July 8, 2008

Collision of History and Reality


IN SEPTEMBER, when shareholders in Silver Fern Farms vote on whether to sell half their company for $220 million, the money may not be the deciding factor.

Equally important, or perhaps more so, will be the character of the people they are being asked to do business with. "Farmers are a funny lot," one shareholder told the Star-Times. "If they think a person's being a bit smart, s---, they'll cut them off at the knees."

Just as well, then, that the deal is being put forward by Craig Norgate and Baird McConnon of PGG Wrightson, whose mana in the agri- business world is considerable.

Their proposal involves buying into a co-operative owned by lamb and beef farmers since 1948, a history its 9000 shareholders value highly.

This was one South Island farmer's initial reaction: "I know things have their times and spans, but co-operatives are farmer- owned. All of a sudden in the last two years the farmer-owned part's been totally forgotten about. They are selling the family jewels.

"They've then got to build credibility with their suppliers - not everybody's going to want to kill with Craig Norgate and (Silver Fern Farms). There's people out there been burnt through all the mergers and they say 'to hell with them, we'll deal with somewhere else'."

Clearly, achieving the 75% shareholder support the deal requires will be no pushover.

But while farmers may be reluctant to change their co-operative tradition, other factors may force change upon them. The meat industry has suffered from poor returns for the past three years in a row as overcapacity in processing plants combined with a weak market position and a volatile currency.

Figures from Meat & Wool NZ show average farm profit declining from $73,265 in 2004/05 to $36,475 in 2006/07, in real terms. Over the same period, Silver Fern has become increasingly indebted, and last year adverse currency movements led to a breach of covenants on its interest cover ratio on debt of some $500m.

To make matters worse, strong dairy returns are encouraging farmers to switch to dairying, if they can. Between 1990 and 2007, pastoral land area devoted to sheep and beef farming fell by 23%, while land devoted to dairying rose 44%.

Norgate has been laying it on the line for farmers. "There's just so much of that South Island finishing country that's going to dairying. If farmers keep voting with their feet they won't have an industry left."

But while Fonterra farmers are strongly committed to supplying their own co-op, investing serious cash for the right to supply their milk, Silver Fern farmers are not so incentivised. Buying shares in the Dunedin-based co-op does not require a large upfront investment and many farmers supply whichever processor offers the best price on the day. Silver Fern's particular rival for South Island supply is Invercargill-based Alliance, and the two processors have many shareholders in common.

This year, sources say, Alliance plants were particularly busy as Silver Fern suppliers switched their business, worried that Silver Fern's debt burden would become unbearable.

Hence the meat industry has made strenuous efforts to find a way to improve their collective lot, but to no avail until PGG Wrightson offered a way forward.

Silver Fern chief executive Keith Cooper said the previous idea did not address the fundamental problems.

"All it was, was a concept of bringing a whole lot of people together, it didn't have any strategy around it. It was bringing a whole lot of processing effectiveness under one hat," he said.

"That's fine. (But) we contended at the time it didn't have a great deal of vision or strategy around doing things differently inside the farm gate, nor did it have any strategy around marketing product in a true marketing sense."

The broad outline of the PGG Wrightson deal is to rid the industry of its supplier-driven process, in which production is determined by when the grass grows rather than what the customer wants. How that is to be achieved is not yet clear, and farmers will need a lot of convincing if part of the plan is to supply stock through the winter.

Such details will be part of farmer concerns as they listen to roadshow presentations from Cooper, Norgate and McConnon, along with their senior colleagues in the two companies.

On the financial side, their interest is likely to fall on whether the $220m PGG Wrightson is paying is enough, and whether the price they get for their stock is likely to improve.

The market itself is already on their side. Lamb prices at around $75 for a YX grade carcass are up from $57 a year ago and world food demand is rising.

But farmers want to see some certainty after their years of struggle.

"The thing is there's nothing out there to say we're going to get $6 a kg for lamb is there?" said one farmer. "And if we don't get there, we're not going to have a lamb industry."

Cooper acknowledges the difficulty in predicting better returns at the farm gate.

"We're certainly indicating to people that lambs are going to be $70 this coming season - that's significantly up on last, that's before any currency depreciation as well, and that's before the market fully comprehends the lesser volume coming out of New Zealand next season.

"But we can't just have a blue sky approach to value because there's no point in saying we're going to get $5 (a kg) when the market won't pay it. We've got to make sure we get lamb, beef and venison, for that matter, positioned relative to other choices the consumer has.

"That said, we've got a fairly strong view that the world's short of protein, demand's increasing, so it's a pretty bright future for demand for protein globally."

The extent farmers take advantage of that trend may well depend on whether Silver Fern shareholders vote for the PGG Wrightson deal, and sources say the big benefits of that will emerge only if other meat companies, particularly Alliance, join the fold.

"What (Norgate) is trying to do is really squeezing Alliance," said one market source. "I know there's stuff there about marketing, but this deal is really about industry rationalisation."

Regardless of what gets decided at the top level however, if the deal starts to show real benefits for farmers, the impetus may be unstoppable.

After attending a roadshow meeting in Otago, a shareholder said: "I was disappointed they didn't promote the fact this company is going to be so attractive to suppliers."

If the growth turns out as good as it could be, he said, "they are not going to need Alliance". THE NEGOTIATORS * CRAIG NORGATE, born in Hawera, educated Massey University, became chief executive of Kiwi Co-op Dairies in 1996.

* BAIRD McCONNON, 58, born in Pukekohe, Auckland, and with brother Alan turned Dunedin-based family business Mainland Products into iconic dairy company with annual turnover of $650m.

* Kiwi Co-op under Norgate took an 83% stake in Mainland in the late 90s. Kiwi then became part of the merger which created Fonterra and which, again under Norgate, bought the rest of Mainland in 2002.

* After being ousted from Fonterra in 2003, Norgate set up Rural Portfolio Investments (RPI) with McConnon as a joint venture to invest in agri-business.

* RPI took over listed agri-business Wrightson in 2004, which bought Williams & Kettle in 2005, ousting Fonterra interests in both companies in the process.

* Wrightson merged with Pyne Gould Guinness in 2005 to create PGG Wrightson, which is owned 30% by RPI. Norgate is chairman of PGG Wrightson, McConnon a director, and the company a dominant market player.

* Norgate and McConnon have together driven the rural servicing sector's biggest restructure in its history. Norgate brings to the partnership a raw brawn and innate corporate cunning, McConnon a quieter shrewdness and eye for opportunity.


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