The Shoeshine Column: Transtasman milk move may sour dairy merger

Friday 8th September 2000

Australians don't usually greet Kiwi incursions with much enthusiasm. So when West-
ern Australian farmers this week welcomed Kiwi Co-operative Dairies as a "white knight" it was an indicator of the mess the $9.4 billion Australian dairy industry finds itself in.

Kiwi has shelled out a little over $A200 million ($269 million) for a 51.6% stake in Peters & Brownes, Australia's fourth-largest, fast-moving consumer dairy products company and the owner of our very own Tip Top.

Kiwi bought out Peters & Brownes' institutional shareholders and has an agreement to take its stake to around 76% by buying shares held by Peters & Brownes managing director Graham Laitt. That might not happen quickly as a court battle between Laitt and ex-business partner Gad Raveh over control of the shares is not expected to be resolved until late next year.

With a controlling stake, however, Kiwi is free to pursue its plan to merge Peters & Brownes with its 83%-owned Mainland Products to form a transtasman consumer foods company. It says it has identified synergies from combining the two companies' chilled and frozen product distribution networks.

The move comes hot on the heels of the deregulation of the Australian industry on July 1. Dairy companies and their farmer suppliers are already feeling the effects deep in their pockets - returns, according to some Western Australian farmers, have already fallen below economic levels and there is talk the entire local sector could go bust.

Not helping is a price war between supermarket groups Woolworths and Coles Myer. Woolworths has been renegotiating supply contracts nationwide and has slashed milk prices by a quarter.

Peters & Brownes' supplier farmers see Kiwi as a partner with sufficient clout to expand the Western Australian industry's manufacturing base and to support the company's export ambitions, particularly in Asia. Peters & Brownes will boost Kiwi's turnover to $3.5 billion and the P&B/Mainland entity will be worth around $1.3 billion.

Another likely beneficiary of the Australian industry's disarray is the New Zealand Dairy Board.

Over on Australia's east coast things aren't looking any healthier than in Western Australia.

This week listed company National Foods and co-operative Dairy Farmers, formerly bitter enemies, announced they were talking about a merger.

National Foods' share price has fallen 37% in a month as milk prices plunged. Woolworths has again been blamed. A round of tenders saw National lose the Victorian and Queensland contracts to Dairy Farmers and it had to cut its price to keep New South Wales.

Enter the New Zealand Dairy Board which is negotiating to buy 25% of Bonlac Foods and to set up a joint- venture Australian consumer products operation.

Bonlac, with total assets of $A965 million ($1.3 billion), is showing profits on the bottom line but has been spewing cash. Last year its net operating cash outflow was $A27.3 million, an improvement on the previous year's $A74.1 million deficit.

Waiting in the wings is the third of New Zealand's terrible trio, New Zealand Dairy Group. It has been pouring money into local processing but has put on hold any expansion across the Tasman.

Many a local dairy farmer will see a fierce irony in our companies wading into the Australian industry. Farmers here have strongly resisted calls by politicians and economists of the right to deregulate the industry in the name of allocative efficiency.

The industry's answer has to date been the failed "Mergeco" merger of Kiwi, Dairy Group and the Dairy Board.

The three claim some sort of deal is still possible but will take another year or two to sort out. The last one fell apart mainly because Kiwi and Dairy Group couldn't agree on approaches to "marginal milk" issues (farmers producing ever more milk) and how the industry's assets would be split between their farmer-owner groups.

What's happening in Australia at both the industry and the corporate levels will have major implications for how things develop here.

In the Armageddon scenario, deregulation could send a heap of dairy farmers out of business and leave most of the upstream industry in foreign hands. If that happens it will rule out any further politically imposed reform of the New Zealand industry.

The Mergeco plan was strongly supported by farmers, whose main concern was to preserve the industry's co-operative structure and co-ordinated marketing. In particular they feared the "weak seller" scenario in which New Zealand companies competing against each other for the same foreign customers cut each others' prices to the bone.

But Kiwi's Peters & Brownes buy-in suggests it is looking for other trees to bark up. Until now no New Zealand dairy processor has owned overseas capacity. And the Dairy Board has acted by statute as sole export marketer of our value-added milk products.

With a merged Mainland/Peters & Brownes that changes. Kiwi will be able to market products in competition with the Dairy Board in Australia and beyond. It is moving, potentially at least, down the path of Nestle, Kraft, and Italy's Parmalat, dairy giants that sell worldwide branded products made from milk produced in the country of sale.

And one of the value allocation problems the original merger plan foundered on was Kiwi's investment in Mainland, itself an unusual move among co-operatives. Peters & Brownes supplies an even more intractable issue.

Shoeshine would not be so impertinent as to question Kiwi's commitment to finding a co-operative solution to the industry's worries. But it sure looks as if it's keeping its options open.

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