Report Highlights

New Zealand's dairy exports reached a record in Marketing Year (MY) 2006/07 (June 1-May 31) on both a value and a volume basis. Fonterra Co-operative Ltd, New Zealand's leading dairy cooperative with a 95% share of exports and the country's largest company, announced a milk price payout to farmers of $6.40/kg of milk solids (U.S.$ 5.12/kg milk solids), a 43.5% increase over last years payout. New Zealand is expected to see a significant production response to the increased payout, estimated at between 4 and 6% during MY 2008/09, followed by a further estimated increase of 3-5% in MY 2009/10.

Executive Summary

Spurred by a 2.6% increase in milk supply during Marketing Year (MY) 2006/07 (June 1-May 31) and a draw down of accumulated inventories, New Zealand's dairy exports reached a record in MY 2006/07 on both a value and a volume basis. The coming year promises to be another record breaker on a value basis, while export volumes are expected to register just below last year's record setting level.

New Zealand's dairy product export destinations, while fairly constant over the past three or four years, have changed dramatically over the past 20 years. In the past, New Zealand's primary markets were the United States and Europe. While these markets are still important, New Zealand is increasingly diversifying its exports markets and expanding dairy product exports to Asia, Australia and the Middle East.

Fonterra Co-operative Ltd, New Zealand's leading dairy cooperative with a 95% share of exports and the country's largest company, announced a milk price payout to farmers of $6.40/kg of milk solids (U.S.$ 5.12/kg milk solids), a 43.5% increase over last years payout. New Zealand will likely have a significant production increase in response to the increased payout, estimated between 4 and 6%, during MY 2008/09, followed by a further 3 to 5% increase in MY 2009/10.

Over the longer term, growth in New Zealand milk production is expected to stabilize at between 1.5% and 3% per year. There are a number of factors tempering production including the ability of producers to manage costs. Each time the milk payout price increases, farmers tend to respond by increasing expenditure on inputs to achieve increased milk output. This, combined with significant land price appreciation, has negatively impacted on returns to capital and brings into question the ability of New Zealand to continue its status as a low cost dairy producer.

Additional factors impacting on growth include a shortage of staff, limited availability of suitable land, the significant capital costs associated with entry into dairying, and a growing public awareness of the environmental impacts of dairy production, which has translated into increased pressure to regulate water quality and greenhouse gas emissions. In fact, the New Zealand Government is in the process of implementing far reaching climate change policies that are expected to impact on the agricultural sector in 2013 and will likely increase the cost of production. (In New Zealand, it is commonly estimated that 49% of green house gas emissions are attributable to agriculture.)

Fonterra Co-operative Ltd, New Zealand's largest company, announced on November 15 that it wants to split into a milk-supply cooperative and an operational subsidiary. If approved by shareholders, the subsidiary will be listed on the stock exchange in 2010 and external investors could purchase up to 20% of the shares, which would enable Fonterra to raise capital through outside investors for expansion of overseas investments, primarily in China, Asia and South America. Fifteen percent of shares would be provided to existing farmer shareholders and the remaining 65% would be held by the co-op. Fonterra controls nearly 40% of the global trade in dairy exports, and its 2007 assets of NZ $12.6 billion (US $10.1) and revenue of NZ $13.9 billion (US $11.12) mean it would dwarf the currently largest listed company on the New Zealand Stock Exchange - Telecom. While the investment community has responded positively to the plan, the initial reaction of farmer shareholders is mixed.

Production

Milk Supply Trends 2007/08 and 2008/09 years

Post forecasts New Zealand milk production to expand 1.5% during MY 2007/08 but increase more sharply the following season. While production is expanding due to high milk prices, the limited availability of cows, combined with climatic and other factors, has tempered the supply response in New Zealand for the current year. Throughout New Zealand, the calving pattern was more spread out than usual, which limits average cow lactation lengths. In addition, October was cold and windy, which decreased the lactation peak. A forecast dry summer for the Southern North Island and South Island will make it difficult for farmers to significantly increase production, even with considerable supplemental feed inputs (grass and maize silage, cereal grains, and palm kernel extract).

Next year will be a different story. Post forecasts production to increase by between 4% and 6% during MY 2008/09 due to the on-going increase in the number of dairy farms and because producers will have had time to respond to higher prices, especially in terms of bringing more cows on line, improving farm pasture management and levels, and securing higher quantities of supplementary feed supplies.

Cow numbers are expected to be up by approximately 100,000 head in MY 2008/09, a 2.4% increase. The increase in cow numbers alone would result in a 2.5% to 3% increase in milk supply. Farmers are also investing in extra feed for their cows to improve their condition, which will pay off during the 2008/09 season and help maximize production. The increased use of supplements this season will allow farmers adequate time to set up their dairy farm pastures for the spring of 2008 and secure supplemental feed supplies as part of an overall effort to expand production to take advantage of the high payout prices for milk.

The on-going surge in conversions to dairy farms will increase milk production during MY 2008/09. During the 2007/08 season, 70 farms were converted to dairy production, down from 85 the previous year. Because the conversion process takes about 12 months, and the sharply increased price signals didn't start filtering through to farmers until April or May of 2007, the wave of new conversions isn't expected to come on stream until 2008 and 2009. Sources estimate that up to 150 or even 200 farms are beginning the conversion process. However, the scarcity of cows, the lack of contractors to build dairy sheds, the limited availability of labor, and other factors will likely limit conversions to between 100 and 130 actually coming on line in the next 12 months. An additional 100 to 120 farms are expected to commence production in 2009. On the flip side, New Zealand loses approximately 150 to 200 small dairy farms each year due to retirement or other factors.

During MY 2009/10, post expects milk supply to increase between 3% and 5%. Record high world dairy prices and the relatively poor profitability of other livestock sectors in New Zealand will help drive this expected growth. Because of the high degree of reliance on exports and lack of domestic subsidies, the New Zealand dairy industry is heavily exposed to global market conditions. Even if dairy prices mediate, an expected downturn in the value of the New Zealand dollar, which reached record highs in 2007, would likely sustain high milk prices for New Zealand dairy farmers.

Milk Supply Trends over the Longer Term

Over the long term, post expects New Zealand dairy industry to sustain annual milk production increases of between 1.5% and 3%. Over the last nine years, milk supply has expanded, on average, 4% per year. (Source: LIC Ltd) However, in recent years, the average growth rate has fallen below 2%.

The on-going surge in dairy conversions has helped New Zealand producers achieve economies of scale and the attendant technological advances and management efficiencies bode well for future productivity. Dairy producers will also continue to benefit from Fonterra's continued expenditures on research and development and a recent industry refocus of its science funding and extension work. (Dairy Insight, an industry commodity organization that raises funds through producer levies and funds research, has merged with Dexcel, the primary research and extension provider for dairy farmers.)

Factors tempering growth over the long term include the ability of producers to manage costs. In New Zealand, each time milk prices increase, farmers tend to respond by increasing expenditure on inputs to achieve increased milk output. This, combined with significant land price appreciation, has negatively impacted on returns to capital and brings into question the ability of New Zealand to continue its status as a low cost dairy producer.

Additional factors impacting on growth include a shortage of staff, limited availability of suitable land, the significant capital costs associated with entry into dairying, which discourages new entrants, and a growing public awareness of the environmental impacts of dairy production, which has translated into increased pressure to regulate water quality and greenhouse gas emissions. (In New Zealand, it is commonly estimated that 49% of green house gas emissions are attributable to agriculture.)

New Zealand has one of the most comprehensive and restrictive biotechnology regulatory regimes in the world and many recent newspaper articles have questioned whether or not this is disadvantaging the New Zealand agricultural sector because of the inability of the sector to avail itself to the benefit of biotechnology, including GM technology.

Note on Seasonal Nature of Dairy Production in New Zealand

Dairy cows in New Zealand are fed principally on pasture. Typically, most cows spend their entire lives outdoors without access to covered housing. They walk to and from their paddocks to the farm dairy once or twice a day to be milked. Pasture growth rates follow a seasonal pattern with a spring/early summer peak and a winter trough. In order to maximize the conversion of pasture to milk, farmers mostly calve their entire herd in as short as possible time span in the spring so their cows' lactation peaks occur when pasture growth rates are peaking. As winter approaches the cows are generally dried off and are not milked during the winter. Supplementary feed (maize silage, cereal grain, vegetable by-products etc) is generally only fed to top up pasture deficits.

Consumption

Domestic consumption is forecast to remain stable through 2007/08 and 2008/09.

Under its marketing and production strategy, Fonterra is treating Australia and New Zealand as one domestic market. Fonterra is working to establish a strong domestic presence in this reasonably homogeneous market of approximately 22 million people (4 million New Zealanders and 18 million Australians), partly as a platform to launch its global marketing effort. To this end, Fonterra has purchased outright control of Bonlac, a significant Australian milk processor and marketer, and is working to achieve control of a significant proportion of milk processing in Australia.

Under the New Zealand Government's Dairy Industry Restructuring Act, which made way for the formation of Fonterra, Fonterra is obligated to supply up to 400 million liters of milk (potentially increasing to 500 million liters over the next twelve months) to other milk processors in order to prevent anti-competitive practices within New Zealand. There will be a review of the act over the next twelve months. Fonterra contends that the pricing mechanism and the actual milk supply mechanism severely disadvantages it and provides an inexpensive means for competing smaller processors to keep processing plants running efficiently for virtually twelve months out of the year.

Stocks

While there are several dairy product exporters in New Zealand, Fonterra processes approximately 95% of the country's milk supply, which means that Fonterra's inventories are representative for the whole of New Zealand. The Fonterra board reportedly made a conscious decision approximately two years ago to build inventories up. However, once world prices started moving up, Fonterra brought down its inventories. As of October 2007, virtually no stocks are being carried forward.

Trade

Whole Milk Powder Exports (WMP)

Whole milk powder production is the most feasible way for a large processing company like Fonterra to handle the seasonal nature of milk production from New Zealand's dairy farmers who mostly calve their cows in spring and milk them through until early Autumn, after which, they are typically dried off during the winter. This enables processors to take advantage of the seasonal nature of pasture production, which peaks in late spring/early summer and drops to a minimum in winter. However, this also means processors must cope with massive inflows of milk for two months of the year and then milk flow easing and virtually ceasing for six to eight weeks in the winter.

Whole milk powder exports from New Zealand have expanded at an average annual rate of 7.3% since 1992. (Milk production has grown at an average annual rate of 4% over the last nine years.) The growth in whole milk powder reflects increased world demand for dairy proteins. From 2003 to 2005, stocks of whole milk powder were built up in New Zealand but were sold down in 2006 and 2007 to a point where they are now virtually depleted.

Post predicts that New Zealand's exports of whole milk powder in 2007/08 will expand by 2.2% over the previous year in response to strong world demand.

Skim Milk Powder Exports (SMP)

Exports of skim milk powder have grown at the average annual rate of 7.0% since 1992. In view of the stock drawn down, combined with production constraints, post predicts exports to fall slightly this year but forecasts production to continue upward in line with long-term trends.

Cheese Exports

Over the past 15 years, New Zealand cheese exports have grown at an average annual rate of 6.6%. While post forecasts New Zealand cheese production to increase 6.8% in 2007/08, exports are forecast to fall by 1.3%. This is in contrast to a 16% increase in exports the previous year. The forecast decline is primarily attributable to limited stock levels. While stocks were trending upward and reached 20,000 tons above historical levels in 2005/06, they have been drawn down significantly since then.

Butter Exports

Butter exports, over the past eleven years, have been growing at an average annual rate of 2.2%. In MY 2006/07, exports jumped 19% over the previous year, due primarily to increased production, which grew an estimated 7.4% over the previous year, combined with a draw down of stocks held over from the previous year. Post expects production in MY 2007/08 to stabilize into line with long term trends. Limited stocks suggest exports will likely drop by approximately 10% in MY 2007/08. Fat taken out of Protein type products but not used in butter production can be broken down into its constituents and sold as ingredients (such as lipids)

Whey Exports

Whey, which is basically a by-product of cheese production, encompasses very valuable proteins that are ingredients in many products. Post estimates that exports will increase in 2007/08 by 3,000 tons, or 18% - the same as the previous year.

Casein Exports

The volume of casein exported in MY 2006/07 was actually lower than in MY 2001/02. Casein manufacture requires dedicated processing facilities and these have not been expanded in the last few years. Casein prices have improved over the last few months so, as milk volumes grow, casein manufacture could potentially expand.

Current Export Trends

New Zealand dairy exports reached a record in MY 2006/07, on both a volume and value basis. Post forecasts total dairy exports for MY 2007/08 on the order of 2.02 to 2.05 million tons (this estimate includes products not in the PS&D), just down from the record set in MY 2006/07, largely due to lower stock levels.

Major New Zealand dairy exports include milk powder, cheese, butter and casein. Of these four, on a volume basis, milk powder is growing the fastest reaching nearly 998,000 tons in 2007 (June 1-May 31 year) - a growth trend of 4% per year over the last six years. On a volume basis, cheese exports were up a meager 0.5% per year during the same period. However, on a value basis, cheese exports have been growing at an average of 8% per year reflecting an increase in world cheese prices.



Butter has held its own with export volumes increasing at an average rate of 1.8% per year between MY 2001/02 and MY 2006/07 (about the same as the rate of increase of milk supply). However, on a value basis, butter exports have increased an average annual rate of 9.7% over the past six years. While casein exports have dropped off considerably in recent years, they recovered somewhat in MY 2006/07. Casein prices have risen dramatically over the last few months so it is likely exports will recover.

Among the more minor export categories, there are some big movers in volume terms with whey and other products now rivaling casein in terms of both volume and value. All the minor export product categories - whey & other, yogurt products, liquid milk, and lactose products - recorded double digit rates of export growth (over the last six years) on a value basis. Other Products include milk protein concentrates. Of the 106,559 tonnes exported in My2007 (up from 57,683T MY 2005) approx 53,000T went to USA and 94% of this is milk protein concentrate.



Longer Term Export Trends/Mix of Products

Over the past several years, the volume of protein product exports has increased slightly faster than butter and cheese. The primary reasons for this are the price advantage for protein products and the suitability of whole milk powder as a product as it is the most feasible way of dealing with the seasonal peaks in milk supply experienced in New Zealand.

The mix of each of the New Zealand dairy product exports, as a proportion of total exports, tend to fluctuate within a fairy narrow band. This trend is expected to continue.

Fonterra predicts world-wide demand for dairy products to increase between 2.5% to 2.7% per annum with the bulk of the demand growth in liquid milk products. To leverage this demand, Fonterra is setting up joint ventures in target countries, including China. China is already New Zealand's fourth largest export destination for dairy products on both a value and volume basis. Fonterra has a 43% share in San Lu, a domestic milk processor and marketer. The joint venture is developing a demonstration farm using New Zealand production methods. More importantly, the joint venture will be used to market Fonterra's premium branded products into China. Currently, the New Zealand Government is in the process of negotiating a free trade agreement with China, which will likely improve Fonterra's access to the Chinese market.

New Zealand's dairy product export destinations, while fairly constant over the past three or four years, have changed dramatically over the past 20 years. In the past, New Zealand's primary markets were the United States and Europe. While these markets are still important, increasingly, New Zealand is diversifying its exports markets and expanding dairy product exports to Asia, Australia and the Middle East. The "other" category in the table below now includes approximately 180 countries.

Government Policy

Dairy Industry Restructuring Act (DIRA)

DIRA was enacted in 2001 when Fonterra was formed. It addressed both external factors impacting on the New Zealand dairy industry, such as export country quota management, as well as domestic issues such as the potential for anti-competitive practices. (See the 2006 New Zealand Dairy and Products GAIN6020 report for additional information including export quotas managed under the act and the timetable by which Fonterra's sole licenses to these quotas will expire.)

The license to the EU butter (77,000 tons) and cheese quota (11,000 tons) expires at the rate of 25% of the total volume per year beginning Dec 31, 2007. An amendment bill to the act, which is currently before the New Zealand Parliament, will re-allocate the license to processors based on the proportion of total milk supply a processor collects from farmers. The licenses will be re-allocated on a periodic basis. On this basis Fonterra will have 95% of the quota, Westland 3%, and Tatua approximately 1%.

It is likely that other export quotas will be handled in the same way except where the Ministry of Agriculture (MAF) decides that it would beneficial to deregulate the quota management entirely, which may happen for parts of the U.S. cheese quota. Fonterra's sole rights to these quotas expire in December 2008 and December 2009.

Climate Change and Greenhouse Gas Emissions

The New Zealand Government announced a suite of measures in September 2007 aimed at halting the increase and ultimately lowering New Zealand's greenhouse gas emissions. The basis of the program is a nationwide, all sector emissions trading scheme (ETS). Under the scheme, there will be limits set on the level of greenhouse gases that each sector can emit. Agriculture will have its emissions monitored as of 2012, and will be fully brought into the ETS in 2013.

Agriculture contributes approximately 49% of New Zealand's total greenhouse gas emissions. This is a growing area of concern, especially for the New Zealand dairy sector. According to AgResearch, a crown research institute, the on-going intensification of the New Zealand dairy sector has resulted in a decline in energy and greenhouse gas efficiency. It is estimated that 70-85% of the carbon footprint of dairy production in New Zealand is directly attributable to the on-farm stage of production while only 2-3% comes from transportation.

No Government Subsidies to Producers

The Government does not provide subsidies for milk to farmers in New Zealand. However, the Government does fund research and other activities in all sectors, but at a level lower than virtually all other OECD countries. The Government also funds trade access initiatives to open markets overseas.

Other

Fonterra Capital Restructure

On November 15, 2007, Fonterra, the largest company in New Zealand and the world's fifth largest dairy company by revenue, presented six options for a fundamental capital restructuring for shareholders to consider, including a preferred option that would retain the cooperative structure while offering shares on the stock market.

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 subsidiary. The second vote, which will probably be around May 2010, will determine whether to let Fonterra list on the stock exchange and introduce external capital. In both ballots, 75% of shareholders must vote to approve the measures.

Reason for IPO

Fonterra wants to change its capital profile to address three sets of pressures on its current structure - the need to provide a secure and expanding capital base to implement its growth strategy, redemption risk, and more flexible investment choices for farmers. Of the six options presented to shareholders by the Fonterra Board, the preferred option was the only one that would achieve all three goals. 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 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."

Pre-Conditions Required Before a Fonterra Listing on the Stock Market

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 - The Process, The Structure, The Safeguards

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 an operational subsidiary with manufacturing and marketing responsibility; and a milk pricing system that sets the price for transferring milk from the co-op, which will collect the milk from farmers, to the operational subsidiary, which will produce and market the milk products. 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 per cent 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.

Under the preferred option, the operational subsidiary will own the assets, liabilities and operations of the existing co-op. The co-op will retain a 65 per cent stake, 15 per cent will go to farmers, and an additional 20 per cent will be issued to external shareholders. Farmers will have the option of selling their shares on the stock market or keeping them.

The preferred option includes contractual, constitutional and legislative safeguards to help ensure New Zealand farmer majority ownership and New Zealand control. These include:

• The operational subsidiary 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.
  
• 50.1 per cent of shares must be held exclusively by New Zealanders.
  
• The co-op will not be able to own less than 50.1 per cent without a 75 per cent approval vote.
  
• The minimum co-op stake will be 35 per cent.
  
• 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 subsidiary, 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

Of all of the options considered, the preferred option reportedly best ensures that Fonterra would be able to raise capital at a competitive cost. It is estimated that NZ $2 to 3 billion (US $1.8 to 2.4) 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 using locally-produced milk. In New Zealand, this strategy is commonly referred to as a "behind the borders" approach.

The preferred option also enables Fonterra to address redemption risk, which is significant. Producers 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.

Wall St. Reaction

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 negative, continuing the rating agencies' declining assessment of Fonterra begun a year ago. Fonterra wants to maintain highest positive ratings, but the rating agencies said the co-operative's business and financial risk profiles have weakened. Fonterra's debt is ranked so its shareholder farmer-suppliers are last in any potential line of creditors. The annual milk payments are Fonterra's single biggest business cost. A revised capital restructure would enable Fonterra to raise capital to fund growth, rather than rely on debt, and would reduce redemption risk if the amount of milk supplied decreased significantly. A Fitch analyst warned that while the capital restructure 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.

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 per cent because the cooperative's equity will be distributed - 15 per cent to farmers and 20 per cent to new investors.

Initial Reaction by Dairy Farmers

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 operational subsidiary will be determined is a key factor as this will determine how much of the operational subsidiary's revenue, after costs, 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.

A team in Fonterra is working on a system to calculate the milk transfer price and aims to put a proposal in front of farmers in the next couple of months. Because there's no market 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.

Another concern among Fonterra shareholders is the issue of non-farmer dominance and encroaching foreign direct investment. While the preferred option put forward to stakeholders has contractual, constitutional and legislative safeguards to protect farmer control and 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 investment, especially if there is a drop in the milk pay out price. (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.) Another frequently heard complaint is that the Fonterra announcement was "big on spin" but "short on hard facts".

New Entrants into the Processing Sector

Over the last year, two more new entrants have entered the industry. A $100 million plant, built in South Canterbury by New Zealand Dairies Ltd, is now processing milk. In addition, Dairy Trust, an offshoot of the meat coy AFFCO and the Talley family interests, has taken over Open Country Cheese and plans to build up to four processing plants near the sites of existing AFFCO meat processing plants. Both these processors will source milk from contract suppliers and from Fonterra.

January 2008

Further Reading

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List of Articles in this series

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December 2007