to be hosed and sprayed around. What possibily could go wrong? Not long to wait now.We'll see.

  3. "Paying over the top for equity in Fonterra is bizarre"
    You wrote what I have been thinking ever since last Friday. Bizarre, and nobody else has put it as well you have.