Fonterra’s December update shows that the strategic reset is under way, albeit at an early stage.
Key indicators include that the Beingmate JV is being unwound and that Fonterra’s China Farms are under heightened scrutiny. The big shock is that Tip Top is on the market. The ownership of Soprole in Chile must also be under scrutiny, although little has been said publicly.
I will return to those issues within this article, but first it is necessary to understand something of the dynamics within the new Fonterra Board.
Farmers spoke very clearly when they recently elected renegade director Leonie Guiney, who was previously ousted in 2017 in what was essentially a Board room coup by fellow directors. One year later, Ms Guiney scored a 63 percent vote in the 2018 director elections. It was a stunning rejection of the Board’s own recommendations for those 2018 elections.
Fonterra has this year lost three experienced farmer directors. First there was the departure of John Wilson for health reasons. Then longstanding director Nicola Shadbolt missed out on being renominated by the official selection process. Then Ashley Waugh just failed to make the required 50 percent minimum support by farmer shareholders.
So, at the time of writing, Fonterra is left with only six farmer directors, with only Monaghan and Guiney having more than two years of experience. Monaghan has been on the Board for 10 years and Guiney had a three-year term from 2014 to 2017. Another director will soon be added in a runoff between two of the previously unsuccessful candidates in the 2018 election.
There are multiple lessons to be learned from recent events at Board level. The first obvious lesson is that the farmers have clearly voted for change. The massive farmer support for outgoing Zespri Chair Peter McBride to become a Fonterra director provides further confirmation of that.
The second lesson is that the current system of voting for directors is a shambles. To some of us, this insight comes as no surprise – it was inevitable that the system would lead to power politics, group-think, and eventual shareholder rebellion.
Underlying those messages is the largely unspoken reality that the old Board had become dysfunctional. There was an inner and an outer Board, and Guiney was clearly on the outside during her first term. However, the friction went much deeper than that.
There is an old saying that there is only room for one bull in a paddock, and for the least ten years there have been multiple bulls in Fonterra’s Board room. Of course, corporate bulls do not necessarily all have the same gender. The point at which strategy and personality differences intersected was often opaque.
Whereas internal frictions were held well in check in the early years of Henry van der Heyden’s tenure, by the time he left in 2012 the situation had become unmanageable. There have been tensions ever since.
One would hope that Fonterra’s new chair, John Monaghan, will have reflected on the need to welcome diversity of thought and to manage that diversity. It won’t be easy. The alternative leads to group-think.
When Guiney was first elected, I recall a discussion I had with some wise Fonterra farmers who recognised that the highly intelligent and forceful Ms Guiney would need to choose her battles. Whether or not that occurred is not clear to those of us on the outside, but she sure rubbed some other directors up the wrong way.
The issue now is that recent outcomes have demonstrated very clearly that Fonterra has been performing poorly. That can no longer be denied. However, there is room for debate as to whether the fundamental problem has been poor strategy or poor execution or both. That debate may well shape the chosen path ahead.
My own view is that the seeds of the problem were sown a long time ago, and I have been writing about those issues for many years. The fundamental flaws have been fifteen years of insufficient retained profits, combined with muddled understanding of the China opportunities, together with poor choice of China partners and associated strategy. There has also been fifteen years of failure to identify the forthcoming A2 revolution.
It is incredible to think that The a2 Milk Company, which generates nearly all of its profits from a2 Platinum infant formula produced under contract by Synlait and sourced from around 70 Canterbury farms, now has a greater capital value than Fonterra. This is despite Fonterra having held a 50 percent share in the original A2 milk patent.
Fonterra’s historical errors are now going to haunt Fonterra for quite some time. Finally, Fonterra has recognised that it is capital constrained and that it needs to reduce debt. The stated target, at least initially, is to free up $800 million.
A key issue is whether Fonterra will now focus on simply trying to strengthen its balance sheet, or will it reposition for another foray into value-add.
Sorting out Fonterra’s messy relationship with Beingmate is likely to have unanimous support from the new Board. But that will not release a lot of funds, given the need to buy back Beingmate’s share of Fonterra’s Darnum Park in Australia as part of the overall divorce proceedings.
I have previously discussed the issues around the sale of Fonterra’s China Farms and so I won’t repeat them here. Suffice to say, that despite lingering and incorrect assertions that Fonterra had no option but to originally make this investment as part of the political cost of extricating itself from San Lu, it is now a costly indulgence. Fonterra does not have the necessary skill-set to be a Chinese dairy farmer.
A key question with Fonterra’s China Farms is that the value of the assets remains unknown until the market is tested. But it could go a long way to satisfying Fonterra’s bankers.
The other obvious asset to sell is Soprole in Chile, and indeed all of Fonterra’s South American assets. These assets have been earning good profits but in the new Fonterra they have minimal strategic value. Their sale may well realise something around $1 billion. However, their sale will also highlight how important Chile has been in buttressing Fonterra’s public relations messaging about its value-add strengths. Once gone, some of the emperor’s value-add robes and value-add profits will drop away.
Given the above context and sale opportunities, it is remarkable that Fonterra is exploring the sale of Tip Top. It seems to say that Fonterra no longer sees itself as a consumer-focused value-add company.
CEO Hurrell has stated that Tip Top is in a mature New Zealand-based market, and that Fonterra is unwilling to make the necessary investment to take it to a new level. Yet, if the new Fonterra were to have an international consumer focus, then Tip Top could well have been the vehicle to take A2 consumer products to Asia.
The biggest question of all for Fonterra to resolve as it searches for its future path is to work out how to manage the A2 issue. Many of the A2 trains have already left the station, and Fonterra is not well organised, but the last trains are still to depart.