Dairy sector takes the cream in a Murray Goulburn bid

Murray Goulburn's synergies and co-operative structure could channel incentives to expand production back to farmer suppliers. Its bid could be a boon for the dairy sector.

One of the curious aspects of the Australian Competition and Consumer Commission’s submission to the Australian Competition Tribunal’s assessment of Murray Goulburn’s bid for Warrnambool Cheese and Butter is how narrow and conventional its approach is.

The tribunal will authorise (or reject) the Murray Goulburn bid after assessing the perceived public benefits and detriments and determining whether there is a ‘net public benefit’ from the proposed acquisition.

The ACCC submission is in keeping with the traditional ‘statement of issues’ that it produces in relation to proposed mergers or acquisitions that pursue the conventional competition policy approval process. Under this process, the ACCC has the authority to approve or oppose a transaction.

Murray Goulburn bypassed that process by going straight to the tribunal. It rendered the ACCC as just another interested party, albeit one with a more elevated status than others.

While the ACCC document submitted to the tribunal is a submission, it reads like a statement of issues. It is very focused on micro-issues. It questions the synergies that Murray Goulburn might be able to extract if it were able to acquire WCB; whether those synergies might enhance Murray Goulburn’s export potential; and the impact on competition for raw milk.

At a macro level, there are three broad issues to be addressed to determine whether or not a successful Murray Goulburn bid would produce public benefit. Even if cleared by the tribunal, given the convoluted structure of the WCB register, there is no guarantee that a bid would be successful.

Would it impact prices of milk and dairy products for consumers? Would it have a positive or negative impact on dairy farmers? Would it have an impact on the national economy?

A bit of background: over the past decade or so the Australian dairy industry has been going backwards, even as international demand for dairy products has been growing strongly. The New Zealand industry, for instance, has expanded dramatically.

The area of Australian land devoted to dairy has been contracting at a compound annual rate of 3.5 per cent since deregulation in 2000. Over the past decade or so, production has been declining at a rate of 1.7 per cent per annum, while New Zealand’s dairy acreage has expanded by 2 per cent a year and its production 3.5 per cent.

New Zealand’s Fonterra accounts for about 20 per cent of the global dairy trade; the Australian industry (the Victorian and Tasmanian industries account for almost all Australia’s exports) represents only about 7 per cent of the global trade. At the start of this century, the Australian and New Zealand industries were roughly similar in size.

There was, of course, the impact of two very significant droughts during that period. but the number of farms continues to shrink. Milk volumes, at about 9.2 billion litres, are still about two billion litres lower than they were a decade ago.

About 42 per cent of the Australian milk intake and more than half the Victorian intake are exported, and a number of submissions to the tribunal highlight the clear correlation between domestic farmgate prices and international prices. If the international market doesn’t actually set the prices, it heavily influences them. That’s a good thing for farmers, given the potential impact of the two big supermarket chains’ $1-a-litre milk prices on domestic liquid milk prices.

If the status quo were to prevail – either WCB remained independent or if it were acquired by Canada’s Saputo, as the WCB would prefer – nothing much would change.

Saputo has no existing Australian operations and therefore limited synergies. To the extent that it could extract benefits from adding WCB’s exports to its international network, these synergies would flow largely back to Canada.

Given the heady valuation the bidding has placed on WCB and the need for Saputo to demonstrate adequate returns on investment to its shareholders, it is difficult to see how or why WCB’s dairy farmer suppliers – or the Australian industry – would benefit.

The arguments against Murray Goulburn are conventional ones. There would be a contraction in the number of competitors in the market for acquiring raw milk in Victoria, South Australia and the Riverina area of New South Wales – although there would still be five other processors in south-east Australia.

If the prices, however, are set or heavily influenced by international prices, a contraction in the number of domestic buyers of raw milk would have little if any impact on farmgate prices. The impact on the supply and prices of processed milk for domestic consumption, would be constrained by the countervailing power of the supermarket chains.

If the Australian dairy industry is to respond to the growing international demand for dairy products, particularly in the Asia Pacific region, it needs to expand at the farm level. There needs to be more land devoted to dairy and more investment in production at the farm level, which is what has occurred in New Zealand. The national milk pool needs to be grown significantly.

That will only occur if either farmgate prices rise to improve farm profitability, or some other channel for capital between the processors and farmers is created or expanded.

The big public benefit and national interest arguments that Murray Goulburn has going for it are that it is already Australia’s largest dairy exporter and it is a co-operative. To the extent that it could realise synergies from a successful takeover of WCB, the benefits would accrue – directly or indirectly – to its farmer members.

Whether that’s through farmgate prices, dividends or (if its proposed new capital structure plan is implemented) through capital appreciation isn’t of consequence, as long as extra income or capital finds its way back to the farmers.

Fonterra’s submission goes to great lengths to argue that the benefits it and its farmer members (and New Zealand) have derived from its merger experience might not necessarily be replicated via a Murray Goulburn/WCB merger. But there is no doubt that its co-operative structure has been a major factor in its success and that of the NZ industry because it has channelled incentives to expand production back to its farmer suppliers.

Under the status quo, the Australian industry has shrunk and its share of export markets has more than halved.

There is no obvious or current option, other than the Murray Goulburn proposal, that would both generate material synergies and deliver the benefits of the increased scale, lower costs and bigger presence offshore back to farmers to reinvest in expanded production to take better advantage of the increasing international opportunity.

Even if Murray Goulburn were cleared to acquire WCB by the tribunal, there is no certainty that it would succeed, give WCB’s consistent preference for Saputo (presumably for ‘cultural’ reasons) over Murray Goulburn and Bega Cheese.

With Murray Goulburn, Bega, National Foods, Saputo and probably Fonterra already on the register, there is in fact no guarantee anyone will emerge with control of WCB.

With consumer interest protected by the big retailers, the farmgate price at least disciplined by international markets and the existence of multiple processors in south-east Australia, it’s difficult to see why Murray Goulburn shouldn’t be given the chance to compete with Saputo to try to advance the interests of farmers and the wider economy. It would be an opportunity to reverse the declining trend of the dairy sector in the face of a tremendous international opportunity.

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