Capital Structure Consultation 2021

Page created by Arnold Gibbs
 
CONTINUE READING
Capital Structure Consultation 2021
Capital
  Structure
Consultation
         2021
Capital Structure Consultation 2021
A strong Co-op benefits
farmers and New Zealand

 It’s good to remember why we’re a Co-op in the first place.
 First and foremost, the role of a           cost, and over the long run they are        For every dollar we earn as farmers,
 co-operative is to give farmers control     incentivised to reduce the price they pay   we spend almost 50 cents in our
 of their own destiny. Because we own        for milk to maximise corporate profits.     communities. 2020/21 looks set to
 and control Fonterra, we know that our                                                  be another season that our Co-op
                                             Having a strong farmer-owned
 Co-op will collect our milk and work                                                    contributes more than $11 billion into
                                             co-operative in our dairy industry
 hard to ensure we receive the best                                                      the New Zealand economy through milk
                                             is important to every New Zealand
 possible price for it. Maximising overall                                               price payments.
                                             dairy farmer, and for the country
 wealth of our shareholders is at the core
                                             as a whole.                                 Our milk price sets a benchmark in
 of our Co-op’s purpose.
                                                                                         New Zealand, so even those who don’t
                                             Specific legislation enabled Fonterra
 Sharing the investment in our value                                                     supply the Co-op benefit from it.
                                             to be formed so that an efficient
 chain between us farmers and having
                                             co-operative of scale could lead New        Fonterra and Tatua are the two main
 confidence that our milk is going to
                                             Zealand into global markets. Working        dairy co-operatives left here. Many
 be picked up means we can have the
                                             together as a Co-op means we are            other milk processing companies are,
 certainty to invest in our individual
                                             connected to local communities around       or have become, fully or substantially
 farming businesses. This is an important
                                             New Zealand. It enables our efficiency      owned by offshore interests.
 reason behind the efficiency and
                                             – from behind the farm gate through
 productivity that has given us some                                                     It’s critical to protect and build on
                                             to our manufacturing operations and
 of the advantages we enjoy today –                                                      what we’ve got – for the benefit of all
                                             beyond – and supports innovation.
 advantages that benefit all Fonterra                                                    Fonterra shareholders. Ultimately, a
                                             The value we create is then returned
 shareholders. We believe that farmers                                                   strong and sustainable Fonterra leads
                                             to regional New Zealand, where it
 are worse off in countries where there                                                  to a stronger and more sustainable
                                             plays a strong role helping to sustain
 is no strong co-operative. Corporate                                                    Aotearoa New Zealand.
                                             local communities and enhance
 processors look at milk as an input
                                             their wellbeing.
Capital Structure Consultation 2021
What’s in this booklet

                                                    1 ON BEHALF OF THE BOARD                                                                                2

                                                    2 WHY WE’RE PROPOSING CHANGES                                                                           4

                                                    3 THE PREFERRED OPTION AND WHAT IT WOULD MEAN FOR US                                                    6

                                                      Reduced Share Standard with No Fund or Capped Fund                                                    7
                                                      How it could work                                                                                     9
                                                      Comparing the preferred option to our current structure                                               10
                                                      Key things to consider                                                                                12
                                                      Why this is the preferred option                                                                      14

                                                    4 HOW WE GOT TO THIS POINT                                                                              16

                                                      A brief history of our capital structure                                                              16
                                                      A recap of our strategy                                                                               18
                                                      How we went about our capital structure review                                                        20
                                                      The detailed findings of the review                                                                   21

                                                    5 THE OTHER OPTIONS CONSIDERED DURING THE REVIEW                                                        24

                                                    6 WHERE TO FROM HERE                                                                                    30

                                                      The consultation process and timeline of next steps                                                   30
                                                      How to get more information and have your say                                                         31
                                                      How to contact us                                                                                     31

                                                    7 GLOSSARY                                                                                              32

This booklet is for consultation purposes only.       requirements, including the Financial Markets      circumstances or your holding of shares or
The options are not yet fully developed, and you      Conduct Act 2013.                                  units, please contact your accountant, lawyer,
are not being asked to vote on anything at this       Some of the information set out in this booklet    financial advisor or other rural professional.
stage. If the result of the consultation is that      relates to future matters that are subject         This booklet is addressed to Fonterra’s
there is sufficient support for a change to our       to uncertainties. The inclusion of forward-        farmer owners, but the interests of other
capital structure, then you will have a chance to     looking information should not be regarded         stakeholders (including the Custodian and the
vote on that change and you will receive all the      as a representation or warranty by Fonterra or     Manager of the Fonterra Shareholders’ Fund)
documents needed to understand and assess             any other person that those forward-looking        have been, and will continue to be, considered
the details before you are asked to vote.             statements will be achieved or that the            as the options have been and continue to be
This booklet is not an offer of financial             assumptions underlying any forward-looking         developed, and these parties will be consulted
products (e.g. shares), and no such offer is          statements will in fact be correct. Actual         as appropriate.
currently intended. No money is being sought          outcomes may vary materially from those            Some of the dollar values in this booklet
from shareholders, and financial products             suggested or implied.                              assume (for illustrative purposes) a share price
cannot currently be applied for or acquired           If you have any questions about the options        of $5.00. This is not a representation as to the
under any of the options in this booklet. If an       being consulted on or would like to clarify your   future price of Fonterra shares. Over the period
offer of financial products is made as part of        understanding of anything in this booklet,         of 90 days ending 30 April 2021, the share
a change to our capital structure, it would be        see Section 6 for who you can contact. For         price has varied above and below that level.
made in accordance with the applicable legal          any questions about your own financial
Capital Structure Consultation 2021
C APITAL STRUC TURE CONSULTATION 2021

1.
On behalf of the Board

                               Dear Farmer Shareholders,                     Our Co-op has refocused on delivering
                                                                             sustainable value back to New Zealand.
                               I’d like to start by acknowledging that the   We do that through a strategy designed
                               temporary cap on the size of the Fonterra     to optimise the value of our New Zealand
                               Shareholders’ Fund will have come as a        milk, using innovation, sustainability, and
                               surprise. We did not make that decision       efficiency to deliver products that are
                               lightly. It is necessary to keep all of our   orientated to what our customers and
                               potential options for change open while       consumers value.
                               we have a free and frank conversation
                               as owners.                                    Alongside that refreshed strategy, the
                                                                             Board has spent a significant amount
                               Over the past 24 months, our Co-op            of time reviewing our capital structure.
                               has been undergoing a cultural and
                               strategic transformation. Change was          Both of these pieces of work are founded
                               needed. If we want Fonterra to continue       on our belief that New Zealand milk
                               supporting our families’ livelihoods for      volumes will likely be flat or declining in
                               another 150 years, we have to keep            the long term as a result of environmental
                               evolving it, while staying true to our        and other regulatory changes, and
                               Co-operative Principles.                      alternative land uses.

2
Capital Structure Consultation 2021
Waiting for the problem to be at our feet will limit our options
and likely increase the cost of addressing them, at the
expense of future opportunities for us.
PETER MCBRIDE – CHAIRMAN

Our Co-op’s financial performance will       Throughout the process we have focussed        In Section 5 we detail the alternative
always be the main determinant of our        on addressing three key issues:                structures that were considered and
share of that New Zealand milk. But we                                                      the reasons why they are not our
                                             1. Maintaining financial sustainability
also know that our rigid compulsory                                                         current preferred option. We are
                                                of our Co-op
capital structure makes it difficult for                                                    keen to hear your views on these
new farmers to join and is a key factor      2. Protection of farmer ownership              different variations as part of
in farmers’ decisions to leave. A more          and control                                 the consultation process.
flexible capital structure that caters for
                                             3. Flexibility for farmers’ invested           We will seek to cater for the diversity
the diversity and different aspirations
                                                capital that helps farmers to be part       within the shareholder base, but we will
within our Co-op would be valued by
                                                of our Co-op at every stage of the          all need to be pragmatic if we are to find
farmers and support a sustainable
                                                farming lifecycle and ensures we            a way forward together that is in the best
future milk supply.
                                                maintain a sustainable milk supply.         long-term interests of our Co-op.
Within that context, our review has found
                                             Having narrowed down the options, we           Once we hear your views, and if the
that our current capital structure could
                                             believe the best option for our Co-op          appetite for change remains, we will
create challenges over time.
                                             is to move to a structure that reduces         do further work to refine the preferred

                                                                                                                                           1 – ON BEHALF OF THE BOARD
1. Under the current structure if milk       the share standard so you have greater         option(s) and have a second round of
   volumes reduce, the number of             flexibility, and either removes the Fund       consultation. If we decide to seek a
   dry shares will increase and could        or caps the Fund from growing further          change to our capital structure, then you
   exceed the thresholds that were           to protect our farmer ownership and            will have a chance to vote on that change.
   put in place to protect our farmer        control. We’re referring to this as a
                                                                                            As some aspects of our current capital
   ownership and control. Our Co-op          “Reduced Share Standard” with either
                                                                                            structure are reflected in the Dairy
   would need to take action to stay         “No Fund” or a “Capped Fund”.
                                                                                            Industry Restructuring Act, a successful
   within these thresholds – such as
                                             Under this option, the Fund would either       vote would likely be conditional on
   buying back shares or units. Buy-
                                             need to be bought back and removed             any necessary changes to legislation
   backs could impact our Co-op’s
                                             from our capital structure (No Fund) or        being passed.
   balance sheet and investment in
                                             remain in the structure but with no ability
   new opportunities that increase                                                          I appreciate there is a real sense of
                                             to exchange shares into units so the Fund
   performance. Conceivably, buying                                                         optimism in the Co-op with our improving
                                             size would be capped (Capped Fund).
   back shares or units to ensure that we                                                   financial performance and how we are
   retain ownership and control of the       A key outcome of this change is that           travelling generally. But there is a sense
   Co-op could cost shareholders up to       shares would be bought and sold                of urgency with this review. Waiting for
   $1.2 billion over the next ten seasons.   between farmers in a farmer-only market.       the problem to be at our feet will limit
                                             I want to be clear with you that we expect     our options and likely increase the cost
2. An alternative to buy-backs would
                                             this change to impact the price at which       of addressing them, at the expense of
   be to increase the thresholds for the
                                             shares in our Co-op are traded, and that       future opportunities for us.
   Fund size, to allow a greater degree
                                             there may not be as much liquidity in
   of external investment.
                                             the market.
We don’t think either of these are ideal                                                    Ngā mihi
                                             Ultimately, the price of our shares would
outcomes, so we have been looking at                                                        Peter
                                             be determined by the performance of our
other options for change. Exactly what
                                             Co-op and trading between us farmers.
that change could look like is what we
want to consult with you on now.             Currently our share price moves in line
                                             with the price of units in the Fund. In that
To give those conversations some
                                             sense it is influenced by unit holders, who
structure, the Board has shared its
                                             have a different investor profile to that of
current thinking. It is detailed in
                                             us farmers – a farmer’s cost of capital is
Section 3 of this booklet.
                                             typically higher.
We have arrived at this point after
                                             To cater for share flexibility, some
reviewing a wide range of capital
                                             farmers would inevitably have more
structure options from co-operatives
                                             shares than others. We believe this is
around the world – both within and
                                             a more sustainable proposition over
outside the dairy sector – as well as
                                             the longer term than the alternatives
options to evolve our current structure.
                                             we are confronted with.

                                                                                                                                       3
Capital Structure Consultation 2021
C APITAL STRUC TURE CONSULTATION 2021

2.
Why we’re proposing changes

Getting our capital structure right is                                                                 The environment in which we’re                                                                                   This is due to factors such as climate
critical to helping ensure the financial                                                                                                                                                                                change impacts, regulatory changes
sustainability of our Co-op.
                                                                                                       operating has changed a lot                                                                                      and alternative land uses. These factors
                                                                                                       since Trading Among Farmers                                                                                      might not have fully impacted us yet, but
We’ve evolved our structure before,
and it’s important we keep evolving                                                                    (TAF) was implemented.                                                                                           we expect this to change over the next
                                                                                                                                                                                                                        five to ten years.
it as things change.                                                                                   Our current structure was put in place in
                                                                                                       2012 when New Zealand’s milk supply                                                                              Having a sustainable milk supply is critical
This section summarises why we believe
                                                                                                       was growing rapidly.                                                                                             for us continuing to deliver on our current
it’s time to evolve our capital structure.
                                                                                                                                                                                                                        strategy, which is all about prioritising
The issues outlined are covered in                                                                     Now, we face a different reality where
                                                                                                                                                                                                                        New Zealand milk.
more detail in Section 4 “How we got                                                                   we need to be prepared for a flat
to this point.”                                                                                        or potentially declining milk supply                                                                             There are elements of our current
                                                                                                       environment across New Zealand                                                                                   structure that are challenging for a
                                                                                                       in the coming years.                                                                                             number of farmers now, or that may
                                                                                                                                                                                                                        create challenges for our Co-op in a flat
                                                                                                                                                                                                                        or declining milk supply environment.
                                                                                                                                                                                                                        These are explained overleaf, and in
                                                                                                                                                                                                                        more detail on pages 22-23.

                                                                                                                 NZ MILK SUPPLY (KGMS MILLIONS)
2,000

1,800

1,600

1,400

1,200

1,000

    800

    600

    400

    200

      0
          1989/90
                    1990/91
                              1991/92
                                        1992/93
                                                  1993/94
                                                            1994/95
                                                                      1995/96
                                                                                1996/97
                                                                                          1997/98
                                                                                                    1998/99
                                                                                                              1999/00
                                                                                                                        2000/01
                                                                                                                                  2001/02
                                                                                                                                            2002/03
                                                                                                                                                      2003/04
                                                                                                                                                                2004/05
                                                                                                                                                                          2005/06
                                                                                                                                                                                    2006/07
                                                                                                                                                                                              2007/08
                                                                                                                                                                                                        2008/09
                                                                                                                                                                                                                  2009/10
                                                                                                                                                                                                                            2010/11
                                                                                                                                                                                                                                      2011/12
                                                                                                                                                                                                                                                2012/13
                                                                                                                                                                                                                                                          2013/14
                                                                                                                                                                                                                                                                    2014/15
                                                                                                                                                                                                                                                                              2015/16
                                                                                                                                                                                                                                                                                        2016/17
                                                                                                                                                                                                                                                                                                  2017/18
                                                                                                                                                                                                                                                                                                            2018/19
                                                                                                                                                                                                                                                                                                                      2019/20

                                                                                                                   New Zealand Milk Supply                                    Fonterra Milk Supply

4
Capital Structure Consultation 2021
The level of investment                        If we provide more                           We have choices to make
to be part of our Co-op is                     flexibility, the Fund size                   around how we could address
challenging for a number                       could grow significantly.                    these challenges, and we want

                                                                                                                                         2 – WHY WE’RE PROPOSING CHANGES
of farmers.                                    Our Co-op has constitutional thresholds      to talk with you first.
We all have a lot of capital invested in the   designed to balance the interests            To stay within the thresholds, our Co-
Co-op. While it’s important for each of us     of farmer owners and the interests           op would need to take action such as
to have skin in the game, we’re hearing        of external investors in the Fund.           buying back shares or units. This creates
there’s a desire for greater flexibility.      Exceeding those thresholds could put         an uncertain demand on our capital,
                                               farmer ownership and control at risk.        potentially impacting our ability to
This has come through in your feedback         We know that’s not something any             invest in strategy and growth. Under the
and we’ve heard it from farmers who have       of us want to see.                           scenarios that we’ve modelled, buy-backs
left in recent years.
                                               If we provide more flexibility to reduce     could cost shareholders between $500
The investment that’s required to supply       the level of investment for farmers to       million and $1.2 billion over the next ten
the Co-op is making it challenging for         be part of our Co-op, without making         seasons.
new farmers to join and can be a key           any other changes to our current capital     We’ve looked at a wide range of options.
factor for existing farmers in deciding        structure, our thresholds could be           No structure is perfect, and all options
to leave so they can pay down debt or          exceeded relatively quickly.                 have trade-offs. What we’re not willing to
invest their capital in other things. This
                                               That’s because farmers would be able to      trade off is farmer ownership and control
can be a real challenge for succession,
                                               hold less shares and non-farmers would       of our Co-op, which protects our interests
forcing difficult decisions when
                                               be able to invest more through the Fund.     as producers.
farm businesses transition from one
generation to the next.                        Therefore, providing more flexibility        Exactly how our capital structure evolves
                                               would need to be combined with making        is a conversation for us as owners and is
At a share price of $5.00, a farmer
                                               changes to the Fund in order to protect      what we want to consult with you on now.
supplying 150,000 kgMS would have
$750,000 invested in our Co-op.                farmer ownership and control.

Strong performance only increases this
investment requirement. As our earnings        The Fund size could also grow
increase, so too should the share price,       if milk supply declines.
which increases the capital investment to      Under our current structure, when milk
join, and the capital for those who leave.     supply declines, the number of wet shares
In short, we believe our capital structure     on issue decreases and the number of
is tilting the playing field against us when   dry shares increases by a corresponding
compared to other processors – the vast        amount. Those dry shares can then
majority of which are corporates and           be exchanged into units at any time,
don’t require any capital investment           increasing the potential size of the Fund.
from farmers who supply them.                  If we make no changes to our capital
What we’re hearing is that providing more      structure and milk supply declines,
flexibility would be valued by farmers and     we expect current thresholds relating
go a long way to supporting a sustainable      to the Fund size to be exceeded within
milk supply.                                   a few seasons.

                                                                                                                                     5
Capital Structure Consultation 2021
C APITAL STRUC TURE CONSULTATION 2021

3.
The preferred option and
what it would mean for us

                                Our aim has been to find options that          This indicates our current thinking,
We’ve spent a significant       give you more flexibility when you             but we are open minded about adjusting
amount of time looking          need it but still protect ownership            that direction based on your feedback.
at a wide range of              and control, without compromising
                                                                               The other options we considered,
alternative structures          our financial sustainability.
                                                                               including staying with our current
as well as options to evolve    We prioritised a couple of structures          structure, are outlined in Section 5,
our current structure.          that we thought could best meet the            and we will discuss them during the
                                objectives of the review and after closer      farmer meetings. Your feedback on
                                analysis, we have a preferred option –         any or all of these is welcome.
                                to adopt a Reduced Share Standard with
                                either No Fund or a Capped Fund – which
                                is explained in more detail in this section.

6
Capital Structure Consultation 2021
3 – THE PREFERRED OPTION AND WHAT IT WOULD ME AN FOR US
REDUCED SHARE STANDARD WITH EITHER NO FUND
OR CAPPED FUND
Our preferred option at this stage is for     This involves reducing the share standard
a Reduced Share Standard, with either         so that the minimum requirement for
No Fund or a Capped Fund. In this section     farmer owners would be one share
we walk through how this could work,          for every four kgMS supplied to the
some key things to consider and why           Co-operative (1:4), rather than the
this is our preference.                       current share standard ratio of 1:1.

 FROM (BEFORE TEMPORARY CAP)                                              TO
 Limited flexibility:                                                     Increased flexibility:
  » Share standard of 1 share/1 kgMS (1:1)                                 » Share standard of 1 share/4 kgMS (1:4)
  » Maximum shareholding of:                                               » Maximum shareholding of:
      – 2x supply; or                                                          – 4x supply; or
      – For shares held in excess of supply, up to 5% of the                   – No change
        Co-operative on a look-through basis

 Minimum shareholding requirements based on milk                          No change.
 supply over a rolling three-season average.
 Dividends are discretionary and paid in respect of each                  No change.
 share held.
 Farmer owners have 1 vote per 1,000 kgMS supplied                        No change, so long as you continue to hold shares on a 1:1
 in the previous season to the extent the supply is                       basis relative to your supply in the previous season. If you
 backed 1:1 by shares.                                                    choose to only hold the minimum required shareholding
                                                                          of 1:4, you would have fewer votes than a farmer who
                                                                          holds 1:1. See also the scenarios on pages 10-11.
 Shares traded on the Fonterra Shareholders’ Market                       Shares traded on the FSM (or a similar farmer-only
 (FSM) (or a similar farmer-only market) and able to be                   market) only. Fund bought back or capped, so no ability
 exchanged into units in the Fund.                                        to exchange shares into units.
 Share price set by reference to public unit market                       Share price set in a farmer-only market.
 alongside the farmer-only market.
 Share-Up Over Time and MyMilk contracts.                                 Share-Up Over Time and MyMilk contract supply options
                                                                          would be phased out (although all existing commitments
                                                                          would be honoured).
 The Co-op can deduct, for tax purposes, dividends                        Under current tax legislation, the amount of dividend
 paid on supply-backed shares, so shareholders are                        that can be passed through to farmers pre-tax would
 paid a pre-tax dividend on those supply-backed shares.                   reduce. However, the Co-op would be able to impute
 Farmer shareholders are then required to pay tax on                      these dividends with income tax paid by the Co-op after
 these dividends.                                                         tax losses are used. See further discussion on page 13.

                                                                                                                                         7
Capital Structure Consultation 2021
C APITAL STRUC TURE CONSULTATION 2021

Reducing the share standard would
make it easier for new farmers to join
our Co-op and give more flexibility          REDUCED SHARE STANDARD                     REDUCED SHARE STANDARD
                                                     No Fund                                  Capped Fund
to existing farmer owners who may
want to free up capital or who are                                                                                  EXTERNAL
working through succession. In line                               FARMERS                            FARMERS       INVESTORS
with the Co-operative Principles, the
financial benefits and obligations                                                                Tradeable           Units
                                                              Tradeable
that arise from capital invested would                        shares                              shares
                                                              1:4 share                           1:4 share
still be allocated in proportion to                           standard                            standard             FSF
shareholding. Control and voting
rights would be based on share-
backed supply in the same way as
today. The caps on share ownership
are intended to protect against
significant levels of concentration       No Fund                                    Capped Fund
of individual ownership within the        » Removing the Fund would involve an       » A Capped Fund would involve the
farmer owner base.                          offer by Fonterra to unit holders to       Fund remaining part of Fonterra’s
                                            buy back their units at a fixed price.     capital structure and listed on the
However, reducing the share standard
                                            The approval of at least 75% of unit       NZX/ASX, but with one key change in
would result in more shares that don’t
                                            holders entitled to vote and voting        that farmer owners would no longer
need to be held by farmers to supply
                                            would be needed for the offer to           be able to sell any further economic
the Co-op – or “non-compulsory”
                                            be accepted.                               rights of shares into the Fund. Shares
shares. If exchangeability with the
                                                                                       would be tradeable in the FSM only.
Fund remained in place as in our          » The offer amount would need to be
current structure, farmer owners            acceptable to unit holders, fair to      » As at 31 March 2021, the Fund
could sell the economic rights of           farmers and would need to make             had 105 million units issued, which
these non-compulsory shares into            more sense to the Co-op than the           comprised 6.5% of total Fonterra
the Fund (i.e. exchange shares into         Capped Fund alternative.                   shares. Capping the Fund would
units to sell those units), causing                                                    mean that it could get smaller, but
the Fund size to grow and exceed                                                       it would not get bigger, other than
the thresholds that protect farmer                                                     in limited circumstances such as
ownership and control of the Co-op.                                                    where a distribution reinvestment
                                                                                       plan is offered.
Because of this, if we want
                                                                                     » Members of the public and other
to provide more capital                                                                investors, including farmer owners,
flexibility, then we expect that                                                       sharemilkers, retired farmers
we would need to take one of                                                           and non-farmer investors, could
the following actions in order                                                         continue to trade units in the
to protect farmer ownership                                                            NZX/ASX with units continuing to
                                                                                       receive distributions in line with our
and control:
                                                                                       performance. Farmer owners would
    » Buy back and remove the Fund                                                     also still be able to exchange any
      (No Fund); or                                                                    units they hold for shares in the FSM.
    » Stop the exchangeability of                                                    » This means that the size of the Fund
      shares for units in                                                              as a proportion of our Co-op could
      the Fund and thereby cap the size                                                not increase materially, but it could
      of the Fund (Capped Fund).                                                       decrease if farmer owners exchange
                                                                                       units they buy or hold into shares.
Both these options would be effective
                                                                                       Fonterra could also potentially buy it
at protecting farmer ownership and
                                                                                       back in the future – partially or fully.
control of the Co-op.
                                                                                     » There could be an ongoing price
                                                                                       difference between the traded price
                                                                                       of shares in the FSM and the traded
                                                                                       price of units in the Fund, for the
                                                                                       reasons described in the key things
                                                                                       to consider on page 12.

8
3 – THE PREFERRED OPTION AND WHAT IT WOULD ME AN FOR US
HOW IT COULD WORK:
Below is our current thinking on how a Reduced Share Standard structure could work, having looked at different options
for some of the features, such as the 1:4 share standard and the 4x cap on shares. We are keen to hear your views on
these points over the course of the consultation process.
 » New members joining the                   to the existing limit on shares           that if you only held the
   Co-op and farmers that are                in excess of supply, being 5% of          minimum 1:4, you would have
   sharing up would need to buy              total shares on issue on a look-          fewer votes than if you held 1:1.
   shares to match 25% of their              through basis.                            See also the scenarios on
   supply at a minimum.                                                                pages 10-11.
                                          » Shares would continue to be
 » Shared-up farmer owners would            traded on the FSM (or a similar         » The Share-Up Over Time and
   be able to sell down to 25% of           farmer-only market) with either           MyMilk contracts would be
   their supply. This might only be         No Fund or a Capped Fund. This            phased out and replaced with a
   allowed in stages – potentially          means the implications of a               standard period for all farmers
   over several seasons.                    farmer-only market outlined on            to share up to the Reduced Share
                                            page 12 would likely apply.               Standard when joining, and to
 » Any vouchers would be cancelled
                                                                                      sell their shares when exiting.
   (as holders would not need them        » Dividends would be discretionary
                                                                                      We suggest extending the
   to count towards the Reduced             and paid in respect of each share
                                                                                      share-up and sell-down periods
   Share Standard).                         held (as they are today).
                                                                                      to five seasons (up from three
 » Minimum shareholding                   » Voting rights would remain as             seasons today).
   requirements would be based on           they are today, in that farmer
                                                                                    » We would continue to honour
   milk supply over a rolling three-        owners would have 1 vote per
                                                                                      all existing Share-Up Over
   season average (as it is today).         1,000 kgMS supplied in the
                                                                                      Time and MyMilk
                                            previous season so long as you
 » Farmer owners would be able                                                        contractual commitments.
                                            continue to hold shares on a 1:1
   to own up to four times their
                                            basis relative to your supply in
   supply in shares, but still subject
                                            the previous season. This means

                                                                                                                           9
C APITAL STRUC TURE CONSULTATION 2021

COMPARING THE PREFERRED OPTION TO OUR CURRENT
STRUCTURE FOR FARMERS
Every farmer’s situation would be unique    indication of how things could change
if we were to evolve our structure          at different stages of your business life
to a Reduced Share Standard with            cycle. Note that these are on the basis
either No Fund or a Capped Fund.            that any transition to the preferred
But the hypothetical scenarios below        option has been completed.
are designed to give you a high-level

 SCENARIO                 CURRENT STRUCTURE                                      PREFERRED OPTION

FIRST FARM OWNER          » Minimum shareholding requirement:                    » Minimum shareholding requirement:
 » Planning                 80,000 shares                                          20,000 shares
   to produce             » Maximum shareholding: 160,000 shares                 » Maximum shareholding: 320,000 shares
   80,000 kgMS            » Flexibility:                                         » Flexibility:
 » Holding no shares         – Purchase 80,000 shares over three seasons            – Purchase 20,000 shares over five seasons
   or units                    during the share-up period                             during the share-up period
                             – Apply for a Share-Up Over Time contract              – Invest further in the Co-op and hold up
                               and commit to supply the Co-op for                     to 320,000 shares
                               the term (e.g. 6 years), and pay a contract       » Voting: 20 votes if 20,000 shares held;
                               fee (currently 5c/kgMS) for                         80 votes if 80,000 or more shares held
                               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
                          » Voting: 80 votes if 80,000 or more shares held

GROWING FARM              » Minimum shareholding requirement:                    » Minimum shareholding requirement:
OWNER                       160,000 shares                                         40,000 shares
 » Average production     » Maximum shareholding: 320,000 shares                 » Maximum shareholding: 640,000 shares
   on first farm is       » Flexibility:                                         » Flexibility:
   80,000 kgMS
                             – Purchase remaining 60,000 shares for                 – Sell up to 60,000 shares to free up capital,
 » Second farm                 second farm over three seasons during                  (e.g. for second farm investment)
   expected                    the share-up period                                  – Invest further in the Co-op and hold up
   to produce
   80,000 kgMS               – Apply for a Share-Up Over Time contract                to 640,000 shares
                               for 60,000 kgMS, but would need to                » Voting: 40 votes if 40,000 shares held;
 » Holding 100,000             commit to supply for the term, and
   shares                                                                          160 votes if 160,000 or more shares held
                               contract fee (currently 5c/kgMS) for
                               non-share-backed supply
                             – Supply MyMilk from second farm under
                               contract with no shareholding requirement,
                               subject to contract fee (currently 5c/kgMS)
                               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
                          » Voting: 160 votes if 160,000 or more
                            shares held

10
SCENARIO               CURRENT STRUCTURE                                  PREFERRED OPTION

                                                                                                                                    3 – THE PREFERRED OPTION AND WHAT IT WOULD ME AN FOR US
ESTABLISHED FARM        » Minimum shareholding requirement:                » Minimum shareholding requirement:
OWNER LOOKING TO          200,000 shares                                     50,000 shares
INVEST CAPITAL          » Maximum shareholding: 400,000 shares             » Maximum shareholding: 800,000 shares
 » Average production   » Flexibility:                                     » Flexibility:
   is 200,000 kgMS
                           – Invest further in the Co-op and hold up to       – Invest further in the Co-op and hold up to
 » Holding 200,000           400,000 shares                                     800,000 shares
   shares
                        » Voting: 200 votes if 200,000 or more             » Voting: 50 votes if 50,000 shares held;
                          shares held                                        200 votes if 200,000 or more shares held

RETIRING FARM           » Minimum shareholding requirement:                » Minimum shareholding requirement:
OWNER LOOKING TO          120,000 shares                                     30,000 shares
RELEASE CAPITAL         » Maximum shareholding: 240,000 shares             » Maximum shareholding: 480,000 shares
 » Average production   » Flexibility:                                     » Flexibility:
   is 120,000 kgMS
                           – Sell up to 30,000 shares to free up capital      – Sell up to 120,000 shares to free up capital
 » Holding 150,000
                        » Voting: 120 votes if 120,000 or more             » Voting: 30 votes if 30,000 shares held;
   shares
                          shares held                                        120 votes if 120,000 or more shares held

                                                                                                                               11
C APITAL STRUC TURE CONSULTATION 2021

KEY THINGS TO CONSIDER

Impacts of a farmer-only market             » In a farmer-only market there may             owners would be required to trade
 » If we moved to this structure, shares      be lower levels of trading (liquidity).       shares to at least comply with
   would be traded within a farmer-only       While we would retain a “market               the Reduced Share Standard and
   market, either with the No Fund            maker” – the registered volume                some farmer owners may choose
   option or Capped Fund option.              provider who is active in making bids         to buy shares over and above their
                                              and offers on a minimum number of             individual minimum requirements.
 » The biggest implication of trading         shares in the FSM – the share price
   in a farmer-only market is that                                                       » The Fund also provides a mechanism
                                              could move more on small volumes
   farmers will set the price for                                                          for those with connections to the
                                              of trading in a farmer-only market.
   shares through trading amongst                                                          Co-op such as sharemilkers, contract
   themselves. This is likely to be         » If we reduce the share standard and          milkers, employees and retiring
   different to how outside investors         more farmers wish to reduce their            farmer owners to invest in the Co-op.
   value units in the Fund today.             shareholding than those looking to           With the No Fund option, this would
                                              increase, there could be sell-side           no longer be available.
 » You may hear the potential price           pressure, which could negatively
   difference in a farmer-only market         impact the share price. This may
   referred to as a “restricted market                                                  Flexibility in how this structure
                                              be more apparent under certain
   discount”. Restricted market discounts                                               could work
                                              circumstances. Examples include
   are commonly observed in any               during transition to a reduced share      We have put forward some of the
   market where participation is              standard (if many farmer owners           mechanics for how a Reduced Share
   restricted (in this case, to farmer        choose to sell down), during a period     Standard structure could work and
   owners). A restricted market already       of milk supply decline and farmers        we hope that these will help guide
   exists in other New Zealand                who are reducing their volumes or         our discussions during consultation.
   agricultural companies you may             exiting sell their shares, or in times    However, many variables are flexible,
   be invested in.                            when all farmer owners may be             and we welcome your feedback.
 » We can’t be certain what the price         negatively impacted by common              » The Reduced Share Standard is
   difference might be, but the advice        events such as low milk prices or            intended to provide meaningful
   that we have received is that in           widespread droughts.                         flexibility for farmers to reduce their
   normal trading the share price is        » The impacts of a farmer-only                 shareholding while ensuring there
   likely to be in the range of 20-25%        market could be different to what            is sufficient ability for other farmers
   lower than if the current structure        happens during the temporary cap             to hold a greater number of shares
   was retained. If there are times           we have implemented in order to              without giving rise to a significant
   when there is stronger sell-side           enable consultation. This is because         concentration of ownership. We
   pressure – for example if farmers          all compliance obligations are on            propose that a share standard
   are experiencing financial pressure        hold during the temporary cap                ratio of 1:4 with a 4x maximum
   or otherwise need to sell shares           and because we are consulting                shareholding cap (or for shares
   (for example if milk supply falls)         on potential changes so there is             held in excess of supply, 5% on a
   – then the discount is likely to be        a degree of uncertainty about                look-through basis) strikes a good
   greater.                                   our future capital structure. If a           balance. A higher share standard
                                              Reduced Share Standard structure is          ratio of say 1:2 might not provide
                                              implemented, then that uncertainty           enough flexibility for new and young
                                              would no longer exist – some farmer          farmers. A ratio of say 1:10 that

12
3 – THE PREFERRED OPTION AND WHAT IT WOULD ME AN FOR US
    allowed farmers to lower their share          farmers are likely to hold more          Tax impacts
    ownership even further would mean             shares in proportion to milk supply       » Currently the Co-op can deduct,
    the 4x cap would need to be higher            than other farmers.                         for tax purposes, dividends paid
    so that there would be enough                                                             on supply-backed shares and
                                               » While all farmers would have some
    buyers in the farmer-only market.                                                         shareholders are subject to tax on
                                                 equity in the Co-op through the
    This could potentially give rise to too                                                   these dividends.
                                                 Reduced Share Standard, some may
    much concentration in ownership
                                                 have greater equity than others.           » The number of supply-backed shares
    with a small group of farmers, or
                                                 Retaining the payment of dividends           would reduce under a Reduced Share
    some farmers not having the level of
                                                 on a “per share” basis and voting on         Standard, so there would be a tax
    connection to the Co-op that keeps
                                                 a “per 1,000 kgMS backed by shares”          impact under current tax legislation,
    us strong together.
                                                 basis, as they are today is intended         in that the amount of dividend
 » We have maintained some variables             to recognise this.                           that can be passed through to
   from our existing structure for                                                            shareholders pre-tax would reduce.
                                               » When it comes to voting rights and
   simplicity and continuity, such as
                                                 the potential for concentration of         » This would have the effect of
   the three-season rolling average,
                                                 ownership, it’s important to note            increasing the Co-op’s annual tax
   and dividend and voting rights as
                                                 that because voting rights would be          charge, but is not expected to have
   we do not think these would need
                                                 “per 1,000 kgMS backed by shares”,           a cash impact for the Co-op in the
   to change if we reduced the
                                                 a farmer who continues to hold               short term due to current tax losses
   share standard.
                                                 shares on a 1:1 basis relative to their      the Co-op can use.
 » We do not yet have firm views on              supply in the previous season will
   the timeframe to share-up and                 retain the same voting entitlement         » Once the Co-op has used those
   share-down to the new standard.               as today, and a farmer who holds             tax losses ($1.52 billion as at
   We are very open to your thoughts             additional shares over the 1:1 basis         31 July 2020), the Co-op would
   on what you would like to see here.           (up to the maximum shares at 4x              start paying tax on earnings on
   Our current view is that we would             kgMS supplied) would only have               behalf of shareholders, and
   want to see any timeframes captured           voting rights up to the 1:1 level, not       shareholders would receive
   in the Constitution rather than               their full shareholding.                     imputation credits to pass on
   through Share-Up Over Time                                                                 the tax paid.
                                               » We welcome your views on
   contracts. At this stage, we have                                                        » The ability of individual farmer
                                                 whether there should be any other
   suggested five seasons to share-up                                                         owners to utilise imputation
                                                 mechanisms to support greater
   on joining the Co-op and five seasons                                                      credits to offset their tax expense
                                                 alignment between farmers.
   to share-down on exiting the Co-op.                                                        would depend on their individual
                                                                                              tax circumstances.
                                              Timing of Transition
Co-operative alignment
                                               » We may want to transition to a
 » A Reduced Share Standard structure
                                                 Reduced Share Standard over
   allows farmer owners to have
                                                 multiple seasons by gradually
   different levels of capital invested
                                                 reducing the share standard, rather
   in the Co-op relative to their milk
                                                 than reducing it all at once. This
   supply which might mean that
                                                 would help reduce supply-side
   farmers have different interests
                                                 pressure in the farmer-only market.
   in the Co-op. For example, some
                                                 We welcome your views on this.

                                                                                                                                    13
C APITAL STRUC TURE CONSULTATION 2021

      WHY THIS IS THE PREFERRED OPTION

      We prefer the Reduced Share Standard structure over the other options outlined in Section 5 for several reasons.
       » Overall, we think this structure measures well against the design principles for the review while remaining aligned
         with our Co-operative Principles. It supports a strong Co-operative and sustainable milk supply but still requires
         all suppliers to become farmer owners with “skin in the game”, and all farmer owners have exposure to both milk
         price and some earnings.
       » It is preferable to a Dual Share structure (outlined in Section 5) at maintaining a strong balance sheet for our
         Co-op. This is a high priority for us and was also reflected in farmer feedback. This is because retaining a single
         share would mean that all share capital is rated as equity (which would not be the case under a Dual Share
         structure where one of the shares may be partially classified as debt by ratings agencies).
       » We think it would be more straight forward to implement than other options.
      We have also reached a preliminary view that having No Fund would be preferable to a Capped Fund because it
      simplifies our Co-op. However, if we cannot reach an acceptable arrangement to buy back the Fund that 75% of voting
      unit holders support, then a Capped Fund would also work. In other words, we would only seek to remove the Fund
      at a reasonable price that was acceptable to unit holders, fair to farmer owners and made sense to the Co-op compared
      to the Capped Fund alternative.

14
Capital structure is an important conversation for us as
                  owners. We want to hear your feedback on any or all of the
                  topics discussed in this booklet.

Do you think that there is a clear rationale for        What do you think about the variables within this
moving away from the current structure?                 structure such as:
                                                        –   the share standard ratio of 1:4
                                                        –   the maximum cap on shareholding of 4x supply
                                                        –   the timeframe to share-up and share-down of five seasons
                                                        –   phasing out Share-Up Over Time contracts and/or
                                                            MyMilk contracts
                                                        –   whether we transition to a Reduced Share Standard over

                                                                                                                            3 – THE PREFERRED OPTION AND WHAT IT WOULD ME AN FOR US
                                                            several seasons, or if we change all at once
What do you see as the benefits and challenges
with a Reduced Share Standard structure?

Do you see reducing the share standard as being
effective at creating flexibility for farmers? Do you   What are your views on how we support alignment
believe that this will make it easier for farmers to    between farmer owners on items like voting
join and stay with the Co-op?                           rights? For example, should voting remain linked
                                                        to share-backed supply, or should some other
                                                        mechanism be considered?

What are your views on moving to a farmer-only
market and the potential impacts?
                                                        Should sharemilkers and others working toward
                                                        farm ownership be able to directly participate in
                                                        the Fonterra Shareholders’ Market?

                                                                                                                       15
C APITAL STRUC TURE CONSULTATION 2021

4.
How we got to this point

A BRIEF HISTORY OF OUR
CAPITAL STRUCTURE                         1. THE FONTERRA SHAREHOLDERS’ MARKET (FSM)
When Fonterra was formed in 2001,           This is the farmer-only market where farmers trade shares in our Co-op
Co-operative shares were issued to          between themselves. The introduction of this market and the other TAF
farmer owners in proportion to supply.      amendments in 2012 meant that our Co-op no longer had to issue and
Our Co-op redeemed the shares of            redeem shares.
exiting farmers and those who reduced
supply for cash at a value that was set
annually by an independent valuer.        2. THE FONTERRA SHAREHOLDERS’ FUND (FSF OR FUND)
When a large number of farmers exited
or reduced supply (e.g., during periods     This is a managed investment scheme under the Financial Markets Conduct
of drought), our Co-op had to redeem        Act. It is listed on the NZX Main Board and on the ASX, and units in the
those shares and pay out the value –        FSF can be bought and sold by the public in the same way as any other
known as “redemption risk”.                 listed security.

In 2012, we implemented the current         Units in the FSF give the holder access to the economic rights in a share
Trading Among Farmers (TAF) structure,      (such as distributions or dividends). Like any member of the public,
primarily to manage redemption risk.        farmer owners can also trade units in the FSF.
There are two key parts to TAF, which
are illustrated on the right.

16
4 – HOW WE GOT TO THIS POINT
To be part of our Co-op, the current       Farmers can buy or sell shares on the         20% of our total shares on issue, and
minimum requirement is to hold one         FSM. Farmers can also sell the economic       an Aggregate Threshold of 15% for
share for every kgMS supplied. This is     rights of shares into the Fund (except        the number of dry shares as a proportion
based on a three-year rolling average      when a temporary cap is in place). In         of total shares on issue. As at 31 March
supply. Farmer owners may, but are not     this case, the farmer-owned Custodian         2021, the Fund size was 6.5% of our
required to, hold additional shares, up    holds legal title to the share and a unit     total shares on issue and the Aggregate
to 2x the minimum shareholding. For        in the Fund is issued, which is then sold     Threshold was 14.0%. If these thresholds
any farmer choosing to leave the Co-op,    on the market. Apart from two supply          are exceeded, our Co-op would need
there’s a requirement to sell shares       offers early in the establishment of TAF,     to take action to get back under the
within three seasons at a minimum rate     farmers have only been allowed to sell        thresholds again. The most likely action
of one third per season.                   the economic benefit of dry shares, not       to achieve this under the current settings
                                           wet shares, into the Fund. Farmers can        would be for our Co-op to allocate
The number of shares that are matched
                                           also exchange units back into shares.         capital to buy back units or shares.
to milk production are known informally
                                           In this case the unit is cancelled and the
as “wet shares” while the shares that                                                    TAF helped to address some of the
                                           Custodian transfers title to the underlying
are held in excess of the wet share                                                      challenges we faced when it was
                                           share back to the farmer owner.
requirement are known as “dry shares”                                                    implemented in 2012.
– although they are in fact all the same   When TAF was implemented, certain
                                                                                         But it has been important to look at
single class of share.                     protections were put in place in relation
                                                                                         whether it will support our financial
                                           to the Fund size to help protect farmer
                                                                                         sustainability into the future based on
                                           ownership and control. These included
                                                                                         how much has changed since then.
                                           an Overall Limit on the Fund size of

                                                                                                                                   17
C APITAL STRUC TURE CONSULTATION 2021

A RECAP OF OUR STRATEGY
Capital structure helps us execute our      what we needed to do to both reset our
strategy successfully over the long-        business and achieve sustainable value
term, so it’s important we’re all clear     over time, by responding to changing
on where we’re headed as a Co-op            consumer, customer and market needs.
before implementing any changes to our      We made some big decisions about the
structure. Our 2019 refresh considered      kind of Co-op we want to be.

Recap of changes made in 2019 strategy refresh

 FROM                                                            TO

 Volume                                                          Value

 Global Milk Pools                                               Prioritise New Zealand Milk + complementary components

 Maximum volume into consumer                                    Focus on key categories to deliver superior value

 Dairy only                                                      Supplement with non-dairy where makes sense

 Partner with cash investments                                   Partner with IP and skills and lift R&D

 Debt funded growth                                              Conservative balance sheet

 Global giant with HQ in New Zealand                             Celebrate Aotearoa New Zealand and take it to the world

                                                                 Divest non-core businesses and focus where we have a
 Invest widely based on aggressive growth plans
                                                                 competitive advantage

18
SUSTAINABLE VALUE

                                      CORE        FOOD       PAEDIATRICS     SPORTS        MEDICAL
                                      DAIRY      SERVICE                     & ACTIVE      & AGEING

                                            Prioritising
                                          New Zealand milk

          Innovation                                                                                  Efficiency
       To create superior value                                                                   Unlock greater value from
        for our customers and                                                                      our scale efficiency and
           our Co-operative                         Sustainability                                   focus on execution

                                                                                                                                            4 – HOW WE GOT TO THIS POINT
                                                   To do what’s right for the
                                                   long term good and meet
                                                consumer and community needs

OUR STRATEGY PRIORITISES
NEW ZEALAND MILK
Our strategy is about prioritising            Raising additional capital is not             We’re building good
New Zealand milk and growing demand
for it by understanding our customers,
                                              the purpose of this review.                   momentum and we are
and differentiating our Co-op’s milk          Having adequate and sustainable access        well positioned to make the
through innovation, sustainability            to capital to fund our strategy is always     most of future opportunities.
and efficiency.                               front of mind, and raising additional
                                              capital is not the purpose of this review.    We have been making good progress
We are focusing on five categories            We will fund our strategy through a           across the Co-op, including improved
– Core Dairy (cream, butter, cheese,          strong balance sheet, cashflow, and           business performance, a stronger
milk powder), Foodservice, Paediatrics,       through leveraging our IP and innovation      balance sheet with reduced debt levels
Sports & Active and Medical & Ageing.         capability to partner in new products and     and dividend payments being resumed.
                                              categories where it makes sense.              Our strategic direction, combined with
We already have a competitive advantage
                                                                                            a diversified portfolio, has positioned
in some of these five categories and          This capital structure review is              us well to navigate through a period of
in others we are drawing on our dairy         about prioritising New Zealand milk,          unprecedented global uncertainty as a
know-how and innovation capabilities          protecting farmer ownership and               result of COVID-19. While there is still
to strengthen our positions.                  supporting a sustainable milk supply          more work to do, we remain on track to
The Co-operative Difference is                over the longer term.                         deliver our targets.
building on the work farmers have             Our strategy is dynamic, and we will
done over recent years to earn more           always be reviewing our portfolio –
premiums for our products based on            asking ourselves what each asset is worth
their New Zealand provenance and              to us now and into the future. We will
sustainability performance.                   continue to turnaround key parts of our
We measure success on how we’re               portfolio and divest non-core businesses
progressing towards our three                 to support new investments as necessary.
interconnected goals – Healthy                Our focus is on maintaining a strong
People, Healthy Environment and               balance sheet to support growth.
Healthy Business.

                                                                                                                                       19
C APITAL STRUC TURE CONSULTATION 2021

HOW WE WENT ABOUT OUR CAPITAL STRUCTURE REVIEW
We were clear from the beginning about        of design principles. We shared these
our objective: to have a capital structure    with you after our annual results in
that ensures our Co-op’s financial            September 2020.
sustainability so we can deliver value
                                              The wide range of alternatives that we
for this generation and the next.
                                              looked at were assessed and prioritised
We started by identifying what the key        based on how well they met the objective
elements of a financially sustainable         and design principles outlined below.
Co-operative are and developing a set

Design principles
                                             Does the structure preserve farmer ownership and control of the Co-operative for
            Ownership & Control
                                             the long term?

                                             Does the structure support our ability to attract and retain high quality, sustainable
            Sustainable Milk Supply
                                             milk and provide financial flexibility for farmers?

                                             Does the structure protect value for current Co-operative members and allow farmers
            Protect Value
                                             to transact their membership / shareholding in a way that is fair?

                                             Does the structure align incentives between shareholders, unitholders and
            Align Incentives
                                             management, to maximise value?

                                             Does the structure manage redemption risk and economic shocks in a way that makes
            Build Resilience
                                             the Co-operative resilient?

                                             Is the transition to a potential new structure affordable, achievable and fair to
            Transition Effectively
                                             unitholders and farmer shareholders?

                                             Does the structure preserve balance sheet strength and provide access to capital at
            Access Capital
                                             a reasonable cost in the future?

                                             Is the structure simple to understand and simple to operate for both farmers and
            Simple
                                             the Co-operative?

We listened to farmer views.                  While we would have liked to have been          sample of 350 farmer owners, as well as
                                              out on the road discussing options              the online survey available to all farmers
It was clear from the outset that             with you earlier, we have gained useful         from January to February 2021 where we
consultation for this review would be         insights from farmer workshops on               had around 1,800 responses.
more challenging than last time because       capital flexibility that were held in 2019,
both shares and units in the Fund are                                                         Your feedback has very much helped to
                                              the roadshows after annual results and
traded securities and we are legally                                                          shape the direction of the review so far.
                                              interim results, a phone survey we did
required to comply with financial market      in December 2020 of a representative
continuous disclosure rules.

20
WHY WE HAD TO IMPLEMENT A TEMPORARY CAP ON THE FUND
    At the same time as launching this consultation process, we announced that we’d be temporarily capping the size of the Fund
    by suspending shares in the FSM from being exchanged into units in the FSF while we consult with you. We’ve done this to
    ensure that all options remain open to us as we have this conversation.
    As we progressed the review and started looking into options that included buying back the Fund, we identified a risk
    that, if we started consulting on options for change without temporarily capping the Fund, the Fund size could have grown
    significantly and taken the option of buying back the Fund off the table before you even had a chance to consider it.
    Some of the options have the potential to see differences emerge between the price at which a share trades in the FSM
    compared to what a unit in the Fund trades at, with units trading at a higher price than shares. If the temporary cap was not in
    place, anyone holding dry shares would be able to exchange them into units in the Fund. This could more than double the size of
    the Fund and make options that include buying back the Fund unaffordable in the context of our current balance sheet targets.
    That’s why we had to temporarily cap the Fund at its current size before consulting on options. This was necessary to enable
    full discussion with you without ruling out options that potentially buy back the Fund. It’s important to note that pricing under
    the temporary cap may not reflect pricing of shares in a farmer-only market.

THE DETAILED FINDINGS OF THE REVIEW

We heard what’s most                            asked you to select up to three areas          The survey results are similar to the
                                                most important to you, and you can see         feedback we’ve had from farmers who
important to you.                               in the graphic below the percentage            have left the Co-op in recent years.

                                                                                                                                              4 – HOW WE GOT TO THIS POINT
The online survey results confirmed that        of respondents who put the following           Essentially, the lack of flexibility in
there is an appetite for change, with 62%       factors in their top three.                    our current structure means that it’s
of respondents either strongly or slightly                                                     challenging for new farmers to join
                                                Those areas in dark blue are the
supporting a change.                                                                           and can be a key factor for existing
                                                standouts, but we also heard that our
                                                                                               farmers in deciding to leave the Co-op.
The results also gave us an insight into        capital structure should make it easy for
what you consider are the main priorities       new farmers to join the Co-op and for
when it comes to capital structure. We          existing farmers to have more flexibility.

        Maintaining farmer ownership and control of the Co-op                                                                       82%

Making sure Fonterra has a strong balance sheet that is resilient
                                                                                                                       65%
         to changing milk supply & climate or economic shocks

                         Providing a good return on investment                                               53%

               Making it easy for new farmers to join the Co-op                              30%

                Giving farmers more flexibility about how much
                                                                                  18%
                                       they invest in the Co-op

                                    Being simple to understand                    18%

Providing growth in the capital invested in the Co-op over time               14%

         Aligning incentives between shareholders, unitholders
                                                                         7%
                           and management to maximise value

                                       Having a high share price        6%

           Being able to raise capital from non-farmer investors      4%

                                                                                                                                         21
C APITAL STRUC TURE CONSULTATION 2021

     HOW DOES OUR CURRENT STRUCTURE CONTRIBUTE TO US HAVING TO INVEST
     SO MUCH CAPITAL?
     The features of our current capital structure that influence the level of investment include:
     1. 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 focussed (i.e. in farming operations) and therefore it’s not possible to ‘diversify away
        the risk’ like an investor. Therefore, it is likely that 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.
     2. The single class of Co-op share bundles together your right to supply the Co-op and the requirement to invest in its
        business, including value-added activities. This together with the current share standard means our farmer owners have
        little choice about the level of exposure they have to Fonterra’s value-added activities, and little flexibility around the level
        of investment required at various stages of their business life cycle.
     In addition to this, when our earnings increase, the share price should increase – so when our Co-op is doing well, our capital
     structure means it costs more for new suppliers to join and for existing suppliers to increase supply to our Co-op and the
     higher share price may also be a key factor for existing farmers to leave our Co-op.
     Overall, we believe that our capital structure is tilting the playing field against us when compared to other processors –
     the vast majority of which are corporates who don’t require any capital investment from farmers who supply them.

We found that our current                         In the chart below:
capital structure could create                              » Scenario 1 represents environmental changes, land use changes, and changes in
challenges over time.                                         productivity, and assumes that our market share continues to change at half the
                                                              rate of the past five seasons. This scenario could result in a decline in milksolids
Our current capital structure was put in                      collected to around 1,300 million kgMS in the relevant period.
place when New Zealand milk supply was
growing rapidly. Today, we have to be                       » Scenario 2 represents the same environmental changes, land use changes,
prepared for a future of flat or potentially                  and changes in productivity, but assumes that market share continues to
declining milk volumes.                                       change at the same rate as it has over the past five seasons. This scenario could
                                                              result in a decline in milksolids collected to around 1,200 million kgMS in the
It is important to remember that under                        relevant period.
our current capital structure, when milk
supply declines, the number of wet shares                   » The scenarios start from the 2019/20 season’s actual milk collections of
decreases and the number of dry shares                        1,517m kgMS.
                                                                              MILK SUPPLY SCENARIOS (KGMS MILLIONS)
increases by a corresponding amount.
                                                                  1,800
We have tested our current structure                              1,600
against potential declining milk supply
                                                                  1,400
scenarios based on variations of the
                                                                  1,200
                                                kgMS (millions)

average net loss of milk we’ve seen over
                                                                  1,000
the past five seasons and the expected
                                                                   800
losses from factors such as climate
change, new regulations and alternative                            600

land uses after allowing for potential                             400
productivity gains.                                                200
                                                                     0
                                                                          2001/02

                                                                                       2003/04

                                                                                                 2005/06

                                                                                                           2007/08

                                                                                                                     2009/10

                                                                                                                               2011/12

                                                                                                                                         2013/14

                                                                                                                                                   2015/16

                                                                                                                                                             2017/18

                                                                                                                                                                       2019/20

                                                                                                                                                                                 2021/22

                                                                                                                                                                                           2023/24

                                                                                                                                                                                                     2025/26

                                                                                                                                                                                                               2027/28

                                                                                                                                                                                                                         2029/30

                                                                                    Fonterra Milk Collections                            Scenario 1                                Scenario 2
22
You can also read