One bed, two dreams Fonterra in China - Rod Oram's lecture to the University of Auckland's
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
One bed,
two dreams
Fonterra
in China
Rod Oram’s lecture to the University of Auckland’s
Rod.Oram@NZ2050.com / Twitter @RodOramNZ North Asia Centre for Asia-Pacific Excellence
+64 21 444 839 / Kiwiki on Facebook Auckland, May 29th , 2018
Two Chinese proverbs
• "It doesn't matter whether a cat is black or white, as long as it catches mice.”
• Deng Xiao Ping
• “One bed, two dreams” – Chinese proverb about ill-matched partners
• Some earlier foreign investment disasters in China I’ve reported on:
• …such as Unilever in the early 1990s
• …late-1990s onwards Fletcher Steel, Lion Nathan, Carter Holt, and AFFCO
• But a few successes too, which I researched for the Asia NZ Foundation in 2011
• http://www.asianz.org.nz/media-release/nz-companies-lack-skills-make-most-
asia%E2%80%99s-rapid-growth-report
Newsroom columns on Fonterra & Beingmate October 1, 2017: Fonterra fails basic tests https://www.newsroom.co.nz/2017/09/30/51025/rod-oram-fonterra-failing-basic-tests January 28, 2018: Beingmate goes from bad to worse for Fonterra https://www.newsroom.co.nz/2018/01/27/78078/beingmate-goes-from-bad-to-worse-for-fonterra February 4, 2018: Beingmate blames Fonterra for its losses https://www.newsroom.co.nz/2018/02/01/80038/beingmate-blames-fonterra-for-its-losses February 18, 2018: How Fonterra hit the wall in China https://www.newsroom.co.nz/2018/02/17/89248/rod-oram-how-fonterra-hit-the-wall-in-china March 10, 2018: Fonterra’s big, big Beingmate problems https://www.newsroom.co.nz/2018/03/10/95465/rod-oram-fonterras-big-big-beingmate-problems March 22, 2018: Fonterra’s selective and unrealistic view https://www.newsroom.co.nz/2018/03/22/99084/fonterras-selective-and-unrealistic-view April 1, 2018: ‘To lose millions is bloody incompetence’ https://www.newsroom.co.nz/2018/03/31/101579/to-lose-millions-is-bloody-incompetence March 22, 2018: Bernard Hickey: Spierings-Wilson era at Fonterra was no great success https://pro.newsroom.co.nz/articles/2591-the-spierings-wilson-era-at-fonterra-was-no-great-success
Agenda • Fonterra’s (unsolved) strategic challenge • Sanlu • Beingmate Baby & Child Food • Capital & Governance
Fonterra’s unsolved strategic challenge
• Fonterra is the 2nd largest dairy processor in the world
• But Fonterra ranks 18th in the 20 largest dairy companies by sales revenue per
kilogram of milk, in the 2016 IFCN rankings
• Fonterra lags 40% below the US$1 per kg average revenue for the 20 largest
processors in the world
• Fonterra’s generates only 60 US cents of revenue per kg of milk
• Top 5: Danone US$2.40, Nestlé US$1.90, Mengnui and Yili (China’s two
largest dairy companies) US$1.40, and Groupe Lactalis of France US$1.30
• https://www.dairyglobal.net/Articles/General/2016/7/Who-are-the-top-20-milk-processors- 2836106W/
Agenda • Fonterra’s (unsolved) strategic challenge • Sanlu • Beingmate Baby & Child Food • Capital & Governance
2006:
Fonterra’s
high hopes
for Sanlu
• After many years
of negotiations,
with Sanlu,
Fonterra took a
43% stake in it in
December 2005
for $150m https://chinaeconomic
review.com/feeding-
china/
• Sanlu had been
China’s top
domestic seller of
infant formula for
more than a
decade
• Fonterra had high
hopes for Sanlu
becoming its key
partner in China
Fonterra’s
high hopes
for Sanlu
https://chinaeconomic
review.com/feeding-
china/
2008: Sanlu fails • http://faifaisoldi ers.blogspot.c o.nz/2016/02/c ase-1-sanlus- melamine- tainted- milk.html
https://en.wikipe
dia.org/wiki/200
8_Chinese_milk
_scandal
Wikipedia
timeline:
https://en.wikipe
dia.org/wiki/Tim
eline_of_the_20
08_Chinese_mil
k_scandalSanlu fails: Fonterra loses its $200m investment
Lessons Fonterra could have learnt from Sanlu
• Sanlu’s ownership structure was highly complex and conflicted
• Sanlu’s management structure was opaque
• Sanlu was dependent on myriad small suppliers of milk
• Sanlu’s operating systems and culture were highly deficient
• Fonterra had three appointees to Sanlu’s board
• Patrick Kwok, Bob Major and Mark Wilson…but only Kwok spoke Mandarin
• Fonterra had extremely limited knowledge of Sanlu’s operations
• It only seconded one or two technicians at a time to Sanlu; none spoke Mandarin
• Fonterra exerted very limited, if any, influence on Sanlu
• Fonterra was totally blind-sided. Chairman Henry van der Hayden and CEO Andrew
Ferrier were clearly astounded by the revelations as the scandal unfolded• https://researcharchive.lincoln.ac.nz/handle/10182/4200
Agenda • Fonterra’s (unsolved) strategic challenge • Sanlu • Beingmate Baby & Child Food • Capital & Governance
Post-Sanlu…pre-Beingmate
• September 2012 - DCD:
• Fonterra found traces of dicyandiamide (DCD), an agricultural chemical, in its
dairy products, unsettling consumers
• …particularly in China, straining relations with its government
• August 2013 – Fines for pricing practices:
• China’s anti-monopoly commission fines a number of multinationals US$100m
for their pricing practices, including Fonterra ($900,000)
• August 2013 – botulism scare:
• …on February 1, a torch was dropped into a piece of equipment at Fonterra’s
Waitoa plant in the Waikato, triggering a series of events that:
• Created a botulism false alarm in reprocessed whey protein concentrate
• Caused panic among some consumers
• …particularly in China, further straining relations with its government
• Revealed how chaotic were Fonterra’s product tracing and recall systems
• …and the food industry’s – NZ government inquiry initiated major overhaul
• Killed Fonterra’s relationship with Danone, its major infant formula customer
• …Danone became a competitor, sued for $1bn, and was awarded $183mCrisis…solution
• By 2014, Fonterra was in a deep crisis. It was still:
• Battling the aftermath of the botulism crisis at home and abroad
• Trying to rebuild its reputation in China, particularly with the government
• Out of the game with its own brands of infant formula, particularly in China
• Had lost Danone, one of its largest customers for making branded formula
• …resulting in its Darnum, Victoria, plant being seriously underutilised
• Solution…Beingmate:
• A Chinese customer for Fonterra’s ingredients for formulas
• A manufacturer, brander and seller of formulas with a near 10% market share
• …through a vast network of affiliated, small retailers
• A leading domestic player…& government was forcing sector consolidation
• Run by a high profile Chinese entrepreneur, Xie Hong (“Sam”)Courting Beingmate
• In early 2014, Theo Spierings, Fonterra’s set out on a “global grovel trip”,
recalls a senior colleague of his at the time
• “When Theo arrived, Sam spotted an opportunity.”
• Chinese government was pushing through major reforms of the infant
formula industry to improve its integrity, particularly among its domestic
manufacturers and distributors, and build consumer confidence in them
• Xie saw the benefits of closer ties to Fonterra as a source of ingredients for its
own formulas and of Fonterra’s own brands to sell in its network.
• “The Chinese drove a very hard bargain.”
• They knew Fonterra had to find a major partner to make Darnum
economically viable again; Fonterra was eager to overcome its market failure
in China with its own infant formula brands; and Fonterra believed it had to
show the Chinese government it was serious about investing locally despite
all its setbacks.
• “Theo kept saying Beingmate was ‘a ticket to the game’ – investing in farms in
China was not enough. One way or another, he was determined to do this deal.”Spierings: Beingmate deal a “game-changer” • Spierings said from the outset his close relationship with Xie Hong was essential to the Fonterra-Beingmate relationship • But he signed the MOU in Beijing, August 27, 2014, with Wang Zhentai, chairman
Beingmate – key to Fonterra’s China strategy • As recently as its FY17 results presentation in September 2017, Fonterra said:
What could possibly go wrong?
• In the late-1990s, McKinsey was the architect of the strategy that led to the creation
of Fonterra. It remains to this day one of the co-op’s key strategic advisers
• As Fonterra was consummating its deal with Beingmate, this was the advice
McKinsey’s Shanghai office was giving for free public dissemination to foreign
companies investing in China
https://www.mckinsey.com/business-
functions/strategy-and-corporate-finance/our-
insights/a-pocket-guide-to-doing-business-in-china…and offered free too by Univ. of Auckland
McKinsey’s 2014 advice…on e-commerce • “China is home to some of the world’s largest, most successful, and innovative Internet-based companies.” • “The pace at which Chinese consumers are embracing the Internet is at the cusp of causing major disruptions to many sectors in China.” • “Perhaps because consumers are still new to our traditional ways of shopping or banking (only having had modern shopping malls for a decade in many cities), consumers are very willing to switch to buying online.” • “Almost no consumer-facing business in China can succeed without an online and offline strategy today. Mall owners are struggling to find a new economic model.” • “Retailers are trying to bring order to their nationwide distribution chains to exert control over the price at which their products are sold online.” • “The online share of retail in China, at 8 percent in 2014, is higher than it is in the United States and is not close to reaching saturation. Increasingly, this is conducted through mobile devices. The payments system is in place, logistics are improving, and online providers are trusted. Many retailers will adapt, often with far fewer physical locations.”
McKinsey’s 2014 advice…on joint-ventures • “If regulations require you to have a joint-venture partner and a minority position today, assume it will be that way forever in the core business activities. From automotive to financial services, the lesson is that it won’t change. If that model is not attractive today, do not invest in the hope that it will change.” • “Establish from the outset a clear hierarchy of who interacts with whom at the joint-venture partner and with relevant government officials. Chinese partners like the certainty this provides. Ensure that the committed executive shows up for board meetings and the like, and don’t delegate.” • “Place a trusted senior colleague in China with a commitment to have him or her be there for the long term. He or she is your go-to person when things get volatile in China, someone whose viewpoint the global management team will trust, and someone the head of your joint-venture partner will also learn to trust.” • “Usually, this person will be very strong in people development, with skills almost overlapping with a head of HR. And he or she will need to be 100 percent trusted to enforce compliance and to role model required behaviors. Typically, make this person chairman of your Asia or China operations, as senior a title as possible.”
McKinsey’s 2014 advice…on reputation
“Don’t do anything to compromise
your global brand and reputation.
If you can’t do business the way you want to,
then don’t do it at all.”Fonterra acquires Beingmate stake
• August 27, 2014: Fonterra agrees to buy stake, up to 20% for $615m
• February 2, 2015: Fonterra launches its offer to buy Beingmate shares
• March 2, 2015: Beingmate reported its 2014 results:
• Sales fell 17.24% to yuan 5.06bn (they had peaked at yuan 6.11bn in 2013)
• Operating profits fell 89% to yuan 104.4m
• Net profit attributable to shareholders fell 91% to yuan 65.7m (US$10.5m), from
yuan 721m in the prior year.
• March 18, 2015: Fonterra buys 192.4m shares at yuan 18 each
• 18.8% stake for $750m…smaller stake, more money than Fonterra expected
• “Due consideration” had been given to Beingmate’s recent results,
said Lukas Paravicini, Fonterra CFO, five days after the deal closed
• The purchase was financed entirely by new debtBeingmate plunges, two Chinese rivals soar • t 2011: Beingmate floated at yuan 42 per share
Heavy losses < . . . . > Dysfunctional board
Johannes Priem, Fonterra’s previous
head of Greater China, non-Mandarin speaker
Christina Zhu, Fonterra’s current
head of Greater China, Mandarin speakerWhat went wrong?
• Constant turmoil out in the markets…and in management and the board
• …beginning with Xie Hong, its founder, who had alienated institutional investors
and quit the board soon after the company floated in 2011
• Beingmate disillusioned its franchisees by trying to extract greater returns from them
• Moreover, Beingmate’s network was heavily focused on third-tier cities
• …then Beingmate floundered as e-commerce rapidly took a large share of the market
away from brick-and-mortar retailers and sharply drove down pricesBeingmate’s problems with e-commerce • t
The cost to Fonterra’s farmer-shareholders
• Of Fonterra’s 7 strategic objectives for its Beingmate investment:
• Sales of Fonterra’s Anmum brand of infant formula are minimal
• Beingmate took 51% stake in Darnum, but is buying less than its share of output
• The other 5 strategic objectives have yet to eventuate
• Beingmate is heavily loss making, pays no dividend (Fonterra expected $16m pa)
• Fonterra has very publicly ruptured its relationship with Beingmate by criticising its
corporate governance
• The cost to Fonterra’s shareholders
• Fonterra has written down its investment from $750m to $244m (-67%)
• In total, so far…
• $506m write down + ≈ $120m in debt costs + ≈ $28m in share of losses
+ $48m in lost dividends = $702m
• Is Fonterra’s current $244m value of its Beingmate stake realistic?
• Beingmate’s recovery looks immensely difficult…Fonterra’s reported no progress yet
• …if ultimately the value is zero…
• …Fonterra’s shareholders will have lost more than $1bn on BeingmateWhat went on in the Fonterra-Beingmate relationship?
• This Harvard Business School case study on Beingmate is highly revealing
http://www.hbs.
edu/faculty/
Pages/item.asp
x?num=52057Xie goes to Harvard • Xie, Beingmate’s founder, has given at least two talks at Harvard Business School on the case study – in 2016 and 2017 • This page is a machine translation from a Chinese parenting website reporting on his 2017 visit • There is no mention of Fonterra in this report, or a long press release from Beingmate about Xie’s comments at Harvard
Life inside Beingmate, as reported by HBS
• The opportunity of sourcing ingredients from Fonterra:
• …reputation of foreign producers, diversifying from Chinese sources
• But the disadvantages…
• “In the international dairy supply, we have to follow a 24-month rolling plan to
cater to the market,” he said. “However, in China, we can adjust product types
whenever we want, which is totally impossible to achieve in the global market.
For example, we can produce one type of product for this month, with high
efficiency and low cost.
“Then for next month, we can produce something different by switching
equipment. The benefit of this mode is that we are able to produce products that
are fresher, and we are more flexible in satisfying customer needs and following
market trends. But [with global sourcing] we have to learn how to operate in the
mode of few varieties and large batches.”
• Bolin Qian, Beingmate’s associate general manager of global strategy (at the time)Conflict with Fonterra
• Conflict within Beingmate over relationship with Fonterra:
• The case writers said some in the company “questioned the wisdom of
allowing a joint brand [Fonterra’s Anmum] — one not branded as part of the
Beingmate portfolio — to exploit Beingmate’s extensive distribution network.”
• They quoted one executive:
• “You don’t want to raise other people’s babies.”
• Beingmate’s infant formula market share:
• Plunged from 9.3% in 2013 to 2.5% in 2017, according to Euromonitor
• Meanwhile, Fonterra’s global arch-rivals have greatly grown their shares:
• Nestlé to 17% from 12%
• Danone to 10.6% from 7%
• FrieslandCampina to 7.4% from 4.1%What went wrong
• Fonterra felt under great pressure to make a big strategic investment in China to
rectify its own failures in the market, and to assuage what it believed were the
desires of the Chinese government
• Beingmate took advantage of Fonterra’s weak bargaining position
to drive a hard bargain
• Was Fonterra’s due diligence report on Beingmate, provided by one of its
external advisers overseas, essentially a straight line extrapolation of
Beingmate’s past growth? Or did it flag up the weaknesses of the company?
• Beingmate has utterly failed to deliver on the prospects promised, through a
combination of its own internal failures and of turbulent market conditions
• Fonterra has doggedly stuck with Beingmate, arguing it is an integral part of its
China strategy and it will eventually come right
• “Beingmate was outside our capability; we’ve denied for three years that there
was an issue; the only issues were external and short-term ones rather than
anything to do with Beingmate”
• A former Fonterra senior executive who was there when the deal was doneWhat has Fonterra learnt?
• Any parallels between Sanlu and Beingmate?
• None. Sanlu was about melamine
• John Wilson, Fonterra chairman,
FY18 interim results presentation, March 21, 2018
• Has Fonterra learnt any lessons from Beingmate?
• “Yes, we have. China evolves very quickly. To have an 18.8% stake in a
Chinese company with regulations increasing very quickly is not the easiest
to say it mildly.”
• Theo Spierings, Fonterra CEO,
FY18 interim results presentation, March 21, 2018
• Is Beingmate still integral to Fonterra's China strategy?
• “You can’t unpick it.”
• Theo Spierings, Fonterra CEO,
FY18 interim results presentation, March 21, 2018…now Fonterra downplays Beingmate
• …saying Beingmate is tiny in its global strategy and small in its China strategy
• Moreover, the Enterprise Value of Greater China (China + Taiwan + HK) rose by
$1bn 2015-17
• But enterprise value includes debt…
• …and Fonterra added $750m of debt to its China operations to fund its
Beingmate stake plus additional debt to develop its China FarmsChina Farms • Years of heavy investment by Fonterra in its three farming hubs in China • But barely profitable…and only because it sells its milk at a premium to Fonterra’s downstream operations • …and it talks up its toe-hold in the fresh milk market
Fonterra’s growth in China
• …has come from ingredients, and consumer and food service
• …which require minimal capex in China
• …while the heavy capex businesses, Beingmate and Chain Farms
have racked up large cumulative losses and debt…but wait, it says Beingmate is still important
Agenda • Fonterra’s (unsolved) strategic challenge • Sanlu • Beingmate Baby & Child Food • Capital & Governance
Capital and Governance
• Fonterra raised some $4.5bn of capital from farmers in the five years up to 2012
• …the year the co-op changed its capital structure
• Fonterra has invested…overheard in the gents
Farmer A: "See the share price today? Down again.”
Farmer B: "The Chinese saw us coming”
Farmer A: "Nobody put their hand up."
Farmer B: "To err is human, they say."
Farmer A: "To lose millions is bloody incompetence.”
Two farmer-shareholders, in the gents at Claudelands Events Centre, Hamilton
Fonterra Shareholders’ Meeting, a briefing after the FY18 interim results
March 26, 2018You can also read
