Bega Cheese's chairman tells Business Spectator's Alan Kohler, Robert Gottliebsen & Stephen Bartholomeusz about:
Alan Kohler: Barry, welcome to Business Spectator. Thank you for coming.
Barry Irvin: Thank you very much. It’s nice to be here.
AK: Now, ironically you need to be seen as a takeover target yourself if you’re ever going to win Warrnambool Cheese & Butter because you’ve declared a final offer. It’s obviously a share and cash offer. But your price is rising because you’re being seen as next.
BI: Yes. Well look, it’s an interesting circumstance. From our point of view I think one of the things that has happened because of this offer is that the profile of dairy and the importance of demand in Asia – the fact that there are certain companies in Australia that are very well positioned to meet that demand, have elevated the interest in dairy and therefore elevated the interest in both companies – Warrnambool Cheese & Butter and Bega. I guess it’s an interesting twist in this entire bid process that the market has not only become interested in what’s happening at Warrnambool but very interested in what’s going on at Bega. We think that we present a great story both in terms of just a very good business that’s going to continue, but clearly there’s some speculation.
AK: You started this whole process with the first offer for Warrnambool. In your mind at the time did you see Bega as a buyer and a seller?
BI: I’ve got to admit I’ve always been very focused on what I wanted to achieve with Bega and indeed the broader industry, and that was to build a really strong Australian listed dairy company. I thought there was a lot more consolidation going on in the Australian dairy industry yet, and so my focus was always on trying to execute that. We’ve been very successful in acquiring and building business, so the focus was on acquisition and we thought there was a great opportunity there.
Robert Gottliebsen: Do you believe that the Fonterra success in blitzing Australian dairy exports from New Zealand was about their scale and being a national champion?
BI: In terms of Fonterra’s success, it’s a different model and to a certain extent it’s a different industry in New Zealand. I guess to be a little bit simplistic, there is no real domestic market for the product that is produced in New Zealand. It’s such a huge industry in New Zealand. Australia was always the natural domestic market, if you like, for Fonterra and so I suppose as they thought about their strategy going forward. It’s best that I don’t try and speak too much for Fonterra, but I think that they see part of their overall strategy is Australia as a natural domestic market because they don’t have a large one in New Zealand. And of course then they have their global structure around expanding that very large amount of dairy product…
RG: But they took us to the cleaners.
BI: I think we could always look back deregulation in 2000 and look at what happened, and the fact that Bomac at the time was a failing company. Fonterra saw that and bought that business and got themselves established in Australia. But you’ve got to say that’s good business practice. That’s what they did. At the same time we benefited from that first round of rationalisation because that was really when Bega started to grow as well.
Stephen Bartholomeusz: Barry, one of the arguments that you would have heard that Murray Goulburn Co-operative has put forward that explains why New Zealand’s exports have soared and ours in volume terms have actually fallen, is that New Zealand is fundamentally a co-operative model and so the capital flows back to the farmers who can then invest in and expand the industry. Do you subscribe to that?
BI: Actually no I don’t. Interestingly enough, I think there are a number of factors, so I was being a little bit too simplistic to say it is just that. I would say two things. Over the last decade more often than not Australian farmers have been paid better than New Zealand farmers, so it’s not actually a fact that that cooperative model is necessarily with better returns.
AK: You mean overall including dividends and milk?
BI: Just in terms of the price, yes, and –
AK: Oh, just in terms of price because the thing about Fonterra is they get the dividends as well.
BI: Yes. But they always count that as their price.
AK: Oh, I see.
BI: I would say that overall you can’t find a very large difference between returns to a New Zealand dairy farmer and returns from an Australian dairy farmer. What you do find is that New Zealand focuses absolutely on dairy, from government right the way through, whether it’s through legislation or whether it’s through resources, research, or focus on actually how you improve productivity.
There’s no question that from the supply chain perspective it’s a very sophisticated, very focused model in New Zealand. Dairy is their mining, so they focus very strongly on it. And you could easily say that that hasn’t been the same in Australia and you can look back and say there’s a lot of rhetoric around food in Australia, but there actually isn’t a lot of government support for what occurs. I’m not talking about subsidy, I’m talking about the research, innovation and productivity, those sorts of things which were once part of the Australian landscape through things like the Department of Agriculture, etc.
AK: I suppose the point about Bob’s question is whether it really means that in Australia what we need is really one dominant company to bring it together, consolidate the industry to become, as Bob says, a national champion.
BI: I can see the argument for it. I’m an advocate on both sides. I think competition is a great thing and I’m not thinking don’t have competition. I’m not a great advocate for monopolies, but I do think you need scale and I do think the Australian industry needs consolidation.
AK: And the other problem for you is that the only business that’s capable of doing that is Murray Goulburn.
BI: Yes, but what I would say is that I think there are a number of ways of achieving it. I wouldn’t quite consider that Murray Goulburn is the only one that’s capable of doing it and I think that at the end of the day we can – and we’ve demonstrated actually that we can – continue to build. I suppose the whole premise of adding Warrnambool to Bega Cheese’s current infrastructure was that we would move from one billion litres of milk to 1.5 billion litres of milk. We would be able to integrate and add more value-adding to the product going forward. We’ve actually grown substantially over the last decade and we’ve demonstrated that you can actually continue to grow to that scale.
AK: But if you by some chance won Warrnambool Cheese & Butter, Murray Goulburn would just come in and scoop you both up.
BI: Well, there are a lot of people speculating on what will happen next. I think a lot of people actually didn’t quite predict what was going to happen at Warrnambool Cheese & Butter when we launched the bid and I am not so convinced that it would be as straight forward as somebody else scooping us up. But I’ve always said one thing – it is far better that people are interested in what you’re doing than not at all interested. And so my perspective is that we’re running a very good business. If Murray Goulburn sees that, a number of other people see it as well.
RG: Would you agree with me that one of the great advantages the Canadians had over you and Murray Goulburn is that they’re going to protect the executive base in Warrnambool and if that’s so, why don’t you match them and shift the headquarters?
BI: Oh Robert, there’s far too much for me to actually speculate on there – I think I’ll leave that one to you in terms of this report.
RG: But it is true though, isn’t it, that the overseas companies have great advantage because they need the local executives and so any local company, whether it be you or Murray Goulburn, are going to rationalise its heavy structure? The Canadians are not. It gives them a huge advantage.
BI: Look, I think we’ve been disappointed that we haven’t been supported by the Warrnambool Cheese & Butter board. There are reasons for that I suppose and one of those –
RG: And would you agree that that’s one of the reasons?
BI: Well, one of those may be the reason. I don’t think it’s appropriate for me to make a comment on the executives of Warrnambool Cheese & Butter. They’re doing the job that they think they need to do and that’s fine.
SB: More generally, Barry, given that the roots of all these businesses are community-based and co-operative, do you think the social issues will actually play a role in how this pans out? I mean, Bob’s referred to one of Australian social issues, but there seem to be some hostilities perhaps because of there’s a common heritage dispute. Do you think that’s a fair comment?
BI: I’ve made the comment over many years that the dairy industry can be like football teams, and it tends to be more difficult for the neighbouring football teams to merge than it does for them to go and merge with somebody from far away. So I think there are some classic rivalries there and they have been there for a long time because of the fact that the businesses go back more than 100 years in some cases.
In saying that, I think there’s a great understanding of them and I think Bega has demonstrated in its merger with Tatura Milk Industries that you can actually achieve both outcomes of larger scale but also never forgetting the heritage and where you’ve come from. And obviously when we did make an offer to Warrnambool Cheese & Butter we did make all those commitments to the community, to the branding, to the operating sites etc because we do see them as very important and we do see community involvement as very important.
RG: Can I take you to a different stage? We’re starting to develop a lot of software in terms of monitoring what happens to cattle, cows and crops for that matter as well. Do you believe this will greatly improve the productivity of the dairy industry?
BI: I think there is a lot of good innovation on the horizon that is going to see productivity increase and improve, and I think it’s extraordinarily important. In reality if you looked over the last decade what the industry has been missing at grassroots level literally is the productivity improvements that we traditionally got in the industry. We went through a generation of improved production, improved genetics, improved pasture types, improved farming practices. Really in the last decade that’s slowed and that’s really why we’ve seen it so difficult for farmers to actually get good returns.
But there is a lot of good work on the horizon and I think you’re right – technology is going to become a very big part of agriculture into the future. We’re seeing that right through to the high-end technology of robotic dairies, through the entire agriculture process system. There is a lot of very good work out there.
RG: And New Zealand is ahead of us in that?
BI: I think they’re more focused on it, quite frankly, and I think they put more resources behind it so that naturally means that there’s a yield. I think that if Australia compares itself to almost any agricultural country around the world, we’re not putting enough into innovation, research, those sorts of things and that’s why we’re falling behind.
RG: But that partly explains why everyone is bidding up Warrnambool – because they can see something ahead that will produce profits for the industry that are rather different to the ones that are there now.
BI: No question. I’ve been at pains to comment that nobody is putting this money on the table because they don’t see opportunity into the future. Everybody is seeing significant opportunity. Whether that is actually from the market demand or from improved production practices, or improved opportunity around the high-end proteins that you get from dairy.
Infant formula, for example, is such a high-demand product, and as you look at those high-value-added products it’s not just about saying ‘Oh, we take milk and we turn it into a powder or a cheese or something else’ – we turn it into highly nutritious products that have a very high value. So it’s both the value of the product and the demand coming through for those products that are seeing everybody recognise that they should be positioned for the future.
AK: You talked before about the national focus in New Zealand on dairy that doesn’t exist in Australia and you mentioned legislation or government focus. What is it about New Zealand legislation that differs from Australia? And what could Australia learn from what the New Zealand government has done?
BI: I’m not so concerned about the New Zealand legislation, but obviously they’ve put in competition legislation that allowed Fonterra to form. That couldn’t happen in Australia. I’m not necessarily advocating that it does, but it demonstrated that they saw the importance of scale and consolidation.
The second thing is, of course New Zealand has been far more successful in Australia with free trade agreements, particularly in China. A lot of people talk about the opportunity in China, and while our biggest competitor is New Zealand, we’ve been batting with one hand tied behind our back. They run into China with a free trade advantage that we do not have.
If you look at those two things, you can see that government strongly supports it. But then you go back internally and look at the amount of research and dollars and effort that the New Zealand government departments – in combination with the businesses – put into research, creating products, thinking about how they can penetrate markets. It’s very different to what occurs here.
SB: I was looking at a graph the other day of the Bega market price for cheese internationally. Over the last decade, it’s just been going up vertically. Why didn’t that price signal create the kind of investment in this market and expansion in this market that it should have?
BI: It’s a sad truth, but it is a truth. We had the worst drought in living memory for a decade only a couple of years ago, so people tend to forget about it. People say: “Well, you know, that’s okay – that’s surely a circumstance that the industry should have been able to deal with.” Once again, they compare us to New Zealand. I don’t want to focus on New Zealand too much, but it is very notable that as soon as New Zealand gets a drought, which in New Zealand is two weeks without rain I think, their production drops off.
The fact is that at the end of the day, we are in an agricultural business and we went through a very difficult time. And when you look at northern Victoria, at what was the largest sector, three billion litres of milk in that sector reduced to $1.8 billion and there was no water and drought. And while there were price and other issues, there was an overwhelming factor and that is always the great leveller with agriculture. Think of the best operator in the world: if the weather runs against you for that sort of period of time, it affects what you produce.
SB: The opportunity is still there, isn’t it? Demand is growing in single digits and supply is not growing at anywhere near that figure.
BI: Exactly right. But I would say that I’ve been in agriculture for a very long time and sometimes what business has struggled to understand with agriculture is that you have to have a very long-term strategic view. Things don’t change quickly, but they can get momentum. And the reality is that that 10 years of drought had its effect, and it knocked the confidence out of the farmers for a fair while.
Even when it ends, there’s a little recovery period to happen. I am very optimistic. We’re now seeing northern Victoria grow again. We are seeing price signals that, if they are sustained, will see farmers start to feel more confident. I’ve got great optimism that this industry will grow, that we will see improvement in returns across the supply chain.
We were affected. The industry was deeply affected. It’s not an excuse. It’s just a fact, if you’re fairly judging it. You have to take that into account.
RG: And Warrnambool didn’t have anything like that to the curve, did it?
BI: No. It didn’t.
RG: It’s a wonderful place for dairy farmers.
BI: It is. Those coastal storms help you a lot in this game.
AK: Could you describe Bega’s relationship with Fonterra?
BI: Yes. If I was saying it in a real short form, they are our biggest customer. I think that’s one of the interesting things about the dairy industry: we are quite sophisticated in thinking about our supply chains and delivering competitive products to our customers.
In terms of Fonterra’s relationship, ironically enough it has its origins around deregulation. We did two very important deals with Fonterra as we came into 2000. The first was that we franchised our Australian marketing into the Bega brand to Fonterra, so they represent the Bega brand in Australia.
AK: What does that mean?
BI: They do the marketing.
AK: Do they own the brand for a period of time?
BI: They’ve franchised it. The franchise is for 25 years, and they pay us a royalty stream on that brand. We still own the brand, but they obviously do the sales and marketing.
AK: They effectively rent the brand.
BI: They do. That would be a way of putting it.
BI: We consolidated the brand marketing, so the Bega brand went into a stable of brands managed by Fonterra in Australia. We manage it in the 30-odd markets around the world in which we export the Bega brand.
We also consolidated all the value adding – the cutting, packing and processing of cheese. We do a very large volume of other brands for Fonterra, but we value-add it and put it into retail packs. We do that for a number of companie.
AK: Do you make it for them?
BI: No. We take in their cheese, but we get it ready for the customer, if you like. We do that for a number of customers.
One of the secrets of Bega Cheese is that we value-add about a 100,000 tonnes. So, in our terms, making bulk cheese retail-ready. We value-add about a 100,000 tonnes of cheese for various customers in Australia and around the world.
Quite often it’s their cheese, but we turn it from bulk into retail-ready packs and that’s a very large business. It’s by far the largest cheese cutting and packing and processing infrastructure in Australasia.
AK: What proportion of your business is that?
BI: That would be 40-odd per cent of our business. It’s very stable, very strong return; a nice piece of business to have in agriculture. Obviously you’re dealing with commodities and currencies and many other factors when you’re in my game, but that piece of business is very stable, very straightforward, very strong.
SB: Apart from being your biggest customer, Fonterra very recently became a very large shareholder.
BI: In fact, our biggest shareholder.
SB: I assume you’ve spoken to them about it. Is that to defend their relationship or do you suspect there’s a more aggressive ambition there?
BI: Fonterra have stated publically that their ambition was to have a ten per cent stake in Bega. I think they’re to about six per cent. I think they’re continuing to look for shares. As I said, our relationship with Fonterra goes back now thirteen years and we’ve just renewed the cutting and packing side of our relationship for a further ten, so we’ve had a very good, very long term relationship with them. I actually take the logic of what they say as sensible. That is, they say 'well we have a very big business relationship with you, so we therefore think that we should be on your register'.
I guess particularly observing what’s happened at Warrnambool Cheese & Butter and equally everybody speculates about what the next corporate play is. If I was Fonterra, I’d be thinking the same thing, but I think well I should be positioned there… if I’ve got a long term good relationship with them, I should make sure that I’m positioned for whatever might happen in the future. I’m fine with that. You know, we have a very positive relationship with Fonterra and, in my discussions about the placement and about the future I can see lots of value being created. I think sometimes what people miss is that it’s not just about taking over companies. What Bega has actually achieved over the last decade -- we’ve gone from a business that employed eighty people to employing sixteen hundred people. We’ve built revenue to a billion dollars. And we’ve done a lot of that by actually just identifying infrastructure that can be rationalised and talking to companies like Kraft, Fonterra, etc., about how you might rationalise infrastructure and how you might improve efficiency in the supply chain. So, I don’t necessarily think that it’s always about saying somebody has to own somebody else, but it is about saying ‘gee there’s a lot of infrastructure around the dairy industry’ and how can you actually streamline that to create value.
AK: But for Fonterra it might be a matter also of trying to contain Murray Goulburn’s ambitions. And I’m just wondering whether… I mean obviously you’re not going to speak for them, but if you were running Fonterra, would you be interested in blocking or containing Murray Goulburn?
BI: Look, if I was running Fonterra, I’d observe that Bega Cheese is a fairly good little business and it’s important that, no, it’d be considered in my strategic structure and if I was running Murray Goulburn, I’d probably think the same thing and in terms of what they think of each other, I mean I think they would all accept the need for the other to exist and I think that they accept competition, but like us, we’re all looking for growth and we’re all identifying opportunities.
AK: I mean the funny thing is we might end up with a dairy industry where you can’t invest in it unless you’re a dairy farmer because it’s not listed, isn’t it? I mean we could end up with both sides of the Tasman in cooperative dairy industry.
BI: I actually think that there is a role for cooperatives, but I think people obsess too much about structure around what the right outcomes are. Look, Bega Cheese had a great history of being a cooperative, a hundred year history of being a cooperative, but we created an enormous amount of value, particularly in the last decade. We made the decision to list because we saw our farmer cooperative shareholders unable to access the value that had been created and we thought it was really important that they had the option to realise the value. So, we restructured and listed because of two things. One, we wanted our farmers. We wanted them to all stay shareholders, but we wanted them to have the option of realising some of the value. That’s what they were able to do. It’s been a fantastic thing for those farmers. Equally, we wanted to be able to grow more rapidly than perhaps a cooperative structure would allow us to, so we therefore said a listed structure is the best model for us. And I would argue going forward there is therefore a role for both. There is a role for a listed entity because I think listed entities can do things in a bit more of an agile way than a cooperative.
AK: Except you do have to discord dividends and there is a lot of investment required in the industry for technology, so if you’re a cooperative, you don’t particularly have to worry about that too much, although you do have to pay dividends to some extent.
BI: There are examples of success and failure in these things. It is interesting to me that it is actually the listed entities that are further down the track of value adding that actually have had greater success with investment. And one of the things that we might lament sometimes around the cooperative model is that the level of investment hasn’t been there to make sure that they actually remain competitive and take their position in the marketplace and I think the cooperative model has struggled with that over a great period of time.
Quite often when you talk about value creation it’s about having the ability to invest in innovation and move forward more rapidly than your competitor. And the reality is sometimes in a cooperative sense, and quite often it’s the case that the cooperatives aren’t actually paying their farmers better, but equally they’re not actually getting the returns required to make the investment required. They don’t have the capital available to them to make the next big step, so I think it’s a debate that’s been going on for as long as I’ve been around, around what the right structures are in agriculture, whether it be cooperative or listed and I think there are great success models on both sides. I think that sadly there are the odd occasions where you see cooperatives that are actually burning value and nobody sees it until it’s too late because there is no measure of their performance. So look, I think there are arguments for both sides.
SB: There is a hybrid model, the Fonterra model, a listing, non-voting, model, something Murray Goulburn’s talking about. Is that kind of a compromised model? Or do you think there are benefits for a Bega being a conventionalist company?
BI: I do. Look, as you can imagine, you don’t make these decisions lightly, so in probably the entire time of my leadership I was thinking about structures and looking at those sorts of hybrid models around the world and in the end I’ve gone ‘gee it’s very difficult to try and be two things’, and you’re actually better to make the decision and say ‘right I will be a listed company’ and this is maybe the point, my view is that we’ll be a listed company, we’ll expect to perform at a level that sees us able to do both and that sees us able to satisfy our obligations to our shareholders and able to outperform as far as what our farmer expectation and our supply expectation might be.
Quite frankly, while people might go ‘is that difficult?’, I don’t believe it is. I actually think you can achieve that, but it’s about having a very focussed strategy and a very good performance. And one thing during this entire Warrnambool Cheese & Butter bid process, the really nice thing that we’ve been able to say is that this isn’t rhetoric, we can actually put our record on the table over more than a decade. We’ve grown year on year on year. We’ve had very stable profits. We’ve been able to look after our dairy farmers. We’ve been able to even demonstrate last year, in what was a very tough year for manufacturers, improved returns to our shareholders. So from my perspective it can be done and there are other very good examples of it being done.
SB: To go back to Warrnambool Cheese & Butter for a moment, can you see any kind of clear outcome to this when you’ve got three shareholders with forty-six per cent of the shares all of whom have competing interests and then you’ve got the social issues around those as well? Is it probable that there’ll be a stalemate?
BI: We’re coming to the sharp end of the game now as we talk about closing dates and final offers and the like. I would like to see that we’ll continue to talk to all shareholders and our offer will be successful. There is a scenario that there is a stalemate. There is a scenario there’s a winner. And I mean I guess at this stage all the players are sort of staring at each other and wondering whether anybody is going to blink. Being in the middle of it, all I can do is focus on our bid and try and make sure that we are successful. Obviously there is a scenario where there is a stalemate. There is another scenario where people just decide that they will support one of the bidders.
SB: If you were to be successful, would you prefer to freeze the situation as it is to date or – you’re sitting on a very, very large profit on those shares. Would you just take the capital and run?
BI: I’ve tried to be disciplined in this. My board said the same thing to me. I think that if you’re focussed on trying to win a game, you don’t think about not winning the game, you think about rolling forward and trying to get to the try line and… to steal an inappropriate analogy for Victoria because obviously that’s a rugby analogy rather than an AFL one.
My perspective is that I believe that the Australian dairy industry will benefit from consolidation and I believe that consolidation is important. So, I’ve continued to argue that case and I continue to argue that Bega Cheese is in the best company position to consolidate.
A stalemate isn’t a good outcome, but we have to wait and see.
AK: Are you getting acceptances at the moment?
BI: We are.
AK: Even since Saputo went unconditional at nine dollars?
BI: Well, yeah. We got a few this morning. We’re not getting a flood of them, but we are getting acceptances, yes.
AK: That’s interesting. Thanks for joining us, Barry.