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Opinion: Is NZ Dairy Foods ready for the flick after this week's deal?

By Simon Louisson of NZPA

Friday 12th August 2005

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Why did Fonterra shell out $754 million this week for part of a company that three years ago cost $310m, half of which was previously owned by Fonterra?

New Zealand's wealthiest man, Graeme Hart, again proved himself a deal-maker extraordinaire when he got Fonterra to pay top dollar for its former assets - primarily the Anchor brand in New Zealand and the Fresh'n Fruity yoghurt brand.

In return, Hart's NZ Dairy Foods (NZDF), bought the Meadow Fresh and Taurarua brands plus the Kiwi smallgoods business from Fonterra. NZDF ended with those assets plus $338m in cash - $28m more than he paid for the entire company.

Questions arise from this deal. Why did Fonterra pay such a rich price and what will happen to NZ Dairy Foods?

NZDF had been reluctantly sold as part of the deal to establish Fonterrra and some semblance of competition within the domestic market.

Fonterra's director of strategy, Graham Stuart, said the repurchase of the Anchor brand in New Zealand was partly an emotional purchase. It had retained the brand overseas and reclamation of the Anchor name at home is part of Fonterra brand supremo Sanjay Khosla's strategy to fine brand numbers from over 100 to 10 global names.

It also aims to be "category captain" in the consumer brands it is in and it would be embarrassing not to have that position in New Zealand.

Industry commentator Tony Baldwin said Fonterra's move was made for both defensive reasons - to keep an aggressive new entrant out of its home base - and offensive reasons - to pursue the brand global strategy.

Baldwin said there was insufficient information to evaluate the business case for the move.

While the Fresh'n Fruity brand had a massive 55% of the local yoghurt market against Meadow Fresh's 20%, it has nothing overseas.

"You could argue - why didn't they kick Meadow Fresh into shape? The New Zealand market is piddly. Either one requires a good deal of investment to create the brand awareness overseas. It may have some advantages, but it is not clear what they are."

The business case for wanting to own the Anchor brand in New Zealand - that there is some kind of synergistic benefit because Fonterra owns Anchor overseas - was equally muddy.

"It's not obvious to me how it will generate more revenues overseas. If it was for emotional reasons it would suggest a lack of commercial discipline," Baldwin said.

Peter McLure, chief executive of NZDF, who will move to Fonterra along with 800 other workers, believes Fonterra will drive its new brands hard locally and internationally.

He said there were only two countries where Fonterra had a significant presence in the cultured foods markets - New Zealand and Chile.

"So leveraging it out from this base makes a lot of sense. You'd have to look at Australia and you'd have to look at Asia."

Who is Fonterra worried about muscling in on its home turf?

In April, the media carried stories Hart had sold NZDF to Philippine brewing and good company San Miguel. The stories said it beat off Swiss giant Nestle, French company Danone and Australian beverage company CC Amatil.

The speculation was denied by Hart but it prompted him to issue a statement to comment that various parties were doing due diligence. Whether that is this week's deal or another is also unclear.

San Miguel has plans to be one of Asia's top 10 food and beverage companies. It outbid Fonterra earlier this year to buy Australia's largest fresh dairy products producer National Foods.

While locked in the $2 billion battle for Fonterra the normally secretive company openly said it was interested in buying NZDF.

However, two things are against a purchase. Firstly, while it has deep pockets, analysts said it has its hands full integrating Nat Foods and the Australian juice company Berri in which it has a 51% stake.

In producing a lacklustre profit result yesterday, San Miguel said it was interested in buying out the Berri minorities, likely to cost around $A150m ($NZ166m). It would not comment on its interest in NZDF.

Food company analyst Pierre Grobler with Australian brokerage CommSec said that although San Miguel was a cash cow, it had its hands full. "They have ample funding capacity for another acquisition, it's just a question of whether it fits their strategy."

The other impediment to San Miguel/Nat Foods buying NZDF has largely gone. Nat Foods applied to buy NZDF in 2002 but was blocked by the Commerce Commission because that would give it dominance in the yoghurt market. It would have combined NZDF's 55% share through Fresh'n Fruity with Nat Foods' 18-20% share through Yoplait.

However, in November, Fonterra ironically helped clear the way for NZDF when it applied for Commerce Commission clearance to buy Nat Foods. The watchdog this time ruled combining Meadow Fresh and Yoplait would not substantially lessen competition. So while the No.1 player, could not combine with any other player, the No.2 and No.3 players could team up.

The commission argued supermarkets could keep a market of just two main players honest with the threat of introducing in-house brands, as they have done in the liquid milks market.

Now that Fonterra and NZDF have swapped brands and market shares, the way is clear for Nat Foods to buy the latter.

Competition law and dairy industry expert Rob Noakes of Kensington Swan believes this is a likely scenario.

"In my view, that's what's going to happen. He will sell off the Mainland brands, the Meadow Fresh and Tararua brands along with perhaps Kiwi and Huttons and make a bloody fortune again.

"He has a ready-made purchaser desperate to get in there - San Miguel wanting to get into Australasia - Fonterra is getting into Australia, so why not National Foods get into New Zealand?

"It's a big ask for San Miguel, but they are not a small company," Noakes added.

Grobler said that while Hart was keen on food companies and the dairy industry, and himself had ambitions to build a global food company, NZDF did not fit well with his vehicle, listed Australian food giant Burns Philp, in which he had the largest shareholding.

Grobler does not believe shareholders in Burns Philp, which bought Australasia food company Goodman Fielder in 2003 for $2.2 billion, would be persuaded to buy NZDF. Synergies are not readily apparent.

If Hart does manage to sell NZDF, he may not get the $1 billion he was reported to want for the company, but he is unlikely to be too many millions off following this week's deal.

"If he does flick it on to National Foods, he will have made a load of money that no one else felt was possible," said Noakes.

Bond Offer: Infratil Ltd, 7.2 year & 10.2 year unsecured unsubordinated bond


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