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FM AMEMBASSY WELLINGTON
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RUEHRC/USDA FAS WASHDC PRIORITY 0370
RUEHBS/USEU BRUSSELS PRIORITY

UNCLAS SECTION 01 OF 05 WELLINGTON 000847 
 
SIPDIS 
 
SIPDIS 
 
EAP/ANP, EEB/TPP/ABT, STATE PASS TO FAS KHALIKA MEARDY - 
OCRA, PAUL KIENDL - OGA, JIM DEVER - OFSO, COMMERCE FOR 
ITA/MAC/AP/OSAO, PACOM FOR JO1E/J2/J233/J5/SJFHQSTATE 
 
E.O. 12958: N/A 
TAGS: EAGR ECON EFIN ETRD PREL NZ XV
SUBJECT: FONTERRA - NEW ZEALAND'S LARGEST COMPANY PLANS TO 
FLOAT FIRST INITIAL PUBLIC OFFERING 
 
 
WELLINGTON 00000847  001.2 OF 005 
 
 
¶1.  Note:  This is a joint Foreign Agricultural Service and 
State report.  End note. 
 
¶2.  Summary.  Fonterra Co-operative Ltd, New Zealand's 
largest company is beginning a two-year consultation with its 
farmer shareholders whether to approve a preferred capital 
restructuring option.  If approved, Fonterra would transfer 
its assets, liabilities and operations to a separate company 
that would be listed on the stock exchange in 2010.  Outside 
investors could purchase up to 20 percent of the shares, 
which would enable Fonterra to raise capital for planned 
expansion into overseas markets, primarily China, other 
countries in Asia, and South America.  Fifteen percent of the 
shares would be provided to existing farmer shareholders and 
the remaining 65 per cent would be held by the co-op. 
Fonterra controls nearly 40 percent of global trade in dairy 
exports, and its 2007 assets of NZ$12.6 billion (US$10.1 
billion) and revenue of NZ$13.9 billion (US$11.2 billion) 
mean it could eclipse the currently largest listed company on 
the New Zealand Stock Exchange - Telecom.  While potential 
investors have responded positively to the plan, Wall St. 
expressed cautious optimism but the initial reaction of 
farmer shareholders has been mixed.  End summary. 
 
Who Is Fonterra 
--------------- 
 
¶3.  The Fonterra Co-operative Group was formed by the merger 
of New Zealand Dairy Group, Kiwi Co-operative Dairies, and 
the New Zealand Dairy Board in late 2001.  The group is owned 
by its 11,000 dairy farmer shareholders and is the world's 
largest exporter of dairy products, exporting 95 percent of 
New Zealand's production.  Fonterra controls about 40 per 
cent of world dairy trade and exports to more than 140 
countries with 32 per cent going to Asia, 25 per cent to the 
Americas, and 21 per cent to Oceania.  With its 2007 assets 
amounting to US$10.1 billion and revenue of US$11.2 billion 
Fonterra could eclipse the currently largest listed company 
on the New Zealand Stock Exchange - Telecom. Fonterra is 
considered a "partnership model" because of the growing 
number of foreign companies with which it has established 
partnerships.  This strategy enables it to access dairy 
markets where dairy demand is met by local supply. 
Partnerships, such as joint ventures, give Fonterra market 
access without major capital investments and financial risks, 
while providing mutual benefits to both companies. 
 
¶4.  In North America, Fonterra has already teamed with Dairy 
Farmers of America, the largest farmer-owned dairy 
cooperative in the U.S.  The resulting partnership, 
DairiConcepts, produces and markets milk protein 
concentrates.  Fonterra has also entered into an agreement 
with Dairy America, a federated marketing cooperative, to 
serve as the marketing agent for the nonfat dry milk received 
from its members (seven U.S. farmer-owned dairy 
cooperatives).  In the U.S. market, Fonterra is a buyer and 
an exporter of U.S. nonfat dry milk to other foreign markets. 
 Its other partnerships include joint ventures with Nestle 
through Dairy Partners Americas in South America, Arla Foods 
in the United Kingdom, Clover Industries in South Africa, and 
Britannia Industries in India.  Fonterra is the world's 
largest dairy ingredients company, but is also a supplier of 
consumer branded products, such as its Anchor brand butter, 
Anlene brand milk powders, and Mainland brand cheese 
products.  Fonterra has a major stake in the Australian dairy 
company, Bonlac Foods Limited, and has undertaken the formal 
merger of both companies' consumer products operations in 
Australia and New Zealand. 
 
Fonterra Announces IPO 
---------------------- 
 
¶5.  On November 15, 2007, Fonterra, the largest company by 
 
WELLINGTON 00000847  002.2 OF 005 
 
 
turnover in New Zealand and the world's fifth largest dairy 
company by revenue, presented for consideration to its 
members, six options for a fundamental capital restructuring, 
including the Fonterra Board's preferred option that would 
result in the co-operative listing its business operations in 
a separate company, while maintaining a controlling interest. 
 Under the preferred option, initially farmers would own 
about 80 per cent of the listed entity, 65 per cent through 
the co-operative and around 15 per cent through their own 
shareholding in the listed entity.  The remaining 20 per cent 
would be available to the public.  Fonterra wants to change 
its capital structure to address three pressures on its 
current structure - redemption risk, investment choice for 
farmers, and the need for a secure and expanding capital base 
to implement its growth strategy.  The preferred (i.e., 
announced) option was the only one of six the Board 
considered that would achieve all three goals. 
 
¶6.  Two years of consultations and two rounds of shareholder 
voting will be required in order to implement the initial 
public offering (IPO).  In May of 2008, Fonterra's 11,000 
shareholders will vote on whether to allow Fonterra to change 
to the two-entity structure and to adopt a more transparent 
milk pricing system.  The milk price system will be used to 
determine the price by which the co-op transfers milk 
produced by shareholders to the new company.  The second 
vote, which will probably be around May 2010, will determine 
whether to let Fonterra list on the stock exchange in order 
to generate external capital.  In both ballots, 75% of 
shareholders must vote to approve the measures. 
 
¶7.  Of the six options presented to members by the Fonterra 
Board, the preferred option was the only one that would 
achieve all three goals of implementing growth strategy, 
reduce risk, and create flexible investment choices for 
farmers.  The start of the consultation process comes two 
months after Fonterra announced a record payout to suppliers 
of NZ$6.40 (US$5.12) per kilogram of milk solids. "While 
NZ$6.40 (US$5.12) is good for farmers, it doesn't give the 
Co-operative the capital to implement our strategy," said 
Fonterra's Chairman, van der Heyden.  "It may lessen the 
redemption risk for a while, but that is debatable because 
our shareholders can choose to redeem their shares regardless 
of the level of payout.  And NZ$6.40 (US$5.12) does nothing 
to address shareholder investment choice," per van der Heyden. 
 
Pre-Conditions for Fonterra Listing on Stock Market 
--------------------------------------------- ------ 
 
¶8.  The following conditions must be met before the IPO can 
be launched: 
 
-  75 per cent farmer shareholder approval to create parent 
co-op and operating subsidiary and a transparent milk 
pricing system (to be voted on by 11,000 Fonterra farmer 
shareholders in May 2008). 
-  A competitive milk pricing mechanism. 
-  Superior business performance across Fonterra. 
-  Acceptable share market conditions. 
-  Acceptable listing value for current shareholders. 
-  Acceptable legislation to support necessary changes. 
-  75 per cent farmer shareholder approval in second vote 
(expected around 2010) of listing and raising external 
capital. 
 
Floating Fonterra: Process, Structure, Safeguards 
--------------------------------------------- ---- 
 
¶9.  The process calls for two years of consultations and two 
shareholder votes.  The first vote is scheduled for May 2008. 
 Fonterra farmer shareholders will vote on: splitting 
Fonterra into two entities - a parent co-op and a separate 
company with manufacturing and marketing responsibilities; 
 
WELLINGTON 00000847  003.2 OF 005 
 
 
and a milk pricing system that determines the price for 
transferring milk from the co-op.  The second and final vote 
is expected around May 2010.  Shareholders will vote on 
listing on the stock market and raising external capital.  In 
both votes, 75 percent approval of shareholders is required 
for the measures to pass.  The two-year consultation process 
will provide farmers with a chance to assess how the milk 
pricing system is working before voting on the listing 
option. 
 
¶10.  Under the preferred option, the assets, liabilities and 
operations of the current co-operative would be shifted to 
the new company.  The co-op and its farmer owners would 
retain a 65 percent stake, 15 percent would be distributed to 
farmers, and an additional 20 percent would be issued to 
external shareholders.  Farmers would have the option of 
selling their shares on the stock market or keeping them. 
 
¶11.  The preferred option includes contractual, 
constitutional and legislative safeguards to help ensure New 
Zealand farmer majority ownership and New Zealand control. 
These include: 
 
- The new company will contract with the co-op to pick up all 
milk produced by shareholders, maintain adequate processing 
facilities, and adhere to a milk pricing agreement. 
- Only the co-op will be allowed to own more than 10 percent 
of shares. 
- The co-op will not be able to own less than 50.1 percent 
without a 75 percent approval vote. 
- The minimum co-op stake will be 35 percent. 
- 50.1 per cent of shares must be held exclusively by New 
Zealanders, even if the co-op's stake drops to 35 percent. 
- The co-op will have a board comprised of eight farmer 
directors and two independent directors. 
- The co-op board will have the power to appoint the board of 
the new company, which will consist of six farmer and four 
independent directors. 
- The two boards will share the same chairman and four farmer 
directors. 
- Fonterra headquarters will remain in New Zealand. 
- Only New Zealand dairy farmers will be able to be 
shareholders of the co-op. 
 
Rationale: "Behind the Borders" 
------------------------------- 
 
¶12.  Of all of the options considered, the preferred option 
reportedly best ensures that Fonterra will be able to raise 
capital at a competitive cost.  It is estimated that NZ$2 to 
$3 billion (US$1.8 to $2.4 billion) could be raised through 
the share offering, which would enable Fonterra to pursue its 
growth strategy of expanding in the fastest growing markets 
around the world, including South America, China and other 
countries in Asia.  In these markets, there is strong demand 
for fresh milk and Fonterra's strategy is to supply this 
demand by building profitable businesses in those countries 
by using locally-produced milk.  In New Zealand, this 
strategy is commonly referred to as a "behind the borders" 
approach. 
 
¶13.  The preferred option also enables Fonterra to address 
redemption risk, which is significant.  Farmers that supply 
Fonterra must purchase fair value shares proportional to the 
amount of milk supplied.  These shares are fully redeemable 
if producers decide to cease supplying Fonterra.  Because of 
the way the Fonterra cooperative was initially set up with a 
fair value shares system, Fonterra has virtually no permanent 
capital.  The total value of all fair value shares represents 
the entire equity capital of Fonterra.   By issuing 
non-redeemable, tradable shares that can be listed on the 
stock market, Fonterra would be able to minimize redemption 
risk.  However, that solution opens them up to the risk that 
 
WELLINGTON 00000847  004.2 OF 005 
 
 
the market could drive down the company's value. 
 
 
Wall Street Reaction 
-------------------- 
 
¶14.  Following the news of the planned restructure, Fitch 
Ratings announced it retained a negative outlook for the 
dairy giant and assigned its AA- (minus) credit rating. 
Standard & Poor's has reassessed Fonterra's rating and 
downgraded the outlook to a slightly negative, continuing the 
rating agencies' declining assessment of Fonterra begun a 
year ago based then on merger problems.  Fonterra wants to 
maintain the highest positive ratings, but the rating 
agencies said the risks created by the co-operative's new 
proposals have slightly weakened its positive profile.  In a 
worse case scenario in a share market arrangement, market 
analysts posit that farmer-suppliers could be "left in the 
cold," i.e., standing last in line of potential creditors to 
be paid.  Currently, the annual milk payments are Fonterra's 
single biggest business cost.  Under a revised capital 
restructure Fonterra would be able to raise capital to fund 
growth, rather than rely on debt, and would reduce redemption 
risk (more outside shareholders to hold risk).  A Fitch 
analyst warned that while the capital restructuring has 
credit-enhancing features, it also requires a restructuring 
of the milk supply arrangements - potentially leading to a 
significant diminution in Fonterra's financial flexibility. 
 
¶15.  According to newspaper reports, a listed Fonterra would 
be worth between NZ$8.6 (US$6.9) and NZ$10 billion (US $8 
billion), making it the largest company on the New Zealand 
stock market.  (The next largest company is Telecom valued at 
NZ$7.7 billion (US$6.15).)  Many in the industry expect the 
fair value share of Fonterra stocks owned by current 
shareholders to go down by approximately 35 percent because 
the cooperative's equity will be distributed - 15 percent to 
farmers and 20 percent to new investors. 
 
 
Initial Reaction by Dairy Farmers 
---------------------------------- 
 
¶16.  Despite the safeguards in the proposal and reassurances 
from Finance Minister Michael Cullen that Fonterra's plan 
would be in New Zealand's best interests, the initial 
reaction from farmers is mixed with most indicating that they 
need more information before they can make a decision.  How 
the milk transfer price between the co-op and the new company 
will be determined is a key concern as this will determine 
how much of the operational subsidiary's after costs revenue 
will be passed on to producers in the form of higher milk 
prices and how much will be passed on to investors in the 
form of higher profits.  The new board will be in the 
unenviable position of trying to balance the desires of 
farmers, who will want the highest possible milk price, and 
external investors, who will want the highest possible 
dividend.  Under the current system, virtually all of 
Fonterra's revenue is passed on to dairy producers in the 
form of higher milk prices. 
 
¶17.  A team in Fonterra is working on a system to calculate 
the milk transfer price and aims to put a proposal before 
farmers in the next couple of months.  Because there's no 
open market determined price for milk in New Zealand, coming 
up with a suitable mechanism that is transparent, competitive 
and fair will be tricky.  According to Fonterra, the new 
system will build on the approach used by Duff & Phelps, the 
company that calculates the fair value of Fonterra shares. 
Farmers will need to be convinced that this system protects 
their interests before they vote to approve the listing plan. 
 
 
 
WELLINGTON 00000847  005.2 OF 005 
 
 
¶18.    Another concern among Fonterra shareholders is the 
issue of non-farmer dominance and encroaching foreign direct 
investment.  While the scheme presented to stakeholders would 
have contractual and legislative safeguards to protect farmer 
control, along with New Zealand farmer majority ownership, 
many farmers are questioning whether these safeguards are 
adequate.  While the proposed governance structure is 
intended to ensure farmer concerns are addressed, many see an 
inherent conflict of interest in the way boards are set up. 
Others have expressed concern that the co-op will still be 
exposed to significant redemption risk and capital management 
issues, which, in the minds of some could lead to a sell off 
of shares and increased external control, especially if there 
is a drop in the milk pay out price.  (Note: If the milk pay 
out price drops and there is a loss of supply, the co-op 
would potentially be forced to sell shares to fund the 
farmers exiting the system. End note.) Another frequently 
heard complaint is that the Fonterra announcement was "big on 
spin" but "short on hard facts." 
 
¶19. Comment: Fonterra's IPO, if successful, will have a major 
impact on the New Zealand economy but its impact on the 
global dairy market is not expected to be that significant. 
The success of the Fonterra IPO proposal depends largely on 
New Zealand milk producers being persuaded that Fonterra's 
"behind the borders" approach is the appropriate way forward 
and that their search for capital should extend to the 
riskier equity market. In the minds of many analysts, access 
to the capital markets through an IPO to expand Fonterra's 
overseas markets and maintaining exclusive domestic control 
of Fonterra are two mutually exclusive propositions.  The 
interests of NZ dairy producers may ultimately be at odds 
with outside (international) shareholders.  Throughout the 
early planning stages of the IPO proposal, New Zealand 
government officials from the Ministry of Agriculture and 
Forestry along with the Treasury had been in close 
consultations with Fonterra's Board in order to ensure 
national interests were adequately considered.  New Zealand 
dairy farmers are yet to be convinced that the plan is in 
their interest. 
McCormick