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Opinion: Fonterra sidesteps debate on merits of National Foods bid

By Simon Louisson of NZPA

Friday 28th January 2005

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The half year results released this week of the country's biggest company, Fonterra, were remarkable for what was left unsaid than what was said.

Executives side-stepped better than Carlos Spencer avoiding the predominant issue of the moment - Fonterra's bid for Australia's National Foods.

Fonterra's revenue for the six months to November 30 was up 2% at $5.74 billion and it registered a net surplus of $15 million, from $16m. Given the co-operative pays out virtually all its net surplus to suppliers, the latter figure was neither here nor there.

The rise in revenue is a pretty fair result given that milk production was down 4% due to intermittent poor growing conditions. Over the year, Fonterra will have to source 75,000 tonnes from third party sources overseas to keep its customers happy.

Chairman Henry van der Heyden stressed the result was significantly affected by climatic conditions (affecting production), the high New Zealand dollar and high commodity prices - all factors outside Fonterra's control.

The high dollar was mitigated by hedging at US61c against the current spot rate of US71.5c, protecting returns for now.

"As a whole we remain optimistic for the year," chief executive Andrew Ferrier said. There is no suggestion of backing away from the $4.30/kg payout, up 5c from last year.

He expects farmers to benefit from continued high commodity prices although these would affect Fonterra's value added businesses such as the ingredients business and New Zealand milk.

All this is well and good.

What was disconcerting was the company's refusal to answer questions on NatFoods.

"We have nothing further to add on National Foods. When, and if we want to, we will actually come out in that point in time," said Ferrier.

Van der Heyden brushed aside reports of farmer unease at the price Fonterra may have to pay, saying he was confident of support.

Just before New Year, Philippine diversified brewer San Miguel trumped Fonterra's $A5.45 ($NZ5.94) per share bid with a $A1.8 billion, $A6.00/share bid.

NatFoods shares are trading at an $A6.26 on the expectation that Fonterra will make a higher pitch.

Fonterra sees NatFoods as a great opportunity to enact its strategy to dominate the world in traded dairy products. Australia will provide the substantial "domestic" base along with New Zealand to expand consumer, branded and ingredient products globally. Fonterra already owns 20% of NatFoods, whose brands include King Island, Yoplait yoghurt and Pura Milk.

The problem is whether the price is right.

Analysts already believe San Miguel's offer is already above the average paid for food companies. It will get a less than spectacular 3.7% return on its investment. Although Fonterra is seen having superior synergy gains than San Miguel, a higher bid totalling over $2 billion may be too rich.

Such a bid would amount to the equivalent of $160,000 per NZ farmer or over 40% of this year's annual payment to farmers of $4.30/kg of milksolids.

Farmers have had static returns for two years and these are well down on 2002/3. If the kiwi dollar stays up, then returns are likely to shrink once hedging contracts expire next season and the squeeze comes on.

If Fonterra accepted San Miguel's offer, the payment would be equivalent to an immediate gain averaging $16,000 for each of Fonterra's 12,300 farmers . That would be very attractive to many who may have a much shorter term focus than the suits at corporate head office.

To increase its bid, Fonterra needs to sell it to farmers, otherwise they will later simply vote directors off the board as they have done in the past.

Kevin Wooding, chairman of lobby group Dairy Farmers New Zealand, has denied an Australian news report that he has called on Fonterra to pull its bid but admits to apprehension.

"It is big bite of the cherry as far as an investment. Farmers haven't been there before," he told The Dominion Post.

Earlier, in a veiled threat, he noted the board would be accountable for any decision on NatFoods.

Farmers want Fonterra to pursue long term strategies as long as there are medium to long-term gains, he added.

Adding to disquiet is news that San Miguel has negotiated a $A17.8 million break fee which it receives if any counter bidder wins over 50%. NatFoods has come under fire from some of its shareholders for agreeing to the fee, which is a further discouragement to a higher bid.

Fonterra appears more willing to explain its case in Australia than locally. Australian media yesterday reported Fonterra was negotiating with NatFoods to see its books. The NatFoods board, which has recommended the San Miguel bid after rejecting Fonterra's, has said it would only allow that if it leads to a superior bid. Understandably, there is more sensitivity over Fonterra inspecting the books because the companies compete on some products.

Fonterra already had one due diligence bite before it made its first bid, so NatFoods may well legitimately be asking what else does it need to know. As well, under the terms of the break fee, NatFoods has agreed not to provide sensitive information before March 31 unless it will lead to a superior bid.

One reason Fonterra may be reticent to talk about NatFoods was that Ferrier boobed in November by stating Fonterra would not budge from its original offer. Such a statement has legal weight and he clumsily pulled back from it.

Fonterra employs high powered public relations firm Baldwin Boyle to control its media relations and the flow of information to the media and the public is not always what it could be.

Of course Fonterra also has direct, strong contacts with its farmer shareholders and keeping them happy is more important to Fonterra than keeping the public or media satisfied.

Canterbury University senior lecturer in accountancy Alan Robb is critical of both Fonterra's bid for NatFoods and its reluctance to debate the case.

He said the NatFoods issue is highly topical to farmers in the light of the six monthly performance and the future.

"I think farmers will be concerned that the company sidestepped it and did not give even an indication of when they would be likely to make a comment."

Robb believes Fonterra's pursuit of NatFoods is unwise.

"They are acting much more like an investor-owned company and less like a co-operative."

He sees alternatives such as alliances with other co-operatives or bidding for the Australian operations of the distressed Parmalat. New Zealand companies had a history of paying inflated prices for Australian companies, such as Telecom's purchase of AAPT.

Fonterra's half-owned Victorian cooperative Bonlac was giving less than stellar returns and he also noted that Fonterra just before Christmas sold its Mexican subsidiary which had performed well below expectations.

"There is a point at which it is not prudent to keep raising the price." he said.

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