Fonterra proposes new Flexible Shareholding structure
23 September 2021
New Flexible Shareholding structure proposed as best option for farmers and Co-op
Fonterra’s Board has presented a revised capital structure proposal that it will discuss with farmers over
the coming weeks before deciding whether to proceed to a shareholder vote.
The “Flexible Shareholding” structure is a progression on the preferred option put forward at the start of
the consultation process in May, but with key changes based on farmer feedback and further expert
advice:
• New minimum shareholding requirement would be set at 33% of milk supply (around 1 share
per 3 kgMS), compared to the current compulsory requirement of 1 share per 1 kgMS. This is
intended to strike a balance between providing a meaningful level of flexibility for those who need
it, which is critical to maintaining a sustainable milk supply, while ensuring all farmers having some
capital-backed supply.
• New maximum shareholding requirement would be set at 4x milk supply, compared to the
current 2x milk supply. This is intended to strike a balance between supporting liquidity in the
farmer-only market – by ensuring more capacity for farmers to buy shares from those who want to
sell – while avoiding significant concentration of ownership.
• More types of farmers could buy shares, including sharemilkers, contract milkers and farm
lessors. This is intended to recognise their connection to Fonterra, provide a pathway for future
farmer owners and increase the number of potential participants in the farmer-only market by
around 4,000 to support liquidity.
• Exit provisions would be extended and entry provisions would be eased. Existing
shareholders would have up to 15 seasons initially to exit, reducing annually to 10 seasons, which
would also support liquidity and give these farmers greater choice about how long they retain an
investment in the Co-operative. Meanwhile any new entrants would have up to six seasons to
achieve the 33% minimum shareholding requirement. This compares to a standard three seasons
for both entry and exit under the current structure.
• The Fonterra Shareholders’ Fund (the Fund) would be capped to protect farmer ownership
and control. If greater flexibility was provided without making any other changes to the current
Fonterra Co-operative Group
Page 2
structure, the thresholds relating to the size of the Fund could be exceeded relatively quickly.
That’s because farmers would be able to hold fewer shares and non-farmers would be able to
invest more through the Fund.
• The Fonterra Shareholders’ Market (FSM) would continue to operate as a farmer-only
market, but shares would no longer be able to be exchanged into units in the Fund. As
communicated in May, this means the share price may trade at a discount to the unit price,
referred to as a restricted market discount. But aside from this initial adjustment, the farmer-only
market should enable the Co-operative’s share price to better reflect the higher costs of capital
many farmers have compared to external investors with more diversified investment portfolios.
• Additional measures to support liquidity in the farmer-only market would be implemented,
recognising there may be lower levels of trading, so the share price could move more on small
volumes. The Co-operative has sourced expert advice to determine the measures it would take to
support liquidity. This includes allocating up to $300 million to support liquidity as farmers transition
to the proposed structure, through an on-market share buy-back programme and other tools.
Fonterra Chairman Peter McBride says changing the Co-operative’s capital structure is a critical decision
and not something the Board and senior management are taking lightly.
“We are confident that this proposal would support the sustainable supply of New Zealand milk that our
long-term strategy relies on. One enables the other, and together they give our Co-operative the potential
to deliver the competitive returns that will continue to support our families’ livelihoods from this generation
to the next.
“Our future success relies on our ability to maintain a sustainable milk supply in an increasingly
competitive environment, and one that is rapidly changing due to factors such as environmental
pressures, new regulations and alternative land uses.
“We see total New Zealand milk supply as likely to decline, and flat at best. Our share of that decline
depends on the actions we take with our capital structure, performance, productivity and sustainability.
If we do nothing, we are likely to see around 12-20% decline by 2030 based on the scenarios we have
modelled.
“Farmers leave the Co-operative for different reasons, but one of the most influential ones is the high level
of compulsory investment that’s required to be part of our Co-operative. A capital structure with Flexible
Shareholding would help to level the playing field with competitors, many of whom are foreign-backed and
don’t require farmers to invest capital.
McBride says the Co-operative's farmer owners staying stronger together is in everybody’s interests.
“Analysis of potential milk supply scenarios we have developed shows that, based on our current
operations, our Farmgate Milk Price could be 6-13 cents lower by 2030 if we make no changes to our
capital structure and continue to lose market share at the rate we’ve seen over the past five seasons to
May 2020.”
Fonterra’s Farmgate Milk Price sets a benchmark in New Zealand, so even farmers who don’t supply the
Co-operative benefit from it. For the 2020/21 season, Fonterra delivered $11.6 billion to the New Zealand
economy through the final cash payout to farmers.
Fonterra Co-operative Group
Page 3
Under the Flexible Shareholding structure, farmer ownership and control would be protected by capping
the Fund. This means shares in the farmer-only FSM would no longer be able to be exchanged into units.
The proposed changes would also protect against the uncertain and recurring risk to the
Co-operative’s balance sheet that would come with having to buy back shares or units to stay within
thresholds related to the Fund size if milk supply declined under the current structure. Those thresholds
exist to protect farmers’ ownership and control of Fonterra.
Flexible Shareholding is detailed in a booklet that has been sent to all farmer owners, who will have a
chance to discuss it further with Directors and senior management at upcoming meetings and webinars.
At this stage, the Co-operative is still aiming for a farmer vote at its Annual Meeting in December.
Before a vote could take place, at least 50% of Fonterra Co-operative Council members would need to
support the final proposed changes. Ahead of a vote, voting documents would provide farmers with
everything they need to know to assess the proposed changes they would be voting on. The approval of
75% of votes from voting farmers would then be required.
As some aspects of Fonterra’s current capital structure are reflected in the Dairy Industry Restructuring
Act 2001 (DIRA), any vote would be conditional on the necessary changes to legislation being passed.
Fonterra says it is continuing to consider unit holders’ interests throughout this process and is consulting
with the management company of the Fund, which communicates with unit holders directly.
Attachments
• Capital Structure Presentation
• Capital Structure Booklet
ENDS
For further information contact:
Fonterra Communications
24-hour media line
Phone: +64 21 507 072
---
Confidential to Fonterra Co-operative Group
September 2021
Confidential to Fonterra Co-operative Group
3
Fund size thresholds could be exceeded, and/or capital required
for share or unit buy-backs $500m to $1.2b by FY30
More conservative risk settings,such as lower debt targets
anddividend policies
Milk Price could reduce by
6 to 13 cents /kgMSby FY30
May need to close between 12 and 18 plants within our
manufacturing sites, on top of operating costs which would need
to reduce by $100m to $160m p.a. by FY30
Harder to attract and retain milk supply and staff; more difficult to
provide scale benefits to farmers
Confidential to Fonterra Co-operative Group
Confidential to Fonterra Co-operative Group
•Share minimum -33% of supply
•Share maximum -4x supply
•Shares could not be exchangedinto units in the Fund
•Farmers set prices for shares in FSM
•Sharemilkers,contract milkersand farm lessors associated
with a supplying farmer
•Existing farmer owners would have up to 15 seasons initially,
reducing to 10 seasons
•New suppliers would have up to 5 seasons
•Associated farmers would have up to 3 seasons
•Up to 6 seasonsfor 33%
•Share-Up Over Time and MyMilkcontracts would no longer be
offered, with all existingcontracts honoured
•1 vote per 1000 kgMSsupplied, backed by shares
Confidential to Fonterra Co-operative Group
8
Note: Thefigures on this slide are targets that we are aiming to achieve only. Theyshould not be taken as forecasts or as a guarantee of returns to shareholders.
Theyare subject tosuccessfully completinga number ofbusiness initiatives,andassumptions, each of which could materially affectthe actual outcomes.The key assumptions and risks relating to these
targets are set out in the Appendixof the booklet titled Our Path to 2030. Please also referto the important cautions and disclaimer at the beginning of our strategy presentation.
9
Supporting a sustainable milk
supplyby providing farmers with
capital flexibility
Protects farmer ownership
and controlby capping the
Fund
Maintains our financial
sustainabilityby supporting
efficiency, enabling our strategy,
and protecting against uncertain
and recurring risk to our balance
sheet
10
•A 4x cap provides headroom for those wanting to sell
•A market maker would provide buy and sell quotes for shares in the FSM within certain limits and
timeframes so that there is a price available for shares to be traded
•We would allocate up to $300 million to support liquidity if needed, as farmers transition to the new
structure
•The FSM would continue to be a regulated market operated by the NZX, so the Co-op would continue to
be required to comply with continuous disclosure requirements and reporting and have robust
governance systems in place, including independent directors
•Independent market research and broker coverage would be expected to continue to provide ongoing
analysis and insight on Fonterra’s performance for farmers and unit holders
•The Fund would provide a reference point for how external investors value the economic rights in a Co-
operative share
Confidential to Fonterra Co-operative Group
Confidential to Fonterra Co-operative Group
Further
Development
of options
Farmer
Survey
Problems to
Solve &
Principles
Detailed Analysis
of options, trade-
offs, risk and
benefits
Research into
Co-operatives
around the world
Proceed with
Preferred Option
(including shareholder
vote, conditional on DIRA
changes)
Further Regional
Meetings
Review
Feedback &
Refine Preferred
Option
Further
Consultation
Director
Meetings
•
•
•
•
Confidential to Fonterra Co-operative Group
14
Confidential to Fonterra Co-operative Group
Farmer-only
Fonterra Shareholders' Market
For supplying farmer owners,
plus associated sharemilkers,
Contract milkers and farm lessors
Flexible Shareholding
-from 33% of supply
-up to 4x supply
Voting rights based
on supply
backed by shares
FONTERRA FARMERS
holding shares
Capped
Fonterra
Shareholders’
Fund
No voting rights
PUBLIC INVESTORS
holding units
Access to
economic rights
of a share
0
50
100
150
200
250
300
350
400
450
500
kgMS (m)
Non-Fonterra Collections
Source: NZ Milk Supply: Dairy NZ –New Zealand Dairy Statistics 2019-20,Summary of milk production statistics for the last 35 seasons.
DCANZ NZ Collections.
•It’s expected tradingbetween farmer owners buying and selling would support
sufficient liquidity,based on our understanding of the levels of tradingprior to the
temporary cap.
•Features of the structure such as the Minimum and Maximum Holdings, the entry
and exit timeframesandenablingassociated farmer ownerstoparticipate would
also support liquidity.
•A registered volume providerormarket makerwould be in place to support the
existence of buy and sell orders in the market.
•Up to $300m would be available to support liquidity in the FSMasfarmer owners’
transitionto the new structure.
•One-off events suchas awidespreaddrought or low milk pricecould impact
liquidity.
•However, manyfarmershavereduced their level of debtfollowing several seasons
ofa strong milk price,putting them in a better position to manage throughthese
types of macro events.
•As set out in OurPath to 2030 booklet,we are planning to continue toprovide
strong returns to our farmers.
New suppliers
Sharemilkers,
contract milkers
and farm lessors
Existing
suppliers
15
10
5
3
22/2323/24
24/2525/26
26/27
21/22
Example assumes changes are approved in
December
Confidential to Fonterra Co-operative Group
19
Potential Fund Size as at September 2021
20
---
Our
Choice
A capital structure for a
better future, together
This booklet is for consultation purposes only.
You are not being asked to vote on any changes
at this time, and you will receive all the documents
needed to understand and assess any proposed
changes before you are asked to vote on them.
Some of the information set out in this booklet
relates to future matters, forward looking
information, financial targets and projections
(together “Forward Statements”) that are subject to
uncertainties, assumptions and risks. The inclusion
of Forward Statements should not be regarded as
a representation or warranty by Fonterra or any
other person that those Forward Statements will
be achieved or that the assumptions underlying
any Forward Statements will in fact be correct.
Actual outcomes may vary materially from those
suggested or implied.
If you have any questions about the revised proposal
or would like to clarify your understanding of
anything in this booklet, see Section 6 for who you
can contact. For any questions about your own
financial circumstances or your holding of shares
or units, please contact your accountant, lawyer,
financial advisor or other rural professional.
This booklet is addressed to Fonterra’s farmer
owners, but the interests of other stakeholders
(including the Custodian and the Manager of
the Fonterra Shareholders’ Fund) have been, and
will continue to be, considered and taken into
account in the development of the revised proposal.
These parties will be consulted as appropriate.
Contents
1ON BEHALF OF THE BOARD 2
2WHY WE NEED TO CHANGE4
3WHAT WE’RE NOW PROPOSING8
Flexible Shareholding at a glance8
4THE NEW STRUCTURE IN MORE DETAIL10
How different elements of the structure would work
The future of the farmer-only Fonterra Shareholders’ Market
How we would transition
The future of the Fonterra Shareholders’ Fund
Farmer scenarios – comparing the proposal to our current structure
10
15
16
17
18
5THE BIG ISSUES YOU’VE RAISED20
6WHERE TO FROM HERE 21
APPENDICES22
1. Why we need to change
2. How a farmer-only market would work
3. Comparing other alternatives
22
26
30
GLOSSARY32
An overview of our
capital structure
consultation
A strong farmer-owned Co-operative is good for
farmers and good for New Zealand. Our milk price
sets a benchmark here – so even those who don’t
supply the Co-op benefit from it – and because
we’re owned by Kiwi families, our profits stay in
New Zealand. Our capital structure review is about
protecting and building on what we’ve got, from
this generation to the next.
Consultation with farmers about our options
has been extensive. Thank you to everyone who
has been involved so far.
This booklet outlines a revised proposal to improve
our capital structure. It is a progression on the
preferred option we presented in May 2021, but
with key changes that reflect your feedback and
additional expert advice. There will be a chance
to discuss it further during the second phase
of the consultation process. We look forward
to continuing the conversations.
90
Director-led farmer meetings
held across the country
7
200
farmer webinars with an
average of around
attendees at each
100s
of written responses
received from farmers
5,000
Over
farmers have directly
engaged through feedback
channels to date
1
WHAT WE ARE NOW PROPOSING:
FLEXIBLE SHAREHOLDING
Our proposed structure gives all farmers
a level of flexible shareholding, which is
critical to supporting farmers to join or
stay with our Co-op. It is a progression on
the preferred option presented to you in
May 2021, but with key changes based on
farmer feedback:
»33% share minimum – you would
only need to hold one share for
every ~3 kgMS supplied.
»4x share maximum – you could
hold up to four times your milk
supply in shares.
»Farmer-only market for shares,
with a capped Fund. Farmers
would decide the prices at which
they buy and sell shares, without
the traded price being influenced
by external investors.
»6 seasons to share up for
new entrants.
»Up to 15 seasons to share down
for existing shareholders after
ceasing. Any new entrants post
these changes would have five
seasons to exit after ceasing.
»A more inclusive pathway to
becoming a Co-op member as
sharemilkers, contract milkers
and farm lessors could buy and
sell shares.
»Voting remains based on share-
backed milk supply.
»Fonterra would allocate up to
$300 million to support liquidity
as our farmer owners transition.
The Board considers these changes to
be our best course of action if we are to
maintain farmer ownership and control of
a financially sustainable Co-operative.
We are confident that this structure
would support the sustainable supply
of New Zealand milk that our long-term
strategy relies on.
One enables the other, and together they
give our Co-op the potential to deliver
the competitive returns that will continue
to support our families’ livelihoods, from
this generation to the next.
We strongly encourage you to read the
accompanying strategy booklet, the
financial targets we are aiming to achieve,
and the key assumptions and risks
included within it.
Top line, those targets out to
2030 include:
»An average Farmgate Milk
Price range for the decade of
$6.50-$7.50 per kgMS.
»A 40-50% increase in operating
profit from FY21 and, with the
reduced interest from having less
debt, this should translate into
an approximately 75% increase
in earnings, giving us the ability
to steadily increase dividends to
around 40-45 cents per share by
FY30.
»A Group Return on Capital of
9 -10 %, up from 6.6% in FY21.
»Through planned divestments and
improved earnings, an intended
return of about $1 billion to
shareholders by FY24, and
around $2 billion of additional
capital available for a mix of
investment in further growth
and return to shareholders. This is
in addition to the approximately
$2 billion expected to be invested
in sustainability and moving milk
into higher value products.
»An increase in our current total
annual R&D investment by over
50% to approximately $160
million per year in 2030, with
about $60 million per annum
specifically targeted at growth in
Active Living.
These targets are subject to successfully
completing a number of business
initiatives, and various assumptions and
risks, each of which could materially
affect the actual outcomes.
Our future share price would be a
reflection of our financial performance
and the value farmers see in that.
As I said at the beginning, this is a critical
decision, and farmers’ to make. Over the
coming weeks, we will ensure that you
have the opportunity to speak with your
Board and management. You will have
access to as much information as possible
to support an informed decision if we do
proceed with a vote in December.
Deciding to stay with Trading Among
Farmers is an option, but we risk
becoming a smaller and less efficient
Co-op. If that is our collective decision,
we would need to re-look at how we
implement the strategy based on even
more conservative risk settings (such as
debt targets and dividend policies). We
are unlikely to be in a position to achieve
the same level of returns in terms of
capital and dividends as the targets we
have published.
These are big decisions and we need to
work together to get a quality outcome.
For its part, the Board is united in its view
that what we are recommending is the
right outcome for all Fonterra farmers
and for New Zealand.
A strong Co-op of scale is essential to
maintaining the highest sustainable milk
price. To support returns to New Zealand
dairy farmers in the long term and
control our own futures, it is important
that we do all we can to maintain a
strong Fonterra.
Peter
“The Board is united in
its view that what we
are recommending is
the right outcome for
all of us.”
PETER MCBRIDE – CHAIRMAN
to maintain a sustainable milk supply in
an increasingly competitive environment,
and one that is rapidly changing due to
factors such as environmental pressures,
new regulations and alternative land uses.
To achieve that, Fonterra must be an
attractive option to farmers who have
a choice on where their milk goes. In
a recent representative survey of our
farmers, 30% said they had seriously
considered leaving to join a competitor
processor in the last two years or so.
Farmers leave for different reasons, but
one of the most influential ones is the
high level of compulsory investment
that’s required to be part of our Co-
op. A capital structure with flexible
shareholding would help to level the
playing field with competitors, many
of whom are foreign-backed and don’t
require farmers to invest capital.
We see total New Zealand milk supply
as likely to decline, and flat at best.
Our share of that decline depends on
the actions we take with our capital
structure, performance, productivity
and sustainability.
If we do nothing, we are likely to see
around 12–20% decline by 2030 based
on the scenarios we have modelled.
Staying stronger together is in all of
our interests.
Our scale efficiencies lead to better
utilised factories, lower processing
costs, and our ability to pay the highest
sustainable milk price. Analysis of
potential milk supply scenarios we have
developed shows that based on our
current operations our Farmgate Milk
Price could be 6-13 cents lower by 2030
if we make no changes to our capital
structure and continue to lose market
share at the rate we’ve seen over the
past five seasons to May 2020.
Dear Farmer Shareholders,
Your Board is pleased to put forward
this proposal to improve our capital
structure, as we reposition our Co-op to
take advantage of the future global dairy
market. That future is bright, despite the
challenges we all have in front of us right
now. It’s a future in which our Co-op can
prosper and deliver for the New Zealand
farming families who supply and own it.
The proposal outlined in this booklet has
changed from what we put forward back
in May, in response to farmer feedback
and further expert advice.
Changing our Co-op’s capital structure is
a critical decision and not something the
Board has taken lightly when preparing
this proposal. Ultimately, it’s farmers’
decision to make.
The Board is united in its belief that
change to capital structure is needed.
Our context here in New Zealand is
changing fundamentally, and we need a
capital structure that maintains a strong
Co-op through these changes.
Moving to a new capital structure now,
while we are in a strong financial position
and have all options available to us, is
our best course of action. The solution
we are now proposing puts us in the
best position to achieve all three of the
outcomes the review has focused on:
1. Supporting a sustainable milk
supply by providing farmers with
capital flexibility.
2. Protecting farmer ownership and
control by capping the Fund.
3. Maintaining financial sustainability
of our Co-op by supporting our
strategy, and protecting against
uncertain and recurring risks to our
balance sheet.
Milk is the lifeblood of our Co-op. Our
strategy is focused on New Zealand milk
and our future success relies on our ability
1.
On behalf of
the Board
CAPITAL STRUCTURE REVISED PROPOSAL 2021
3
2
1 – ON BEHALF OF THE BOARD
2.
Why we need
to change
WE NEED A SUSTAINABLE
MILK SUPPLY TO SUPPORT
OUR STRATEGY
We aim to sustainably grow
earnings for shareholders through
three key strategic choices:
1. Continue to focus on
New Zealand milk.
2. Be a leader in sustainability.
3. Be a leader in dairy innovation
and science.
These choices support the four key value
targets we’re aiming to achieve by 2030:
»Average Farmgate Milk
Price range for the decade of
$6.50-$7.50 per kgMS.
»A 40-50% increase in operating
profit from FY21 and, with the reduced
interest from having less debt, this
should translate into a 75% increase
in earnings, giving us the ability to
steadily increase dividends to around
40-45 cents per share by FY30.
»A Group Return on Capital of 9-10%,
up from 6.6% in FY21.
»Through planned divestments and
improved earnings, an intended return
of about $1 billion to shareholders
by FY24, and around $2 billion of
additional capital available for a
mix of investment in further growth
and return to shareholders. This is
in addition to the approximately
$2 billion expected to be invested
in sustainability and moving milk
into higher value products.
Our strategy and ability to achieve
these targets is based on a sustainable
supply of New Zealand milk and, in
turn, a capital structure that enables
this. This is why changes to our capital
structure are so important.
These targets are also subject to
successfully completing a number
of business initiatives, and a number of
assumptions and risks, each of which could
materially affect the actual outcomes.
More detail on our ambitions to deliver
further value, including key assumptions
and risks, are set out in the strategy
booklet titled Our Path to 2030, which
has been provided to you together with
this booklet.
Note: The figures in this section are targets that we are aiming to achieve only. They should not be taken as forecasts or
as a guarantee of returns to shareholders. They are subject to successfully completing a number of business initiatives,
and assumptions, each of which could materially affect the actual outcomes. The target years assume long-term
average levels of price relativity and lag pricing impacts, and individual years are likely to vary from this assumption.
The key assumptions and risks relating to these targets are set out in the Appendix to the booklet Our Path to 2030.
Please also refer to the important cautions and disclaimer at the beginning of the booklet Our Path to 2030.
Average Farmgate Milk Price range for the decade
$6.50-$7.50
per kgMS
Operating Profit
40-50%
increase from FY21
~$160m
per annum invested in R&D, up ~50% from FY21
Group ROC
~9-10%
~$1b
invested in
sustainability
~$1b
invested in moving
milk into higher value
products
~$1b
intended to be
distributed to
shareholders after
asset sale
~$2b
available for a mix of
investment in further
growth and return to
shareholders
Make progress towards 2050
aspiration to be
Net Zero Carbon
THE VALUE WE’RE AIMING TO CREATE BY 2030
Our Co-operative’s
strategy is to enhance
people’s lives through
convenience, health
and wellbeing
by unlocking the
goodness of NZ milk.
WE AIM TO
Prioritise the
Farmgate
Milk Price
Grow
Foodservice
Strengthen
Consumer
Move towards
higher value
products in
ingredients
OUR PLANS
Sharpen portfolio
• Sell Chile business
• Explore ownership structure of
Fonterra Australia, one option is
an IPO
Continue our shift to
higher value
Focus on
NZ Milk
Develop our people capabilities for
a changing and technological world
Embed culture to drive
high performance
Prioritise innovation, IP,
simplification and digitisation
Create competitive advantage
through nutrition solutions
Extend further into health
and wellbeing
Be a leader in dairy
Innovation
& Science
Bring our NZ dairy story to life
Make the most of our operational
footprint and invest in
sustainability
Be a leader in
Sustainability
Support further on-farm change
to stay in front of customer
expectations
Our strategy
and plans
5
4
2 – WHY WE NEED TO CHANGE
CAPITAL STRUCTURE REVISED PROPOSAL 2021
1,000
1,200
1,400
1,600
1,800
2,000
2,200
2001/022003/042005/062007/082009/102011/122013/142015/162017/182019/202021/222023/242025/262027/282029/30
kgMS (m)
NZ Milk Supply Scenario
New Zealand Milk Supply
Fonterra Milk Supply
Strategy Base Case
Scenario 1
Scenario 2
MILK SUPPLY SCENARIOS (KGMS MILLIONS)
IF WE DON’T PROVIDE
FLEXIBILITY FOR FARMER
OWNERS, WE ARE LIKELY TO SEE
OUR MILK SUPPLY DECLINE
The New Zealand milk supply
environment is changing significantly
due to factors such as environmental
pressures, new regulations and
alternative land uses.
On top of that, the rigidity of our current
capital structure is tilting the playing
field against us when compared to other
processors – many of whom are foreign-
backed and don’t require farmers to
invest capital.
»In a recent representative survey
of our farmers, 30% said they had
seriously thought about leaving to join
a competitor in the last two years or so.
»Results from the last two years of exit
interviews with farmers show that lack
of capital flexibility was the number
one reason to leave our Co-op.
We need to be prepared for declining
milk and increased competition and
understand what that might mean under
our current capital structure.
We have modelled the impacts of
potential declining milk scenarios on
our business. The graph below illustrates
the following:
»Total New Zealand milk supply
declining by around 2.4% by FY30.
This reflects the impact of new
environmental regulations, land
use change, offset by ongoing
productivity gains.
»Our Strategy Base Case of milk supply
at 1,525 million kgMS. This reflects
the actions we are taking to help
offset milk decline pressures – such
as supporting on-farm environmental
and productivity gains, and the
proposed capital structure changes
set out in this booklet.
»Scenario 1, which represents
a decrease in milk supply from
environmental changes, land use
changes, and changes in productivity,
and also assumes that our market
share losses continue at half the
rate of the five seasons to 2019/20.
This scenario results in a decline in
milksolids collected to around 1,350
million kgMS or a ~12% decline in the
relevant period.
»Scenario 2, which represents the
same decrease in milk supply from
environmental changes, land use
changes, and changes in productivity,
and assumes that our market share
losses continue at the same rate we
saw over the five seasons to 2019/20.
This aligns with the average annual
increase in processing capacity that we
have seen from competitors over the
past 15 seasons. This scenario results
in a decline in milksolids collected
to around 1,230 million kgMS in the
relevant period, which is a ~20%
decline in the relevant period.
»The scenarios start from the 2020/21
season’s actual milk collections of
1,539 million kgMS.
IF MILK SUPPLY DECLINES, OR IF
WE PROVIDE MORE FLEXIBILITY
UNDER OUR CURRENT
STRUCTURE, WE COULD EXCEED
CONSTITUTIONAL THRESHOLDS
FOR FARMER OWNERSHIP
AND CONTROL
Under our current structure, if milk
supply declines or we provide more
flexibility around the minimum
shareholding, the number of wet shares
on issue decreases and the number of
dry shares increases by a corresponding
amount. Those dry shares can then
be exchanged into units at any time,
increasing the size of the Fund.
If we make no changes to our capital
structure and milk supply declines,
we expect current thresholds related
to the Fund size to be exceeded within
a few seasons.
Our Co-op would need to take action to
stay within these thresholds – such as
buying back shares or units. This could
require a capital allocation of up to $1.2
billion over the next ten seasons, which
would be more reactive, and at uncertain
times and prices.
Likewise, if we provide farmers more
flexibility to help support a sustainable
milk supply but make no other changes
to our structure, we could also quickly
see the thresholds related to Fund size
exceeded, and again Fonterra having
to buy back the shares or units.
So, providing more flexibility would
need to be combined with making
changes to the Fund in order to protect
farmer ownership and control, and
protect Fonterra from the redemption
risk TAF was designed to remove.
A STRONG CO-OP OF SCALE
PROTEC T S VALUE
FOR SHAREHOLDERS
If milk supply declines under the
Scenarios above, we may see the
following value impacts:
»We would still seek to implement
our strategy, but we may need to
apply even more conservative risk
settings to our business (such as
lower debt targets and dividend
policies), as our balance sheet would
need to accommodate the uncertain
and recurring costs of share or unit
buy-backs.
1. See Appendix 1 for more detail, including
key assumptions.
»Based on our current operations, milk
price could decrease by around 6 cents
per kgMS (Scenario 1) and 13 cents per
kgMS (Scenario 2) as a result of lower
efficiency in our plants
1
.
»To respond, we may need to close
12-18 plants within our manufacturing
sites, impacting local communities,
and we would need to reduce
operating costs by between $100
million (Scenario A) and $160 million
(Scenario B) per annum by FY30.
»We risk undermining our scale
efficiencies such as our ability
to support farmers with on-farm
sustainability, our ability to invest
in innovation and new product and
market development, and our ability
to advocate for farmers’ best interests.
Significant and sustained expansion
of dairy
FlatteningWe need to be prepared for
declining NZ milk
TAF
Source: NZ Milk Supply: Dairy NZ – New Zealand Dairy Statistics 2019-20, Summary of milk production statistics for the last 35 seasons.
DCANZ NZ Collections. Fonterra internal modelling.
-2 . 4%
-1 2 . 2 %
-19.7 %
1,000
1,200
1,400
1,600
1,800
2,000
2,200
2001/022003/042005/062007/082009/102011/122013/142015/162017/182019/202021/222023/242025/262027/282029/30
kgMS (m)
NZ Milk Supply Scenario
New Zealand Milk Supply
Fonterra Milk Supply
Strategy Base Case
Scenario 1
Scenario 2
NOTE:
Y axis
starts at
1b kgMS
7
6
2 – WHY WE NEED TO CHANGE
CAPITAL STRUCTURE REVISED PROPOSAL 2021
3.
W ha t we’re
now proposing
We are now proposing that we move to
a Flexible Shareholding structure. This
means that instead of the compulsory
1 share per 1 kgMS we have currently, all
farmer owners would have more flexibility
around increasing and decreasing their
shareholding during their farming career.
We are also proposing to cap the Fonterra
Shareholders’ Fund (the Fund) at its
current size to protect farmer ownership
and control of the Co-op. This means the
Fonterra Shareholders’ Market (FSM)
would continue to operate as a farmer-
only market, but shares would no longer
be able to be exchanged into units.
We would allocate up to $300 million
to support liquidity in the FSM as farmer
owners’ transition to the new structure.
The adjacent table provides a high-level
overview of the proposal in practical
terms. A comparison is made with our
Trading Among Farmers (TAF) structure
before we put the temporary cap on
the size of the Fund in May to enable
consultation. More detail on how each of
the elements of the new structure would
work is set out in Section 4.
FROM*TO EXPECTED BENEFITS
Increased flexibility
»Minimum shareholding requirement
of 1 share for every 1 kgMS
(or 100% of supply)
»Maximum shareholding of 2x supply
»Minimum shareholding requirement
of 1 share for every ~3 kgMS
(or 33% of supply)
»Maximum shareholding of 4x supply
»Gives you flexibility to free up capital
at any point in your career
by decreasing your shareholding
»Enables you to increase your stake
in the Co-op, while also supporting
liquidity by providing more capacity
for farmers to buy shares from those
who want to sell
Move to a farmer-only market with the Fund capped
»TAF
–Farmer owners can trade shares
in the FSM, and also exchange them
into units in the Fund
–Farmer owners can convert units
into shares
»Farmer-only FSM and capped Fund
–Farmer owners can trade shares in
the FSM, but cannot exchange them
into units in the Fund
–No change
»Protects farmer ownership
and control
»Maintains stronger balance sheet than
buying back the Fund, so our Co-op
has more options to support liquidity
More types of farmers could hold shares
»Supplying farmer owners
»Sharemilkers, if shares are transferred
to them by a supplying farmer owner
in accordance with set rules
»Supplying farmer owners
»Associated sharemilkers, contract
milkers and farm lessors
»Recognises these farmers’ connection
to our Co-op
»Provides a pathway for future
supplying farmer owners
»Increases the number of potential
buyers and sellers in the FSM by
around 4,000, which would be likely
to support liquidity
Entry provisions eased
»Up to 3 seasons
»Share-Up Over Time contracts
»MyMilk contracts
»Up to 6 seasons
»Share-Up Over Time and MyMilk
contracts no longer offered, but all
existing contracts honoured
»Provides the same flexibility to all
»Provides new suppliers with a lower
capital obligation to join the Co-
op over a similar timeframe to the
current Share-Up Over Time contracts
Exit provisions after ceasing extended
»Up to 3 seasons, with a requirement
to sell at least a 3rd of the shares
each season
»For current supplying farmer owners,
up to 15 seasons initially, reducing
down to 10 seasons
»For new supplying farmer owners,
up to 5 seasons
»For sharemilkers, contract milkers and
farm lessors up to 3 seasons
»Gives you greater choice about
how long you retain an investment
in the Co-op, which would also
support liquidity
Voting rights remain the same
»1 vote per 1,000 kgMS supplied in the
previous season to the extent supply
is backed 1:1 by shares
»No change »Voting rights still based on both
milk supply and capital commitment
to the Co-op
PUBLIC INVESTORS
holding units
FONTERRA FARMERS
holding shares
Access to
economic rights
of a share
Flexible Shareholding
– from 33% of supply
– up to 4x supply
Voting rights based
on supply
backed by shares
No voting rights
Capped
Fonterra
Shareholders’
Fund
Farmer-only
Fonterra Shareholders’ Market
For supplying farmer owners,
plus associated sharemilkers,
contract milkers and farm lessors
* This refers to our Trading Among Farmers (TAF) structure from before we implemented the temporary cap on the size
of the Fund in May to enable consultation
9
8
3 – WHAT WE’RE NOW PROPOSING
CAPITAL STRUCTURE REVISED PROPOSAL 2021
4.
The new structure
in more detail
This section sets out further details
on the changes we’re proposing under
the Flexible Shareholding structure.
This includes putting a spotlight on the
measures we intend to take to support
liquidity in the farmer-only Fonterra
Shareholders’ Market (FSM). We also
provide hypothetical scenarios of how
things would change for farmers at
different points in their careers. This is
intended to help you see what the new
structure would mean for you compared
to our current structure.
HOW DIFFERENT ELEMENTS OF
THE STRUCTURE WOULD WORK
The Share Standard
We are proposing that we keep the 1:1
Share Standard as it is, while separately
reducing the minimum shareholding
requirement, which we refer to as the
“Minimum Holding”, to 33% of the Share
Standard (currently it is 100% of the
Share Standard).
The 1:1 Share Standard has been a
feature of our Co-op for many years.
We think it represents our Co-op
principles and encourages alignment
between farmer owners.
The 33% Minimum Holding would
provide flexibility for those who may
need it at particular points in their
farming career, or who otherwise choose
to hold less equity in our Co-op.
Minimum Holding, Maximum
Holding and Individual Limit
The Minimum Holding would be 33% of
the 1:1 Share Standard, which is around
1 share for every 3 kgMS. This strikes a
balance between providing a meaningful
level of flexibility for those who need
it, which is critical to maintaining a
sustainable milk supply, while ensuring
all supplying farmer owners have some
capital-backed supply.
The Maximum Holding would be 4x
the 1:1 Share Standard (currently it is
2x). Lifting this cap on share ownership
would help to ensure that there is more
capacity for other farmers to buy shares
from those who want to sell. The cap
also needs to be set at a level that avoids
significant concentration of ownership.
The Minimum Holding and Maximum
Holding would continue to be determined
based on a rolling three-season average
(or relevant estimates where there is no
average), as they are today.
Separate to the Maximum Holding, the
overall limit on the number of shares
any individual shareholder could hold
on a “relevant interest” basis, would
be tightened. This is referred to as the
Individual Limit in our Constitution.
Currently this Individual Limit only
applies to dry shares, and is set at
5% of the total shares in the Co-op
(around 81 million shares). This would be
tightened so that it applies to all shares
held (i.e. both wet and dry shares).
Who could hold shares?
Currently, shares can be held by those
who supply milk to our Co-op and meet
our Terms of Supply. We refer to this
group as “supplying farmer owners”
in this booklet.
Some sharemilkers can also hold shares
under our current structure, but a
supplying farmer owner has to transfer
the shares to them based on set rules,
and very few have taken up this option.
To recognise their connection to our
Co-op, provide a pathway for our
future farmer owners and support a
successful farmer-only market, we
are now proposing that the following
additional types of farmers would also
be able to own shares under the Flexible
Shareholding structure:
»Sharemilkers under a sharemilking
arrangement with a supplying
farmer owner;
»Contract milkers under a contract
milking arrangement with a supplying
farmer owner; and
»Farm lessors – that is dairy farmland
owners who have leased their land to a
supplying farmer owner.
SHARESSUPPLYING FARMER OWNERASSOCIATED FARMER OWNER
(SHAREMILKER, CONTRACT MILKER OR
FARM LESSOR)
Wet shares equal to the Minimum Holding Yes – responsible for holding theseNo – not responsible for holding these,
or eligible unless approved by the Co-op
Wet shares above Minimum Holding and
up to the Share Standard
Yes – can hold these if they choose No – not eligible to hold these
Dry shares (above Share Standard and up
to Maximum Holding)
Yes – can hold these or can allocate
either a percentage or a fixed number of
dry shares to an associated farmer owner
Yes – can hold these if allocated a
percentage or fixed number by their
supplying farmer owner
Since all of these farmers would need to
be associated with a supplying farmer
owner to be eligible to hold shares in
our Co-op, we refer to this group as
“associated farmer owners” throughout
this booklet.
We would look to introduce additional
eligibility guidelines to set out criteria
such as who would qualify as an
associated farmer owner.
Enabling associated farmer owners to
hold shares in our Co-op should help
support buy-side demand and liquidity
in the farmer-only market. It also makes
sense, and is more inclusive, to provide
an opportunity for potential future
supplying farmer owners of our Co-op
to purchase shares.
The table above summarises who
would be responsible for the Minimum
Holding, who would be eligible to vote
on supply-backed shares, and how the
Maximum Holding for a farm would be
allocated. The guiding principle would
be that, because associated farmer
owners are not the supplier of milk to our
Co-op under our Terms of Supply, they
would only be eligible to own dry shares
allocated to them by their supplying
farmer owner. These shares would not
carry any votes given they would not be
backed by milk supply.
This means the supplying farmer owner
would be responsible for the Minimum
Holding and can also hold wet shares,
which are shares up to the 1:1 Share
Standard that are backed by milk supply
and therefore carry a right to vote.
The supplying farmer owner would also
have the right to hold the dry shares
up to the Maximum Holding, or to
allocate some, or all, of those dry shares
to any associated sharemilker, contract
milker or farm lessor.
For any supplying farmer owner who
owns more than one farm, we would
continue to treat the supply of milk
from each of those farms separately for
milk quality and supply purposes, but
for shareholding purposes we would
remove that requirement to hold shares
against specific farms. This change would
mean that, instead of having a separate
Common Shareholder Number (CSN) to
register the Minimum Holding and Share
Standard for each farm, you could have
a single CSN going forward. However,
where any dry shares are allocated to
associated farmer owners, that allocation
of shares would need to be recorded
against the relevant farm so that we
could maintain clear records.
11
10
4 – THE NEW STRUCTURE IN MORE DETAIL
CAPITAL STRUCTURE REVISED PROPOSAL 2021
Entry timeframes, Share-Up Over
Time and MyMilk Contracts and
the Contract Fee for Units Trust
New supplying farmer owners, or existing
supplying farmer owners who have a
material increase in milk supply, would
be able to purchase shares, or increase
their shareholding, to achieve their 33%
Minimum Holding over six seasons. In
the first season, they would only be
required to hold 1,000 shares, and the
remainder would be split evenly over
the following five seasons. We think
this strikes a balance between flexibility
and retaining a minimum requirement
for supplying farmer owners to share
up. At approximately 6.6% of supply
over those five seasons, the compulsory
investment to supply the Co-op would
be significantly reduced compared to the
current requirements.
The existing Share-Up Over Time and
MyMilk contract options would no
longer be offered, although the Co-op
would honour all existing contractual
commitments. Also, the share-up
obligations under those existing
Share-Up Over Time contracts would
be reduced to reflect the 33% Minimum
Holding, and the contract fee under all
existing contracts would be set to zero for
their remaining terms. This would make
these contracts more consistent with the
capital structure changes, which do not
have a fee or different payment for milk
that is not share-backed.
We are aware that the obligation to
purchase shares under Share-Up Over
Time contracts can be treated as a
contingent liability by farmer owners’
banks. Under the proposed changes, any
contingent liability – whether under an
existing contract or for new suppliers
joining the Co-op – would reduce to
33% of what it would otherwise be based
on the introduction of the new Minimum
Holding. The proposed changes do not
include any unshared supply options
such as MyMilk. This is because MyMilk
has specific eligibility criteria, whereas
the flexibility under the new structure
would be an option for all supplying
farmer owners.
Since the 2018/19 season, the contract
fee under Share-Up Over Time and
MyMilk contracts has been transferred
to the “Contract Fee for Units Trust”,
which uses those fees to purchase units
that are held on trust for, and distributed
to, the relevant supplying farmer owner
or MyMilk supplier when they need
to share up. As part of the proposed
changes, all units (and any cash) held on
trust for supplying farmer owners under
a Share-Up Over Time contract would be
distributed to them. Units held on trust
for MyMilk suppliers would be distributed
to them when they become a supplying
farmer owner, which they could do at any
time. If MyMilk suppliers choose not to
transition to become a supplying farmer
owner at the end of their contract term,
the units (and any cash) held on trust will
be forfeited to the Co-op. Once all units
have been distributed or forfeited, the
Contract Fee for Units Trust would also
be wound up.
New supplying farmer owners who
purchase their Minimum Holding over six
seasons would be committed to supply
the Co-op for that period, although this
would be subject to any DIRA and other
legal requirements.
Exit timeframes
Under the proposed changes, supplying
farmer owners would have a longer
timeframe to hold onto or sell their
shares once they have left the Co-op.
The specific timeframe would depend on
what type of farmer owner they were and
when they joined the Co-op.
Everyone who is a farmer owner on the
vote date, including any farmers who
have already ceased supplying but haven’t
yet sold their shares under the current
three-season requirements, would have
up to 15 seasons to sell their shares. This
would reduce to 10 seasons as described
below. It means all existing farmer
owners could hold all of their shares
until the Compliance Date in the season
ending 31 May 2037. This reflects your
feedback that existing farmer owners
should be given a longer timeframe to
sell, recognising they would be impacted
by the move to a restricted market. It
would give all existing farmer owners
greater choice about how long they retain
an investment in our Co-op after they
cease and should also help reduce any
shorter-term sell-side pressure that may
arise from the changes.
The 15 seasons would reduce by one year
over each of the following five seasons
to 10 seasons. This is partly to protect
the Co-op from being owned by a larger
proportion of ceased farmer owners over
time. By way of example:
»Any current farmer owner who has
already ceased or who ceases with
effect from 1 June 2022 would have
15 seasons to sell their shares;
»Any current farmer owner who
ceases with effect from 1 June 2023
would have 14 seasons to sell their
shares etc.;
»Any current farmer owner who ceases
with effect from 1 June 2027 or
after would have 10 seasons to sell
their shares.
All new supplying farmer owners who
join after the vote date would have up
to five seasons to sell their shares
should they cease to supply the Co-op.
This is intended to reflect the benefit
that new supplying farmer owners would
have compared to existing farmer owners
by joining our Co-op under the new
capital structure.
All associated farmer owners would
have up to three seasons to sell shares,
once they cease to be associated with
a supplying farmer owner. This shorter
timeframe is intended to reflect that they
are not the supplier of milk to the Co-op,
while providing some flexibility to allow
for adjustments when they switch to a
different supplying farmer owner.
Under our Constitution, the Board
currently has the discretion to set a
shorter or longer timeframe to exit
the Co-op for any number of farmer
owners when they cease in the future.
This discretion would be extended so
that a new timeframe could also be set
for any farmer owners who had already
ceased, to enable the Board to respond
to different circumstances as fairly as
possible. For example, in the unlikely
event that the proportion of shares
held by ceased shareholders became
significant, the Board would be able to
reduce the timeframes in a way that
applied fairly to farmer owners who had
already ceased and those who ceased
going forward.
Permitted transfers when leaving
our Co-op
As supplying farmer owners would
have longer time frames to sell their
shares, and we know that ownership
arrangements are often restructured or
changed on retirement, we would enable
these farmers to transfer their shares to
a person(s) approved by the Co-op who is
related to or associated with them. This
could happen:
»Within the first season after the
supplying farmer owner has ceased
supply to the Co-op – this would be
limited to one season to protect against
multiple and ongoing changes; or
»At any time in the event of the death
of the supplying farmer owner, or a
member of a partnership, trustee or
shareholder of that farmer.
We would look to introduce additional
guidelines to set out criteria as to who
supplying farmer owners would be
permitted to transfer their shares to
under these provisions and what kind
of supporting documentation would
be required.
These “permitted transfer” provisions
would not apply to associated farmer
owners because they are not the
supplying farmer owner and they have
shorter exit timeframes. However,
the existing provisions for shares to
pass with the estate of a deceased
shareholder would still apply to
associated farmer owners.
13
12
4 – THE NEW STRUCTURE IN MORE DETAIL
CAPITAL STRUCTURE REVISED PROPOSAL 2021
Voting rights
To date, voting rights have been based
on both milk supply and equity in our
Co-op, at a ratio of 1 vote per 1,000
kgMS of share-backed supply in the
previous season.
With the introduction of a new Minimum
Holding, we need to decide how voting
rights would apply for farmers who may
choose to reduce their level of investment
in our Co-op below their milk supply.
We think the fairest option is for voting
rights to stay the same as they are. This
means they would reduce to the extent
a supplying farmer owner chooses to
reduce their shareholding below the 1:1
Share Standard. So, if you are currently
fully shared up and were to reduce to
the Minimum Holding of 33%, then you
would have 33% of the votes you have
today. If you were to reduce to 57% of
the Share Standard, you would have
57% of the votes you have today, and
so on. If you were to keep your current
shareholding, you would keep 100% of
the votes you have today. And finally, if
you were to hold shares anywhere from
the 1:1 Share Standard up to 4x supply,
you would only hold 1 vote for every
1,000 kgMS of share-backed supply,
as is the case currently.
We asked corporate advisors Cameron
Partners to analyse what this might
mean in terms of ownership and voting
concentration in our Co-op. Currently,
the largest 30% of farmer owners hold
around 62% of total shares and total
votes. Under the proposed changes,
we expect ownership concentration to
increase over time, potentially to where
the largest 30% of farmers hold around
75% of total shares. However, we expect
potential voting concentration to increase
by a lesser amount to around 70%. This
is due to the fact that, as some supplying
farmer owners choose to reduce their
equity below the Share Standard, the
shares that are currently backed by supply
would become dry shares, and therefore
not carry a voting right.
Vouchers
A voucher is a certificate that was
provided to farmer owners who sold
economic rights of up to 25% of their wet
shares to the Fund under the 2012 and
2013 supply offers. Farmer owners have
been able to use these vouchers to count
towards their share compliance and votes,
but vouchers are not tradable and do not
receive a dividend.
Vouchers would be cancelled as part of
the proposed changes. Supplying farmer
owners who currently hold vouchers
would not be required to purchase more
shares, because vouchers have only been
able to count towards a maximum of 25%
of the Share Standard. With a reduction
in the Minimum Holding to 33% of the
Share Standard, those supplying farmer
owners would still hold shares well in
excess of the new minimum requirement.
They would lose the voting rights that
their vouchers currently count towards,
which is consistent with the position
on voting outlined above. They would
need to invest the equity in the Co-op in
the same way that other farmer owners
have to obtain full voting rights on their
share-backed supply. For voucher holders
who already also hold additional dry
shares, these would automatically start
being counted as wet shares up to the
1:1 Share Standard.
Tax impacts
Currently, any dividends or other
distributions paid on wet shares held by
a farmer owner are tax-deductible for
the Co-op.
The proposed capital structure changes
are not expected to change this, but there
would be a potential impact on the Co-
op’s tax profile in the future, because the
aggregate number of wet shares held by
farmer owners could reduce as a result of
the 33% Minimum Holding.
Farmer shareholders would continue to
be required to pay tax on these dividends
or distributions.
THE FUTURE OF THE
FARMER-ONLY FONTERRA
SHAREHOLDERS’ MARKET
The Board believes that moving to a
farmer-only market is necessary to
provide the additional flexibility required
to support a sustainable milk supply while
protecting farmer ownership and control.
By farmer-only market we mean the
FSM with no ability to exchange shares
into units in the Fund (as it is currently
operating under the temporary cap).
This is because our thresholds relating
to the Fund size could be exceeded
relatively quickly if we provide farmers
the flexibility to reduce their level of
capital investment in our Co-op but
make no other changes to our current
capital structure.
Having the FSM operate as a farmer-
only market in this way means that our
farmer owners would set the prices at
which they buy and sell shares. The share
price would no longer be influenced by
external investors in the same way as it
was prior to the temporary cap. In many
cases those external investors have a
lower required rate of return than a
dairy farmer, because they have a more
diversified investment portfolio and
less of their wealth concentrated in one
sector. Therefore, they may be prepared
to pay more for a share than a dairy
farmer would.
WE BELIEVE A FARMER-ONLY FSM SHOULD FUNCTION WELL
We believe this farmer-only FSM
should function well over the long
term and serve in the best interests
of our farmer owners while supporting
the financial sustainability of our
Co-op. The reasons for this include:
»A 4x cap provides headroom for those
wanting to sell.
»A market maker would provide buy
and sell quotes for shares in the FSM
within certain limits and timeframes
so that there is a price available for
shares to be traded.
»We would allocate up to $300 million
to support liquidity if needed, as
farmer owners transition to the
new structure.
»The FSM would continue to be a
regulated market operated by the
NZX, so the Co-op would continue
to be required to comply with
continuous disclosure requirements
and reporting and have robust
governance systems in place,
including independent directors.
»Independent market research and
broker coverage would be expected
to continue to provide ongoing
analysis and insight on Fonterra’s
performance for farmers and unit
holders.
»The Fund would provide a reference
point for how external investors
value the economic rights in a
Co-operative share.
However, as we outlined in May, having
the FSM operate as a farmer-only
market does mean the share price is
likely to trade at a discount to the unit
price. This is referred to as a “restricted
market discount”.
We have had some visibility of this
discount because we have been trading in
a farmer-only market since the temporary
cap was placed on the Fund in May.
However, the share price since then is
likely to also be reflecting the uncertainty
caused by this capital structure review
and share compliance obligations
being on hold.
Aside from this initial adjustment, a
farmer-only market should result in our
share price being a better reflection
of the higher costs of capital many
of our farmers have compared to
external investors.
As we said in May, there may be lower
levels of liquidity in a farmer-only FSM, so
the share price could move more on small
volumes. We have heard your concerns
about this in your feedback. There are
three main situations to consider:
»Day-to-day liquidity – this would be
supported through:
–the expected trading levels between
farmer owners buying and selling,
based on our understanding of
the levels of trading before the
temporary cap.
–features of the structure such as the
Minimum and Maximum Holdings,
the entry and exit timeframes and
enabling associated farmer owners
to participate in the market.
–a registered volume provider or
market maker to support the
existence of buy and sell orders in
the market (similar to the registered
volume provider that has been
operating under TAF).
»Liquidity during transition – as detailed
further below, up to $300m would be
available to support liquidity in the
FSM in certain circumstances as farmer
owners’ transition to the new structure.
»Liquidity during one-off macro events –
in a farmer-only market, one-off events
such as a widespread drought or low
milk price can impact liquidity if many
farmers wish to sell shares at the same
time. Many farmers have reduced their
level of debt following several seasons
of a strong milk price, putting them in
a better position to manage through
these types of macro events, and as set
out in the booklet titled Our Path to
2030, we are planning to continue to
provide strong returns to our farmers.
15
14
4 – THE NEW STRUCTURE IN MORE DETAIL
CAPITAL STRUCTURE REVISED PROPOSAL 2021
WHAT IS AN ON-MARKET SHARE
BUY-BACK?
An on-market share buy-back is when
a company with shares traded on a
licensed market (such as any company
on the NZX, or in our case, the Fonterra
Shareholders’ Market) buys its own
shares in the market during the usual
course of trading. This is different to
an off-market buy-back, which is when
a company makes an offer directly to
shareholders (or in our case it could
also be made to unit holders in the
Fund), rather than buying back through
the market. Both have the effect of
reducing the total shares on issue.
HOW IS THE PROPOSED $300M
LIQUIDITY SUPPORT DIFFERENT
TO THE POTENTIAL $500M
TO $1.2B OF SHARE OR UNIT
BUY-BACKS OVER THE NEXT
10 YEARS UNDER TAF IF MILK
SUPPLY DECLINES?
»The $300m is a proactive and
transitional step only as part of
moving to the proposed Flexible
Shareholding structure. It is to
support liquidity in the FSM and may
be through an on-market share buy-
back or through other tools such as a
market maker arrangement. It would
be at prices that we think represent
value to the Co-op and are in the best
interests of all shareholders.
»In contrast, our current capital
structure does not provide the kind
of capital flexibility required to
support a sustainable milk supply.
In a declining milk supply scenario
(see Section 2), we could need to
buy shares or units to stay within our
current constitutional thresholds,
creating an uncertain and potentially
recurring draw on our capital of
$500m to $1.2b. While we don’t
expect this to be unaffordable, we
may have less choice about when and
how we effect share or unit buy-backs
and we may therefore be exposed to
future and unknown market prices for
shares and units. To be prepared for
this we would likely need to maintain
a more conservative balance sheet,
restricting our ability to put capital
to its best use at the time.
HOW WE WOULD TRANSITION
We propose moving to the Flexible
Shareholding structure all at once.
This means that the new Minimum
Holding and Maximum Holding would
apply immediately from the time the
changes were effective, rather than
being phased in over several seasons.
This would provide immediate and
meaningful flexibility for farmer owners
as well as more certainty in the medium
term. If we instead transitioned to the
new Minimum Holding over several
seasons (e.g., 66% to start with and then
33%), trading in the farmer-only market
could be impacted by speculation around
potential additional share sales coming
onto the market in the next season.
However, given some aspects of our
current TAF structure for shares are
reflected in DIRA, we would not be
able to move to the new structure
without necessary changes to legislation
being passed.
DIRA does not prevent us from providing
flexible shareholding, but we would need
the Government’s support to move to
a farmer-only market.
We are continuing to work with the
Government on the DIRA changes that
would be needed to enable this and
would hope that, following a successful
vote, those changes could be agreed
and passed by Parliament in time to
transition next season. However, this
would depend on Government and
Parliamentary willingness to make
changes and timeframes.
HOW WE WOULD SUPPORT
LIQUIDITY THROUGH THE
TRANSITION
When the Minimum Holding is reduced
there may be a small subset of farmers
that come under pressure to sell shares.
Depending on the number of shares,
selling by those farmers could result in
downward pressure on the share price
in the months after moving to the new
capital structure.
Recognising this potential impact on
trading, we would allocate up to $300
million to support liquidity in the market
as farmer owners’ transition to the new
structure, starting when the changes
become effective.
This would be through an on-market
share buy-back programme, which would
reduce the total number of shares on
issue, and potentially other tools such
as the market maker arrangements.
However, we would only exercise these
options in order to support liquidity
where there is an imbalance between
the number of shares that farmer owners
want to sell and buy, and where we
think the price represents value to the
Co-op and is in the best interests of
all shareholders.
You would know when we have bought
back shares on the market, because we
would be required to disclose details such
as the number of shares we have bought
and the average price.
THE FUTURE OF THE FONTERRA
SHAREHOLDERS’ FUND
During the first phase of consultation,
there was no clear preference for the
future of the Fund that came through
in your feedback.
We have considered this feedback
and done further analysis and are now
proposing that the Fund remains as part
of our capital structure, but capped.
At around 6.7% of total shares on issue,
the economic interest of unit holders
in the Fund comprises a meaningful
component of our Co-op. As the Fund
is listed on the NZX and ASX, it also
provides a mechanism for non-dairy
farmers to invest in the future of our
Co-op by purchasing units in the Fund.
This enables those in our wider
New Zealand community to share in the
Co-op’s future, supporting alignment.
Furthermore, while farmer owners will
determine the prices at which they buy
and sell shares, the Fund would serve as a
reference for how outside investors value
the shares. Maintaining the position of
the Fund within the NZX also supports
research coverage of the Fund and
Fonterra’s performance.
We think it would be better to use our
capital to support liquidity in the FSM
as farmer owners’ transition to the new
structure, as set out in the section above,
rather than using it to buy back the Fund.
With a capped Fund, no further shares
would be able to be exchanged into
units in the Fund. The Fund size would
remain at around 6.7% of total shares
on issue, although the actual percentage
could fluctuate from time-to-time if
the total shares on issue change, for
example, through the on-market share
buy-back programme or a dividend
reinvestment plan.
The Board could still choose to buy back
the Fund in the future, and capping the
Fund preserves that option.
Unit holders are an important part
of our Co-op and we will continue to
consult with the Manager of the Fund
and consider unit holders’ interests
throughout this process. We are making
a conscious decision to retain some non-
farmer capital through the Capped Fund.
As outlined earlier, we would need
Government support to move to a
farmer-only market by capping the
Fund. We are continuing to work with
Government on the changes to DIRA
that would be needed to effect this and
would not be able to change our capital
structure until any necessary changes to
DIRA had been made.
17
16
4 – THE NEW STRUCTURE IN MORE DETAIL
CAPITAL STRUCTURE REVISED PROPOSAL 2021
SCENARIO CURRENT STRUCTURE
(BEFORE MAY ANNOUNCEMENT)
REVISED PROPOSAL
First-time
farmer owner
»Leases dairy
farm-land
»Planning to supply
80,000 kgMS
»Holds no shares
or units
»Minimum Holding: 80,000 shares
»Maximum Holding: 160,000 shares
»Flexibility:
–Purchase 80,000 shares over three seasons
during the share-up period
–Apply for a Share-Up Over Time contract and
commit to supply the Co-op for the term
(e.g. 6 years), and pay a contract fee (currently
5c/kgMS) for non share-backed supply
–Supply MyMilk under contract with no
shareholding requirement, and pay contract
fee on all supply (currently 5c/kgMS) for up
to five seasons
–Invest further in the Co-op and hold up to
160,000 shares
»Votes:
–Supplying farmer owner would have 80 votes
if 80,000 or more shares held
–Farm lessor has no votes
»Minimum Holding: 26,400 shares
»Maximum Holding: 320,000 shares
»Flexibility:
–Purchase 26,400 shares over six seasons:
• 1,000 shares in the first season
• 5,080 per season for each of the
following five seasons
–Invest further in the Co-op and hold up
to 320,000 shares and/or allocate up to
240,000 dry shares to the farm lessor
to invest in the Co-op
»Votes:
–Supplying farmer owner would have:
• 26 votes if 26,400 shares held
• 40 votes if 40,000 shares held etc.
• 80 votes if 80,000 or more shares held
–Farm lessor would have no votes
FARMER SCENARIOS – COMPARING THE PROPOSAL TO OUR CURRENT STRUCTURE
Every farmer’s situation is unique. But the hypothetical scenarios below are designed to give you
a high-level indication of how things could change at different stages of your business life cycle.
Note that these are on the basis that any transition to the new structure has been completed.
For the comparison, we have used the structure we had before the May announcement, which is
when we put a temporary cap on the size of the Fund to enable consultation.
SCENARIO CURRENT STRUCTURE
(BEFORE MAY ANNOUNCEMENT)
REVISED PROPOSAL
Retiring farmer
owner looking to
release capital
»Average production
is 120,000 kgMS
»Holding 150,000
shares
»Minimum Holding: 120,000 shares
»Maximum Holding: 240,000 shares
»Flexibility:
–Sell up to 30,000 shares to free up capital
»Votes:
–Supplying farmer owner would have 120 votes
even though 150,000 shares held
»Minimum Holding: 39,600 shares
»Maximum Holding: 480,000 shares
»Flexibility:
–Sell up to 110,400 shares to free up capital
»Votes:
–Supplying farmer owner would have
120 votes if 120,000 or more shares held
Established farmer
owner looking to
invest capital
»Average supply is
200,000 kgMS
»Holds 200,000
shares
»Sharemilker on farm
»Minimum Holding: 200,000 shares
»Maximum Holding: 400,000 shares
»Flexibility:
–Invest further in the Co-op and hold up
to 400,000 shares
»Votes:
–Supplying farmer owner would have
200 votes based on 200,000 shares held
–Sharemilker has no votes
»Minimum Holding: 66,000 shares
»Maximum Holding: 800,000 shares
»Flexibility:
–Invest further in the Co-op and hold up
to 800,000 shares, and/or allocate up to
600,000 dry shares to the sharemilker
»Votes:
–Supplying farmer owner would have:
• 66 votes if 66,000 shares held
• 200 votes if 200,000 or more shares held
–Sharemilker would have no votes
Growing farmer
owner
»Average supply
from first farm is
80,000 kgMS
»Second farm
expected to supply
80,000 kgMS
»Holds 100,000
shares
»Minimum Holding: 160,000 shares
»Maximum Holding: 320,000 shares
»Flexibility:
–Purchase remaining 60,000 shares for second
farm over three seasons during the share-up
period
–Apply for a Share-Up Over Time contract for
60,000 kgMS
–Supply MyMilk from second farm under contract
with no shareholding requirement and potentially
sell 20,000 shares to free up capital for on farm
investment
–Invest further in the Co-op and hold up to
320,000 shares
»Votes:
–Supplying farmer owner would have:
• 100 votes based on 100,000 shares held
• 160 votes if 160,000 or more shares held
»Minimum Holding: 52,800 shares
»Maximum Holding: 640,000 shares
»Flexibility:
–Sell up to 47,200 shares
–Invest further in the Co-op and hold up to
640,000 shares
»Votes:
–Supplying farmer owner would have:
• 100 votes based on 100,000 shares held
• 160 votes if 160,000 or more shares
held
19
18
4 – THE NEW STRUCTURE IN MORE DETAIL
CAPITAL STRUCTURE REVISED PROPOSAL 2021
5.
The big issues
you’ve raised
Through the first round of consultation,
we received the most amount of feedback
and questions in three main areas.
The first relates to why we need to
change, or whether we need to change
at all. We heard questions like:
»Is milk supply really going to decline?
And if so, why should
we be concerned about this?
»Wouldn’t consistent good performance
be enough to attract and maintain
a sustainable milk supply?
The second area was around how a
farmer-only market would work,
especially given we’re proposing
more flexible shareholding options.
Some of your questions included:
»Won’t there be too many farmers
trying to sell their shares?
Who is going to buy them?
»What will my shares be worth
in a farmer-only market with
more flexibility?
The third was around whether there
are other alternatives that could
also support a financially sustainable
Co-operative, for example:
»Could we list part of the business
to raise capital for growth?
»Should we move back to a nominal
share structure?
»What would happen if we stayed
with TAF ?
Appendices 1 – 3 provide
an overview of how we’re
thinking about each of
these areas.
6.
Where to
from here
It’s important we all understand what’s
being proposed – through reading
the consultation materials like this
booklet and/or taking part in the
farmer meetings in September and
October. You can find dates, times
and locations for these meetings via
www.nzfarmsource.co.nz/meetings.
We’ll also host regular farmer webinars
during this time as well as providing
updates through our usual channels such
as the Farm Source website, My Co-op
app, email and social media.
At this stage, we are aiming for a farmer
shareholder vote at our Annual Meeting
in December.
You can provide feedback on this
proposal in the way that’s most
convenient for you – whether it be during
a farmer meeting or webinar, directly
to one of our Directors, via your Area
Manager or Fonterra Co-op Councillor, or
by emailing CSfeedback@fonterra.com.
If we do decide to proceed to a
farmer vote, and the timeframe is our
Annual Meeting, we will distribute the
information you need about the final
proposal and how to vote along with the
Notice of Meeting.
Ongoing engagement with other
stakeholders is a key focus for us over the
coming weeks. This includes those who
would be involved in enabling any change.
The Fonterra Co-operative Council
(formerly the Shareholders’ Council) has
been a valuable sounding board during
this consultation process and we continue
to work closely with its members.
The support of at least 50% of Council
members is required to make the capital
structure changes to the Co-op’s
Constitution, that would also require
a 75% shareholder vote.
As outlined earlier, some aspects of our
current capital structure are reflected in
DIRA, so a successful farmer vote would
be conditional on any necessary changes
to legislation being passed. We are
continuing to consult with Government
on this.
We have also been engaging with the
Manager of the Fund, which has been
communicating with unit holders directly.
Finally, we are in regular contact with
rural professionals, banks and research
analysts, because we know how
interested they are in understanding what
any changes may mean for their clients.
We will keep you updated with how these
conversations are going.
HOW TO CONTACT US
»Feel free to contact your Area Manager if you’d like to find out more, particularly around what the new
structure would mean for you.
»Alternatively, you can ask technical questions or provide feedback by emailing CSfeedback@fonterra.com
»Directors and Fonterra Co-operative Councillors are also available to talk through the proposed changes.
Contact details can be found in the back of any Farm Source Magazine.
Problems to
Solve & Principles
Farmer
Survey
Farmer
Meetings
Research into
Co-operatives
around the
world
Detailed Analysis
of options, trade-
offs, risk and
benefits
Further
Development
of options
Proceed with
Preferred Option
(including
shareholder vote,
conditional on
DIRA changes)
Further
Consultation
We are here
Review Feedback
& Refine Preferred
Option
Stay up to date with all the latest developments by visiting www.fonterra.com/capitalstructure
21
20
5 – THE BIG ISSUES YOU’VE RAISED
CAPITAL STRUCTURE REVISED PROPOSAL 2021
Appendix 1.
Why we need
to change
Why we think our milk supply may
decline if we make no changes
There are two parts to this equation:
1. New Zealand total milk supply outlook
2. Our Co-op’s milk supply outlook
NEW ZEALAND’S TOTAL MILK
SUPPLY IS LIKELY TO DECLINE
Our operating context is changing.
Water quality and climate change
regulations are becoming a part of life.
We are now seeing more land going
out of dairy than coming into dairy.
At the same time, we are also seeing
incremental productivity gains year-on-
year through management efficiency
and genetic gains, and there look to be
some great new technologies on the
horizon. New innovations do have the
potential to support farm productivity
in the future through things like
more targeted nutrient application,
better pasture utilisation, precision
animal management and potentially
breakthrough technologies that reduce
methane emissions. There is no question
that New Zealand farmers are great
innovators when faced with a challenge.
However, when we balance these
factors overall, we are expecting total
New Zealand milk supply to decline over
the coming decade, and be flat at best.
This is because:
»There is likely to be less land in dairy.
We have gone from significant growth
in dairy land to now seeing this as
declining slowly due to other land uses,
as well as the Government restrictions
on conversions to dairy.
»There may be deintensification
in some farm systems as a result
of changes that farmers need
to make to meet environmental
requirements. For example, reducing
fertiliser applications and reducing
supplementary feed usage.
»While these changes may improve
farm profit in a lot of instances, they
may also reduce the milk produced
and supplied to our Co-op.
These losses will be partly offset by
productivity gains. We expect around
0.7% productivity gain each year going
forward through things like improved
genetics and farm management
efficiencies. This is lower than the long-
run average. To arrive at this number, we
have disaggregated productivity gains
into those that were directly from animal
and pasture improvement, and those
from fertiliser and supplementary feed
additions to the farm system. We’re clear
that there may be some upside to this
productivity gain as farmers will innovate
and adopt new technologies in response
to changes, but we’re not sure that it
will increase milk production overall –
as environmental policies aim to lower
absolute water and climate impacts, so
productivity increases may just get the
same output from fewer inputs.
When we put that together with the
impact of land-use change, we see a total
impact on New Zealand milk of around
a 2.4% decrease by 2030.
ProblemPotential value impacts
Total NZ
milk likely to
decline
Potential for
declining
Fonterra
milk supply
Smaller and
less efficient
Co-op
Fonterra’s
share of
NZ milk
IF WE DON’T ADDRESS THE
HIGH LEVEL OF COMPULSORY
INVESTMENT TO BE PART OF OUR
CO-OP, FONTERRA’S SHARE OF
NEW ZEALAND MILK IS LIKELY TO
CONTINUE TO DECLINE
On top of changes behind the farm
gate, we’re also expecting to see other
milk processors continuing to set up
new businesses or grow their existing
businesses in New Zealand. Global
markets want what New Zealand has,
and with continuing strong demand, we
expect to see an increase in competition
for milk here at home.
This is supported by the consistent
expansion we have seen over the past
15 seasons, and the fact that this has
not slowed despite total New Zealand
milk supply flattening over the past
5-6 seasons.
Right now, it is an uneven playing field
with corporate processors coming into
the industry. The level of compulsory
investment required to join and stay with
the Co-op is high.
Fund size thresholds could be
exceeded, and/or capital required
for share or unit buy-backs
$500m to $1.2b by FY30
Harder to attract and retain milk
supply and staff; more difficult to
provide scale benefits to farmers
More conservative risk
settings, such as lower debt
targets and dividend policies
Milk Price could reduce by
6 to 13 cents / kgMS by FY30
May need to close between
12 and 18 plants within our
manufacturing sites, on top of
operating costs which would
need to reduce by $100m to
$160m p.a. by FY30
IS FONTERRA’S MILK SUPPLY LIKELY TO DECLINE IF WE DON’T
CHANGE OUR CAPITAL STRUCTURE? IF SO, WHAT WOULD HAPPEN?
The following diagram summarises the problem and potential value impacts we face.
Each part is explained in further detail in the following sections.
CHANGE IN TOTAL NZ DAIRY HECTARES
Hectares
-50,000
0
50,000
100,000
150,000
200,000
250,000
2016/17 to
2019/20
2012/13 to
2015/16
2008/09 to
2011/12
Source: DairyNZ - New Zealand Dairy Statistics 2019-20
23
22
APPENDIX 1 – WHY WE NEED TO CHANGE
CAPITAL STRUCTURE REVISED PROPOSAL 2021
This has resulted in farmers leaving the
Co-op in order to free up capital.
»Results from the last two years of exit
interviews with farmers show that lack
of capital flexibility was the number
one reason to leave our Co-op.
»In a recent representative survey
of our farmers, 30% said they had
seriously thought about leaving to join
a competitor in the last two years or so.
»Once we lose a farm, it takes a long
time to win that farm back (if at all).
»We have been told by some farmers
who have left that they are accepting
lower prices for their milk because they
want to access capital tied up in shares.
What about performance? Won’t
this solve this problem?
While improved performance increases
willingness to invest capital, it does not
stop suppliers leaving our Co-op. This is
mainly because:
1. As our earnings increase, so too should
the share price, which increases the
capital investment to join, and the
capital for those who leave.
2. The share price is partly set by
reference to the value of units traded
in a public market. Investors in public
markets may value shares differently
than farmers. On the whole, farmers
are less diversified and have competing
priorities for their capital – their
investments are more focused (i.e., in
farming operations) and therefore it’s
not possible to ‘diversify away the risk’
like an investor. Therefore, it is likely
that some farmers require a greater
return from a share to make holding the
share worthwhile. This means investors
in the Fund may be more willing to pay
a higher price for a unit than farmers
would otherwise be willing to pay
for a share.
3. Some farmers just want or need
access to capital, and shares may be
considered discretionary in comparison
to other farming assets like land and
livestock (regardless of what return
they provide). The return on that
capital may be secondary to the want
or need for that capital. There is a wide
variety of reasons farmers want or
need to free up capital.
For example:
–To invest in their farming
business, including:
• Investing in new assets for growth.
• Meeting new environmental
regulations, such as upgrading an
effluent system.
• Paying down debt.
• Working through succession.
–To invest in other areas, for example,
diversifying their business.
–For recreation or quality of life –
many farmers have worked hard for
a long time and want to be able to
enjoy their wealth.
Not offering flexible shareholding
options means that these farmers have
little choice but to leave the Co-op to
access this capital.
Unless farmers have a greater degree of
flexibility on the level of investment to
supply the Co-op that can be taken up
at any point in their career, we think we
will continue to lose milk to corporate
processors.
In summary:
»We are likely to continue to see
increased competition for milk in
New Zealand as a result of strong
global demand.
»Farmers may want or need to free
up capital for a variety of reasons.
»At present, farmers have no choice
but to leave our Co-op altogether
in order to free up capital, taking
their milk away from the Co-op.
»Strong performance only increases
the investment requirement.
As our earnings increase, so too
should the share price, which
increases the capital investment
to join, and the capital for those
who leave.
»Unless we provide capital
flexibility for all farmers, this cycle
is likely to continue.
»Meaning that, all else being equal,
we need to be prepared for the
Co-op’s milk supply to decline.
WE NEED TO BE PREPARED FOR
OUR MILK SUPPLY TO DECLINE
Combining the changing New Zealand
milk supply outlook with our declining
share of New Zealand milk means that,
unless we provide capital flexibility for
farmers, we believe that our milk supply
is likely to decline into the future. We
outlined these potential scenarios in
Section 2 of this booklet.
So, what happens if our milk
supply declines? What does it
mean for capital, payout and our
Farmgate Milk Price?
If we don’t change our structure and
milk supply declines, under our current
TAF structure we would need to buy
back shares or units to remain within our
constitutional thresholds designed to
balance the interests of farmer owners
and the interests of external investors
in the Fund. Exceeding those thresholds
could put farmer ownership and control
at risk. We estimate the cost of these
buybacks to be between $500m and
$1.2b by FY30.
This is an uncertain and recurring draw
on our capital, and does not address
the underlying issue of milk leaving the
Co-op.
It would also impact capital management
and decision making. We would need to
consider questions like:
»Does our balance sheet need to be
more conservative to ensure that we
have capital available to buy back
shares in the future in order to stay
within our constitutional thresholds?
»Would we need to reconsider capital
returns to strengthen this position?
»Is a more conservative strategic
investment programme appropriate?
If our Co-op’s milk supply
declines, we would need to make
significant changes to the way we
operate to try and maintain total
available for payout
If milk supply declines, we would have
less milk to process through the same
amount of stainless steel. Our overheads
wouldn’t necessarily change, but the
amount of income we generate would
need to increase to offset higher average
costs per kgMS.
Our manufacturing footprint has been
established over many decades, but a
significant amount of this was built to
handle the expansion of milk supply
in the South and central North Islands
during the period from 2005 to 2015.
Our factories are built to handle your
peak milk, which means we carry excess
capacity on the shoulders of the peak.
This is at the core of our Co-op – we share
in the fixed costs of our peak processing
assets so that we can maintain low-
cost pasture-based systems behind the
farm gate.
Our analysis shows the total available for
payout could potentially be maintained
close to or in line with the alternative
under declining milk scenarios over the
10-year horizon. However, this would rely
on several factors, including:
»Demand growth for higher value
products and our Co-op optimising to
this higher value demand.
»A sustained reduction in operating and
overhead costs on an ongoing basis to
reduce the impact of fixed costs being
spread over fewer milksolids.
»Undertaking a rationalisation
programme of plants of varying sizes
and types over 10 years to reduce
operating costs.
–There would be a non-cash impact
of plant write-downs in this case
that we would expect to get bigger
towards the end of the 10-year
horizon due to the majority of plants
initially identified for closure being
fully depreciated.
»Our ability to recognise and
successfully execute this cost reduction
and rationalisation programme on a
timely basis – noting the difficulty in
this given seasonal fluctuations in milk
supply and their potential to mask
underlying structural changes.
IF OUR CO-OP’S MILK SUPPLY
DECLINES, WE ARE LIKELY TO
SEE FIXED COSTS BEING SPREAD
OVER FEWER MILKSOLIDS,
WHICH WOULD REDUCE THE
MILK PRICE
If milk supply declines:
»Fixed costs and overheads would be
spread over fewer milk solids, which
would increase costs per kgMS in the
Milk Price Model and flow through
to a lower milk price.
»There would be no ability to increase
the revenue line in the milk price to
offset higher costs per kgMS as the
nominal processor in the milk price
has no product mix flexibility beyond
powder stream products.
This would flow through to a structurally
lower milk price over time relative to
maintaining milk supply.
»The modelled impact of declining milk
is 6 to 13 cents per kgMS in 2030 (in
milk supply scenarios 1 and 2).
The magnitude of the impact reduces
when a potential response is factored in
with overhead costs reduced in the milk
price cost reset years of 2024 and 2028.
This would have to be worked through
and justified. The modelled impact of
declining milk with a cost reset response,
but without other changes to the milk
price methodology, is 4 to 8 cents per
kgMS in 2030 (in scenarios 1 and 2).
Our milk price sets the benchmark
in New Zealand. A less efficient
Co-operative would mean a
lower milk price for all dairy
farmers here.
Co-operatives often suffer from a
“free rider” problem, and our Co-op
is no different.
Our milk price sets a benchmark in
New Zealand, so even those who don’t
supply the Co-op benefit from it.
We believe that farmers are worse off in
countries where there is no strong co-op.
Corporate processors look at milk as an
input cost, and over the long run they are
incentivised to reduce the price they pay
for milk to maximise corporate profits.
(Source: DairyNZ, DCANZ & Fonterra Milk Collections)
kgMS (m)
0
50
100
150
200
250
300
350
400
450
2001/022003/042005/062007/082009/102011/122013/142015/162017/182019/20
NON-FONTERRA MILK COLLECTIONS (KGMS M)
25
24
APPENDIX 1 – WHY WE NEED TO CHANGE
CAPITAL STRUCTURE REVISED PROPOSAL 2021
Appendix 2.
How a farmer-only
market would work
Through consultation we heard many
questions on how a farmer-only market
might work.
To understand this, we have asked
Cameron Partners, a leading corporate
advisor, to consider how well the farmer-
only market is likely to function. To do
this, they have looked at the following
questions and their responses are
set out below:
1. Will prices in the market generally
reflect farmer views on fair value?
2. Will there be sufficient trading to allow
farmers to trade at fair value?
3. Will there be sufficient buyers for those
who have to sell shares?
4. Will buyers be able to buy enough
shares given proposed ownership caps?
1. Will prices in the market
generally reflect farmer views
on fair value?
Under a structure in which only farmers
can trade shares and those shares can
no longer be exchanged into units in the
Fund, a restricted market will be created.
In a restricted market, discounts are
observed to the pricing that would be
observed in an open and public market.
This is referred to as the restricted market
discount (RMD).
In the case of Fonterra, if only farmers
can trade shares, the main causes of a
RMD are:
»The exclusion of potential price-
setting investors from trading – often
institutions with a global mandate
and portfolio.
»Farmers having asset portfolios
comprising mostly farmland and
other farming related assets which
are non-diversified and therefore
imply a higher cost of capital.
»Farmers having limited capital with
competing demands for that capital.
This means that shares require a
greater return (i.e., lower share prices)
to be attractive compared to other
investment options.
An example of a RMD was Air
New Zealand during the 1990s.
During that period, Air New Zealand
had A and B shares with A shares
restricted to NZ-domiciled investors
and B shares able to be held by any
investor. As the graph below shows,
there was a persistent discount
between the A and B shares of 30%
in the first half of the decade, reducing
to 15 – 25% in the second half.
Cameron Partners has estimated that
the RMD (compared to the prices that
might be expected if the TAF structure
was maintained) is likely to be in the
order of 20% to 25%. This pricing
outcome will represent the consensus
view of how farmers value the Co-op and
can be regarded as a fair value, subject
to the following:
»There being the level of liquidity
expected (see question 2 below).
»The price being set by “voluntary”
trading (i.e., a decision to buy or sell
based on an individual’s view on value)
and trading not being overwhelmed
by those who have to sell shares (see
question 3 below).
2. Will there be sufficient trading
to allow farmers to sell shares at
fair value?
The key issue in assessing how well the
farmer-only market will work is the level
of aggregate buy-side interest there will
be in Fonterra shares when farmer-only
trading commences. Cameron Partners
estimated future aggregate buyside
demand by examining the trading
patterns in the FSM and FSF prior to the
temporary cap on the FSF.
Two separate databases were compared:
»The first being daily movement in
supplier share compliance; and
»The second being daily share trading
by suppliers.
As at 31 August, the average trading
volume since the temporary cap had been
around 80,000 shares.
The chart below ranks selected NZX
companies by daily trading volumes and
shows where the FSM would sit at 90,000
shares traded per day.
Cameron Partners’ view is that the NZX-
listed companies with similar trading
volumes as expected for the FSM (with a
reduced minimum holding) do not appear
to suffer from concerns about liquidity.
However, there are some risks to ongoing
satisfactory pricing outcomes:
»The analysis assumes aggregate milk
supply stays at least at or around
current levels. If there is increased sell-
side pressure from further meaningful
milk supply loss (and consequent
ceasing), then prices may fall to
accommodate these sales.
»There may be times in the future when
all farmers have a similar exposure to a
financial threat – for example, low milk
prices or widespread drought. Such
macro events may create an increased
level of sales and the price may fall to
accommodate these sales.
1992199319941995199619971998199920002001
0%
5%
10%
15%
20%
25%
30%
35%
40%
While the databases did not match
conclusively, this comparison suggested
that somewhere between 50% and 70%
of farmer trading could be explained
by movements in share compliance.
Therefore, it was expected that
somewhere between 30% and 50%
of trading volumes observed prior to
the temporary cap on the FSF were
unrelated to share compliance and
may be a level of trading that might be
expected to continue with a reduced
minimum holding.
In the year prior to the temporary cap,
the average trading volume in the FSM
had been ~210,000 shares per trading
day. 30% to 50% of this figure is 63,000
to 105,000 shares per trading day.
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
Spark
Fletcher Building
A2 Milk
Kiwi Properties
Pushpay
Meridian
Air NZ
Auckland Airport
Contact Energy
Sky City
Precint Properties
Mercury
Goodman Property
Oceania
Fisher & Paykel
Z Energy
Argosy
Chorus
Genesis
Infratil
Ryman
Arvida
Kathmandu
Heartland Bank
Stride Properties
Summerset
Property for Industry
Pacific Edge
Vital Healthcare
NZX
Vista
Investore Property
Vector
Skellerup
Port of Tauranga
Synlait
Freightways
Restaurant Brands
Scales
Tilt
Ebos
Warehouse
Fonterra
Trustpower
Serko
Mainfreight
Hallensteins
Napier Port
Briscoes
Delegats
AFT Pharma
Volume traded (000s)
DISCOUNT BETWEEN AIR NZ A SHARES AND B SHARES
AVERAGE DAILY VOLUME
27
26
APPENDIX 2 – HOW A FARMER-ONLY MARKET WOULD WORK
CAPITAL STRUCTURE REVISED PROPOSAL 2021
Cameron Partners also acknowledge that
it is likely there will be on-going instances
during trading of intra-day or intra-week
timing differences between when buyers
and sellers are active and believe that
reliable liquidity through a trading period
will require Fonterra contracting with
a market maker (or makers) to:
»Provide minimum buy and sell order
quantities within regulated bid-ask
spreads that must be refreshed on
a part-minute basis.
»Accumulate positions if necessary on
one side of the book or the other if a
short-term absence of one trading side
exists over a defined period and to a
capped level of financial risk.
Subject to the expected level of
underlying trading emerging (and the
risks identified above not emerging) and
appropriate market maker arrangements,
Cameron Partners’ view is that the FSM
could be expected to have pricing that
would be adequately efficient – i.e.
price sensitive information would be
incorporated into the trading price
quickly, prices would generally reflect
consensus farmer views on value
(incorporating an RMD) and there should
be a level of liquidity that would allow
trades in line with the average order
sizes observed before the temporary
cap to be bought and sold at the observed
market price.
3. Will there be sufficient demand
for shares if people have to sell?
Cameron Partners conducted analyses to
test whether the expected level of buy-
side activity would be sufficient to meet
at least the sale of shares by those who
have to sell their shares. Two groups of
farmers were identified as those who may
have to sell shares:
»Financially pressured farmers – analysis
suggests there may be a meaningful
number of farmers who, when the
minimum holding requirement is
reduced, will be under a level of
financial pressure that requires them
to sell shares above the minimum level.
There is a risk of a large number of
shares coming onto the market in the
early stages of trading where these
sellers will accept prices below the
longer term “voluntary” equilibrium.
»Ceased farmers – who have an
obligation to sell their shares within a
certain timeframe. The proposals now
include extending the timeframe for
sales by ceased farmers. In the short
term, selling pressure from this group
is likely to be alleviated (other than
to the extent these farmers are in the
“financially stressed” group referred
to above) but, in the long run (i.e., in
10-15 years) there will be an ongoing
level of constitutionally required share
sales per annum which the market
needs to absorb.
The potential extent of the two groups is
discussed below:
Financially pressured farmers
Reserve Bank data on dairy industry
lending (May 2021) shows that ~7% of
loans to dairy farmers were regarded
as “stressed” and a further 2-3% were
regarded as non-performing. With a
Minimum Holding of 33%, around one
billion dry shares will be created. 5-10%
of this figure is 50m to 100m shares.
There are also approximately 75m
2
shares held by farmers who have already
ceased. While the time allowed for these
farmers to exit is being increased to 15
years, there are likely to be farmers in this
group who are also financially pressured.
Cameron Partners believes this indicates
an estimate in the upper end of the range
(i.e. 75-100m shares) is a more likely
sizing of potential level of financially
pressured sales.
Cameron Partners advised that it was
unlikely the FSM could absorb this level
of sell-side pressure early in trading
without a material reduction in price
below the longer term expected levels.
Consequently, Fonterra is intending to
allocate capital to support liquidity in
early trading, through an on-market share
buyback and other tools (see section
4 “How we would support liquidity
during transition”).
Ceasing farmers
As long as total milk supply remains
at or around current levels, the sell-
side pressure from ceased farmers is
estimated as follows:
»Every year 1/30th of the Fonterra
supplier base is assumed to exit.
So over 10 years, 1/3 of the supplier
base has rotated out and been replaced
by new suppliers. These ceased farmers
are assumed to sell down over the time
they have available.
»The incoming suppliers who replace
these ceased farmers only acquire the
minimum shareholding (33%). So, the
residual needs to be absorbed by the
buy-side demand described above.
»In addition, it is assumed that of the
75m
3
shares (from those who have
already lodged cease notices), 25m
are absorbed by the proposed liquidity
support (i.e. they overlap with the
financially pressured suppliers) and
the remaining 50m shares are sold
down over the time they have available.
The dark blue line in the chart overleaf
shows the net selling pressure that arises
from these assumptions. The light blue
and green horizontal lines in the chart
show the buy-side volume if natural
trading volumes are between 30% and
50% of volumes observed prior to the
temporary cap.
The net selling pressure peaks in year
15 due to the ceased farmers at the
record date having 15 years to sell,
then this steadily reducing to 10 years
over the next 5 years – making year
15 a more pronounced peak.
However, the chart assumes that all
ceased farmers sell their shares evenly
over the allowed time. In reality, shares
will be sold irregularly by ceased farmers
as conditions vary, so it may be more
appropriate to use the average picture
over the 15 years.
2. As at June 2021.
3. As at June 2021.
If the assumptions of supply and buy-side
and sell-side activity used in this analysis
hold, then longer term buy-side activity
should have the ability to absorb the
level of constitutionally required sell-side
activity. The chart does not include the
impact from two factors that should
boost buy-side activity:
»The reduction in trading price due
to the restricted market discount
encouraging more buy-side activity
»The proposal to allow sharemilkers,
contract milkers and farm lessors (up to
a further ~4,000 potential buyers) to
participate in the market.
4. Will buyers be able to buy
enough shares?
Cameron Partners was asked to consider
whether a 4x cap would provide sufficient
long-term headroom to allow the buy-
side to acquire the shares necessary to
meet longer term sell-side expectations
and to test the reasonableness of
expectations for the number of shares
that active buyers will need to acquire.
The level of headroom required depends
on two key factors that increasingly limit
the number of buyers and requires more
headroom per active buyer (and more
shares acquired per active buyer) to
accommodate selling pressure. The two
factors are:
»The proportion of the shareholder base
who have preferences to sell shares and
are therefore unlikely to be potential
buyers. The more sellers there are, the
fewer potential buyers there are and
the greater the headroom required
across them.
Year 1Year 2Year 3Year 4Year 5Year 6Year 7Year 8Year 9
Year 10Year 11Year 12Year 13Year 14Year 15Year 16Year 17Year 18Year 19Year 20
0
25
50
75
Millions of shares
Net selling pressureAbsorption capacity - upper bound
Absorption capacity - lower bound
»Of the non-sellers, the extent to which
only a subgroup truly comprise the
potential buyer set. The more the
potential buy-side set is restricted to
a subset of non-selling shareholders,
the greater the headroom required
across them.
Cameron Partners created several
scenarios to test different settings across
these variables (assuming in all cases a
long-term level of total trading consistent
with the concentration analysis). Their
view is that, as long as buying behaviour
is relatively widespread across non-
sellers, a 4x headroom appears unlikely
to be a limiting factor on the ability of
the shareholder base to absorb shares.
However, notwithstanding ownership
caps, the market will be more successful
if the more selling is not widespread and
the more buying is widespread, so that
the buying activity required per buyer is
more moderate.
To manage a risk that the actual buyer
set is highly concentrated, Cameron
Partners expressed a preference for
the cap to be the higher of 4x supply or
0.25% of total shares on issue to provide
more headroom. However, the Board is
of the view that such a cap would allow
ownership and supply to become too
separated on an individual basis. The
Board noted for example that under
a 4x cap, a farmer supplying 75,000
kgMS could own up to 300,000 shares
under the proposed 4x cap, and up to
four million shares under a 0.25% cap.
Subsequently, the proposal has been
changed to allow sharemilkers, contract
milkers and farm lessors (up to a further
~4,000 potential buyers) to participate in
the market.
Important Notice
Cameron Partners Limited (Cameron
Partners) has been engaged by Fonterra
Co-operative Group Limited (Fonterra)
under a specific engagement letter
to provide Fonterra with advice on
certain elements of Fonterra’s capital
structure proposals (the Proposals).
Fonterra has chosen to include some
aspects of Cameron Partners’ advice
in this Appendix 2. Recipients of this
Appendix 2 must note the following:
»Cameron Partners’ advice is
only for the benefit of Fonterra.
Notwithstanding the inclusion of
parts of Cameron Partners’ material
in this Appendix 2, no other party
(including any shareholder) may rely
on it in any circumstances.
»Nothing in this Appendix 2
constitutes, nor is to be construed as,
Cameron Partners’ advice. For clarity,
Cameron Partners is not making, is
not purporting to make, and must
not be interpreted as making any
assessment of the merits of the
proposed capital structure changes
or making any recommendation to
any shareholder in regard to those
proposed changes.
»Cameron Partners’ liability is at all
times strictly limited to Fonterra
under the terms of the engagement
letter it has with Fonterra in regard
to the Proposals. Cameron Partners
will not be liable to anyone else for
any reason (including negligence) in
respect of the material contained
in this Appendix 2.
29
28
APPENDIX 2 – HOW A FARMER-ONLY MARKET WOULD WORK
CAPITAL STRUCTURE REVISED PROPOSAL 2021
Appendix 3.
Comparing other
alternatives
Throughout the consultation, some of
you have raised questions about whether
alternative structures could better
address the challenges we face. The most
common alternatives have been:
»Listing part of the Co-op.
»Returning to a nominal share.
»Increasing the extent to which
unshared supply could be used.
We have considered all of these
suggestions in detail, both before we put
forward the preferred option in May, and
since. We are not recommending that
we proceed with these options and we
discuss why in this section.
1. Listing part of the Co-op
»Early on in the review we considered
a structure we called “Split Co-op”.
»This involved splitting Fonterra’s assets
into two companies, which could be
characterised as “core” and “value-
add” businesses. These businesses
could operate independently from
one another, they could have separate
governance and management, and
Fonterra could keep ownership of the
core, but list all or part of the value-
added assets.
»The rationale for this type of structure
is two-fold – that a Co-op may
struggle to invest the level of capital
to accelerate growth of a value-added
business; and that there are different
skills and capabilities required for these
businesses to reach their potential.
»There are merits to this type of
structure, and there are some examples
around the world where listing parts
of co-ops has created significant value
for shareholders. It is not without
challenge, however, and there are risks
to navigate in ensuring that farmers’
interests are protected over the long
term. There are several examples of
co-ops that have gone down this path
and found themselves either unable
to access capital to grow value behind
the farm gate (because investment in
new business opportunities has been
prioritised over investment in new
processing capacity) or where they
have gradually eroded their share of
the assets over time and ultimately
lost the ownership and control that
protects farmers’ fair share of value.
»Our view is that the risks in these
structures can be significant, and
that there are other ways to realise
the benefits of external investment
such as partnerships, joint ventures,
and evolving our portfolio through
the divestment of Soprole. We are
also considering the most appropriate
ownership structure options for
Fonterra Australia, one of which is an
Initial Public Offering (IPO), with the
intention that we retain a significant
stake, as referred to in the booklet
titled Our Path to 2030.
»New Zealand milk is our biggest
strength, and we are continuing to
make decisions that align our capital
and our people to this core. Our
portfolio will always continue to evolve,
and we are open to external capital
where it makes sense, but not at the
expense of farmer ownership and
control of the core of our Co-op.
2. Returning to a fixed-value or
nominal share
» We’ve heard suggestions that moving
to a fixed or nominal value share that
is issued and redeemed by the Co-op
would be simpler and give farmers
more certainty.
»A range of possible values have been
put forward, from a low-value $1 share
to a higher-value $3.50 share.
»This structure is like a traditional co-op,
and many of you will recall this type of
structure from our history.
»There are several challenges with this
type of structure.
–Tr ansition: To transition to a low-
value nominal share would require
a significant capital return, which
we could not afford all at once.
For example, if we were to move to a
$1 nominal share, this would require
a capital return in the order of $4-6
billion, which could compromise the
financial sustainability of the Co-op.
–Redemption risk: This would also
re-introduce redemption risk to the
Co-op’s balance sheet, which means
that as farmers leave or decrease
milk supply, the Co-op would need to
return capital to them. At a low-value
share this might be manageable
(although, if a significant capital
return were required, this may not
be the case), but a higher nominal
share would place pressure on the
Co-op’s balance sheet from year to
year and limit our ability to grow
value over time.
–Regulatory constraints: A further
constraint with a nominal share
is that our current regulatory
framework is not based on a nominal
value share. Therefore, moving to a
nominal value share could result in
other regulatory changes.
–Unbundling of supply and
investment: Lastly, moving to a
nominal share would mean that we
move away from a traded investment
share that should appreciate with the
value of the Co-op, to a supply share,
that represents a right to supply
but not to the underlying assets
of the business. While this would
provide more certainty for farmers
around the price at which they enter
and exit, a nominal share wouldn’t
reflect the changes in asset values
over time.
3. Allowing more contract supply
»We have had discussions around
whether more contract supply could
mitigate a declining milk supply.
»We agree that this would be a good
option if our only objective was to
maintain a sustainable milk supply.
However, within our current structure,
when we allow a greater degree of
unshared supply, this would create
more dry shares (as farmers sell shares
to move to contract supply) that could
move into the Fund. Allowing more
unshared supply would only take us so
far before we needed to begin buying
back shares in order to stay within
constitutional thresholds relating to
the Fund size.
31
30
APPENDIX 3 – COMPARING OTHER ALTERNATIVES
CAPITAL STRUCTURE REVISED PROPOSAL 2021
Associated farmer ownermeans a sharemilker, contract milker or farm lessor who may become a shareholder
in the Co-op
Boardmeans the board of directors of Fonterra
Constitutionmeans Fonterra’s constitution, as amended from time to time
Contract milkermeans a person that is contract milking for a supplying farmer owner under
a bona fide arrangement
Co-op, Co-operative or Fonterrameans Fonterra Co-operative Group Limited
CSNmeans “common shareholder number” which is the number you are provided
with in relation to your shareholding in the Co-op
Custodianmeans Fonterra Farmer Custodian Limited
DIRAmeans the Dairy Industry Restructuring Act 2001
Dry sharemeans a share that is not backed by milk supply
Economic rightsmeans the rights to receive dividends and other economic benefits derived from
a share held by the Custodian for the benefit of the trustee of the Fund
Farm lessormeans a land owner that has leased dairy farm-land to a supplying farmer owner under
a bona fide arrangement
Farmer-only market or
farmer-only FSM
means the Fonterra Shareholders’ Market where shares are no longer able to be exchanged
into units in the Fund
Farmer ownermeans a shareholder in the Co-op
FSF or Fundmeans the Fonterra Shareholders’ Fund
FSMmeans the Fonterra Shareholders’ Market
kgMSmeans kilogram of milksolids
Managermeans the manager of the Fund, being FSF Management Company Limited
Glossary
Market makermeans a third party appointed by the Co-op who is active in making bids and offers
on a minimum number of shares in the FSM
MyMilk contractmeans the current contract supply option without any requirement to purchase shares,
available to farmers who meet the relevant criteria
Relevant Interestis a term that is broadly defined in the Financial Markets Conduct Act 2013, but can be
thought of as a proxy for “influence” in respect of shares - it includes:
»legal or beneficial ownership of shares
»the power to control votes on, or a decision to buy or sell, shares (this includes having a
20% or more ownership or voting interest in other entities that hold shares)
»holdings of shares through different but related companies
»agreements to act together in respect of shares
Sharemeans a co-operative share in Fonterra
Sharemilkermeans a person that is sharemilking for a supplying farmer owner under a
bona fide arrangement
Share standardmeans 1 share per 1 kgMS supplied, being the number of shares a farmer owner is currently
required to hold in accordance with clause 3.4 of the Constitution
Share-Up Over Time contractmeans the contract options to supply Fonterra on the basis that shares are purchased over
time, including strike price contract options
Supplying farmer ownermeans a farmer responsible for supplying milk to the Co-op under our Terms of Supply who
is a shareholder in the Co-op
TAFmeans Trading Among Farmers
Temporary capmeans the temporary cap on the size of the Fund that was put in place in May to
enable consultation
Wet sharemeans a share held by a supplying farmer owner that is backed by milk supply
Unitmeans a unit issued by the Fund
Vouchermeans a certificate referred to in clause 3.4 of the Constitution that was provided to a
farmer owner on the transfer of the economic rights of a wet share to the Fund under the
2012 and 2013 supply offers to farmer owners, and that can be used by the farmer owner,
together with shares, to meet the Share Standard
33
32
GLOSSARY
CAPITAL STRUCTURE REVISED PROPOSAL 2021
0800 65 65 68
csfeedback@fonterra.com
fonterra.com/capitalstructure
Data sourced from publicly available filings. Our datasets may not be complete. Automated analysis can produce errors. If you believe any data on this page is incorrect, please contact us at hello@nzxplorer.co.nz. For informational purposes only. Not investment advice.
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