Fonterra has today (7 April 2010) announced its new proposals for trading of shares. It is a complex and sophisticated proposal. I am going to withhold final judgement until I have had some days to reflect on the complex issues. But some issues are already clear.
The long term redemption issue is not solved
Chairman Sir Henry van der Heyden said in an email to dairy farmers on 30 March that the proposal would solve the redemption issue ‘once and for all’. Today’s material from Fonterra makes similar claims. But the proposal will not achieve this. It would appear to solve the short term redemption issue from share capital washing in and out due to factors such as drought. And this is important. But it does not protect Fonterra, despite the claims, from long term loss of capital as a result of losing suppliers to new start up companies. In that situation, Fonterra would need to buy back shares to bring the percentage of dry shares back within constitutional limits.
The scheme should facilitate acquisition of fixed capital
Fonterra needs some fixed capital which is not redeemable. Tradability has the potential to help achieve this, in that it makes dry shares non-redeemable. With the proposed overall cap of 20%, there is potential to add close to a billion dollars of dry share capital.
The trading scheme will not make Fonterra the ‘New Zealand Nokia’
Nokia is the company that transformed the economy of Finland. We sometimes read in the media that Fonterra should be the vehicle for Fonterra to achieve something similar. Regardless of whether or not this trading scheme proceeds, Fonterra will not become ‘New Zealand’s Nokia’. In any case, Fonterra has no such aspirations. If (and it is a big if) NZ is ever to have the equivalent of a Nokia then it will come from the brilliance of a concept such as the NZ-designed ‘Yike Bike’, and not from the dairy industry. Go the Yike Bike!
The proposal needs testing against the ‘law of unintended consequences’
Fonterra is going down an untrodden path. This scheme is fundamentally different to existing ‘hybrid’ co-operatives. There are going to be big challenges in managing share liquidity issues and hence share price volatility. Fonterra has had many months to devise the proposal and it will now take some time for independent people to test it against various scenarios.
The avoidance of insider trading.
If this scheme proceeds than there can no longer be ‘off the record’ conversations between directors and milk suppliers. All communication will need to be on a formal basis to ensure that all suppliers have access to exactly the same information. This will require a major change of culture, which will come as a shock to many farmers. It will make ‘shed meetings’ relevant only to those who do not read the written word. The Board will also need to be very careful in sharing commercial confidences with the Shareholders Council.
Fonterra will be the ultimate insider
Companies that trade in their own shares are often, in commercial law commentary, referred to as the ‘ultimate insiders’. Section 60 of the Companies Act determines the rules under which companies may buy and sell their own shares in the market. The rules are not designed to cover ongoing trading. Fonterra’s legal advice is that their proposed actions fall within the law and do not require dispensation from the Act. Assuming this is correct, Fonterra will be its own ultimate insider, which by its actions will influence the price of its own shares.
At this stage I have two concerns. The first is that Fonterra seems to have over-claimed in relation to solving the redemption issue. The second is that the precise rules by which Fonterra as an insider will buy and sell shares are not defined. Those rules, and how they are implemented, could have a major effect on the market price. The question is whether these concerns are sufficient to over-ride any benefits of this proposal relative to the existing capital structure.
Professor of Farm Management and Agribusiness