Can Murray Goulburn's aspirations mature?

With Warrnambool Cheese and Butter’s directors urging their shareholders to accept the Saputo offer, there is a sense of a clock ticking loudly in the Murray Goulburn boardroom if it wants to stay in the takeover game.

With frenzied bidding by the three suits already pushing WCB’s value above $500 million (and the knowledge that the protracted timetable for competition policy approval leaves it at a significant disadvantage to Saputo), Murray Goulburn knows that it would need to materially over-bid the Canadians if it is to convince WCB shareholders to hang on for its offer.

As Saputo is at $9 a share, that probably means Murray Goulburn will have to contemplate something closer to $10 a share – adding another $56 million to its existing $9 a share offer – if it is to persuade the WCB to withdraw its recommendation of the offer from the bidder it clearly prefers.

While there has been speculation that Murray Goulburn will announce plans for an historic raising of external capital to help it fund its ambitions – and it may well do so on Friday – the complexity of creating access to external capital within a co-operative structure and the need to both explain and sell the concept to its existing farmer members means the new capital structure probably won’t be in place in time to fund a revised bid.

That suggests that while Murray Goulburn may well announce its plans to raise capital shortly, it will probably have to rely on its so-far supportive bank lenders to fund an increase in the bid, presumably with the comfort that Murray Goulburn will endeavour to create the new capital structure and pay down the debt as quickly as possible. At least in today’s environment the cost of debt is cheap, which may also underpin the economics of the Saputo offer.

Murray Goulburn has been working on plans for raising equity for some time. The obvious model is the one New Zealand’s Fonterra created last year when it listed a unit trust. The units have the same economic interest as the shares held by its farmers, but don’t carry the voting rights attributable to the shares.

The Fonterra scheme was designed not just to get access to external capital, but to create an ability for its farmer shareholders to trade their shares (or the economic interests underlying the shares) at arms’ length from its own balance sheet. It gives the farmers an opportunity to generate and extract capital for their own purposes without relinquishing their voting rights and control of the giant co-operative.

Under Gary Helou, Murray Goulburn, traditionally regarded as the conservative giant of the Australian dairy sector, has been galvanised, stripping about $100 million a year out of its cost base and investing aggressively in new processing facilities, including the $120 million investment in milk processing plants to support an agreement it struck this year to supply milk to Coles.

The bid for WCB is an important component of Helou’s ambition of positioning Murray Goulburn to take far greater advantage of the boom in dairy consumption occurring within Asia. It would bring together the two companies’ processing facilities, milk pools and distribution systems in western Victoria, the most productive dairy region in the country. There would be considerable synergies and optionality created by their combination.

At the weekend, Helou provided the context for the intense three-cornered contest between Murray Goulburn, Saputo and Bega Cheese for control of WCB.

He told the ABC’s Inside Business program that the markets within Asia for dairy products were growing at 7 or 8  per cent  year but the capacity to supply those markets was growing at only 2 or 3 per cent. Growth in supply capacity had been zero last year and was expected to be only about 2 per cent this year.

With the Asian economies unable to produce sufficient dairy products to close the gap between supply and demand in a market that is 10 times larger today than it was a decade ago, he expected that gap to widen even further in future.

Given that macro backdrop, the opportunity for Australian dairy is stark and compelling with a potentially massive payoff for those who can take advantage of it. However, with a declining share of dairy export markets and declining volumes it is an opportunity that could be missed.

WCB, as one of the two listed dairy businesses and the one with existing export capacity, is central to any attempt to create a better platform for Australian dairy exports. This is something that has been recognised and capitalised into offers by all three bidders. Bega, sitting on an offer for WCB that is uncompetitive and which has been declared final, would be a second and somewhat less strategic prize.

WCB’s directors have been telling their shareholders that, if they accept the Saputo bid, they will receive their $9 a share of cash within five business days of it becoming unconditional, which they expect to occur on 28 November.

That’s an unusual position to take, given the potential for the bidding to continue and the very real prospect that Murray Goulburn will have another (higher) offer on the table within days.

With about 46 per cent of WCB held by three strategic shareholders – Bega, Murray Goulburn and Japan’s Kirin – there is potentially a long way to go in the tussle for control of WCB. It is probably in the shareholders’ interests at present to regard the Saputo offer as a free option while they wait to see how the saga unfolds.