Capital Structure Consultation 2021
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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.
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
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
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
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
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
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
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
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.
83 – 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
9C 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
10SCENARIO 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
11C 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
123 – 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.
13C 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.
14Capital 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?
15C 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
17C 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
18SUSTAINABLE 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.
19C 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.
20WHY 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%
21C 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
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