Sitting on farm fence in a bidding war for WCB

While big business battles for control of the Warrnambool dairy producer, farmers are undecided, writes Jared Lynch.
By · 9 Nov 2013
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9 Nov 2013
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While big business battles for control of the Warrnambool dairy producer, farmers are undecided, writes Jared Lynch.

Nick Renyard's farm is far from the clang and clatter of city traffic and investment bankers' offices. Bush and bird song line the road to the third generation dairy farmer's property nestled in the rolling green hills south of Timboon, in Victoria's Western District.

Renyard's association with Warrnambool Cheese and Butter is more than just that of a supplier and processor. His father John was a director at the company, and Renyard, 39, has owned WCB shares longer than he can remember.

"I've had them since I was a little kid," Renyard says. "I can't remember exactly how long I've had them but when I got them they were $2 ordinary shares and there were 500."

Almost all of Australia's main milk processors, including NSW's Bega Cheese and the country's biggest milk processor, Murray Goulburn, have entered a global bidding war for WCB, which until recently was little known outside its home base in south-west Victoria.

Its head office and factory in Allansford, a hamlet at the end of the Great Ocean Road about 10 kilometres east of Warrnambool, is unassuming.

Its corporate suites, in a two-storey building at the front of the plant, have remained mostly unchanged for the past three decades. The wood-panelled rooms overlook Cheeseworld, an attraction built during the "world craze" of the 1980s, dedicated to the company's history, and cheese tastings.

It has a proud history dating back to 1888, but this is not why food companies in Australia and Canada are stalking WCB. The company is well placed to take advantage of an Asian boom, which is being fuelled by increased affluence and appetites for a more Western diet.

As well as being able to supply the growing demand for basic dairy produce, WCB also produces milk extracts, which are the main elements in health products from baby formula to bone supplements. The extracts are apart of the nutraceutical market, which is set to be worth $80 billion in the Asia-Pacific region by 2017, and WCB is just one of two processors in Australia that has the capacity to produce them.

But as the battle to take over Australia's oldest listed dairy processor intensifies in boardrooms from Bega to Quebec, Renyard says he remains undecided about which company represents the best fit for Warrnambool.

His main concern is protecting farmer milk payments in the long-term. That, he says, is more important that any dividend or share price movements in WCB.

Farmers like Renyard are therefore weighing up maintaining local competition within the local dairy industry, by welcoming Canada's Saputo as another player, or creating a bigger Australian company, with Murray Goulburn or Bega, to increase competitiveness overseas.

"I'm sort of sitting on the fence," Renyard says. "I am swayed a little by the argument that yes, [WCB's] competition is overseas, we are about 50 per cent export, 50 per cent local. And the local price is driven largely by the international price because of our relationship with New Zealand, and they're such a big exporter there. But I find it hard to discount the local competition angle as well.

"Say, for example, Murray Goulburn took over Warrnambool. We really only have one other major player down here [Fonterra] that we could potentially sell milk to, but they probably have limited capacity to take more milk."

Murray Goulburn, Australia's biggest milk processor, has offered $7.50 cash a share for WCB, compared with Saputo's $8 cash a share, which is subject to Foreign Investment Review Board approval, and Bega's $2 cash plus 1.2 of its shares for every WCB share, which values the bid at about $7.57. It is the second time both Murray Goulburn and Saputo have had bites at Warrnambool.

Saputo approached WCB about a takeover in October 2009 at an undisclosed price, but below $4 a share. Two months later, Saputo increased its offer to $4, and a few days later WCB rival Murray Goulburn arrived with a $3.80-a-share cash takeover proposal. But WCB's board said both offers were too low.

The offers came after a collapse in international dairy commodity prices and a disastrous joint cheese venture between WCB and National Foods (now called Lion), which weakened the company and led to a exodus of farmers to rival processors. WCB couldn't afford the $50 million for its 50 per cent stake in the venture, and cut the price of milk it was buying from farmers.

Its $24.5 million net profit from a year earlier curdled into a $19.9 million loss in 2009 as a result.

Former chief executive John McLean was called out of retirement to replace Neil Kearney, and almost pied piper-like lured back farmers with his safe hands. When current chief executive David Lord began his tenure in 2010 most of the farmers had returned, but some, to this day, have not.

Renyard is concerned a takeover by Murray Goulburn, which has a 17 per cent stake in Warrnambool, could again put farmers' milk payments at risk.

"Their level of indebtness - there has been so many figures thrown around, anywhere from 53 per cent. Murray Goulburn taking on so much more debt should be a concern for everyone because that interest needs to be serviced ... well, it would be from farmers' payments."

But Murray Goulburn managing director Gary Helou says, as a farmer co-operative, his group is focused on maximising farm gate returns.

"Through scale, which will come through the combination of Warrnambool and Murray Goulburn, we will deliver [a] net increase in farm gate prices from day one, despite the debt people are talking about," Helou says. "We are on a strategy to increase farm gate prices by $1 per kilogram solids. It's a huge increase and the Warrnambool acquisition will contribute to that, as well as the other modernisation initiatives that we are doing."

Helou says if Murray Goulburn acquired 100 per cent of WCB, its gearing would rise to 52-54 per cent. He says that is less than Fonterra, whose debts levels were about 60 per cent when it began its expansion phase.

WCB chief executive David Lord says the board had been "seriously considering" Murray Goulburn's offer.

But a week later Saputo trumped MG, increasing its bid from $7 to $8 a share. Lord says that allowed the board to maintain its recommendation to unanimously support Saputo.

Helou says he is confident Murray Goulburn's bid will be successful and that it will be approved by the competition regulator, but adds the co-operative "reserved its right to review" the offer in the future.

Renyard warms to Bega's bid more than Murray Goulburn's, but says the offer from the NSW dairy company isn't high enough because it is dependent on Bega's share price.

"Bega is not a bad fit with Warrnambool. They only have a small number of suppliers in the region, so it still maintains a competitive situation locally. And it does create another pretty sizeable player with some reasonable horsepower as an exporter. I just don't think that they can justify the share price out there.

"You only have to look back 12 months and the share price was less than half what it was now. If they are going to $2 plus shares, back in the first place it should have been $2 plus two or three shares."

Bega bought a 15 per cent stake in WCB in November 2010, in what was promoted as the two companies joining forces to form a "strategic management group" to identify opportunities in processing, manufacturing and distribution. There was no talk of mergers or takeovers.

Bega steadily increased its holding in WCB to 17 per cent before launching a bid in September this year, which Lord described as "highly opportunistic" and inadequate. Lord also hinted that an overseas player was also interested but declined to name the company.

Two weeks later, Saputo chief executive and vice-chairman Lino Saputo jnr posed for photographs outside WCB's factory (overlooking Cheeseworld's giant milkshake statues). By his side was Lord, who announced that Saputo was the board's preferred suitor.

Saputo said his company, which has no presence in Australia, has been eyeing WCB for 12 years, recognising that its acquisition is key to its growth plans for the Asia-Pacific region. He says there will be no rationalisation of staff or redeployment of assets. "We would see Warrnambool as a platform for growth in Australia and through which to expand into the Asia-Pacific region, working with Warrnambool's management to capture those opportunities," Saputo says.

And he's not the only one saying it. Former BHP Billiton boss Marius Kloppers said in August last year that supplying a growing global population with food would be a challenge. "By our estimation, food will be a material issue for the world over the next decades and potash is our way to play into supplying the world with food," Kloppers said.

Commonwealth Bank's dairy report, released last February, said China's consumption for dairy products was rising rapidly.

"The enormous size of the Chinese population, 1.35 billion people, means growth in per-capita consumption has a big impact on total Chinese demand and, in turn, total global demand," the report said. "Since 2010, China has contributed 33 per cent to global fresh milk consumption growth, 36 per cent to global skim milk powder growth and a staggering 80 per cent to whole milk powder growth."

WCB has already focused on the potentially booming infant formula market in Asia. Under a recent deal with New Zealand's Tatua Co-operative, WCB is expected to start extracting and processing lactofarrin, which is used in infant formulations, from milk.

The milk extract has been dubbed "white gold" by some analysts because it is worth about $1000 a kilogram. That kilogram takes about 100,000 litres of milk to produce.

RBS Morgans analyst Belinda Moore says China in particular is looking to Australian productions because of their reputation of being "clean, lean, green, quality and safe". Six babies died and about 54,000 more were hospitalised in China in 2008 after a Chinese infant formula was contaminated with melamine, which causes renal and urinary problems, in attempt to increase its protein content.

"You are seeing very strong demand for our dairy products," Moore says. "It's not about fresh milk. It's the milk powders which all the babies are drinking. As they consume a more Western-style diet, demand for dairy is [growing] very strongly year-in year-out, and that is expected to continue.

"Their people want to eat from producers such as Australia because of that quality, clean, green image."

Such is China's appetite for foreign infant formula that there have been media reports of Chinese students clearing supermarket shelves and ordering huge amounts of the product.

But Moore says the high-tech milk products, which trade at a high margin, aren't the only reason a global bidding war has ignited for WCB.

"The thing about Warrnambool is 50 to 60 per cent of the business is export, so it's got a very strong export position. That's what is attractive, that availability.

"It's also in the best dairying region in the country, which has high rainfall. It is the most efficient dairy producer in the country because it is largely a single plant."

But PAC Partners agribusiness analyst Paul Jensz says WCB and the successful buyer will still have a long way to go to capitalise on the Asia boom.

Jensz says his valuation for a standalone WCB based on discounted cash flow is between $4 and $4.50 a share. At Friday's close WCB shares were $8.46.

"We have got this frenzied activity now because there are scarce assets in the space and the next owner will probably hold on to Warrnambool for a significant amount of time. It's not a private equity show that's going to buy it and throw it out in a few years," Jensz says.

"[But] they need to do a lot more with their margins and their brands, their location down there to get up to $8 a share. It is a big, big ask."

Adding intrigue to the fight over WCB are two multinationals. The world's biggest dairy exporter, Fonterra, has bought a 6 per cent stake in Bega, while Japanese-owned food conglomerate Kirin snapped up a 10 per cent of WCB through its subsidiary Lion.

Jensz says Fonterra moving on Bega gives the NSW company's offer more firepower.

"Fonterra investing in Bega rather than Warrnambool shows that Bega is their favoured partner here in Australia.

"If Bega selects to have another look at the investment in Warrnambool, Fonterra is suggesting that it likes the strategy of Bega, it likes the way it does things."

Bega's board met on Thursday to discuss whether to make its offer unconditional or increase its bid. It chose to do neither, releasing a short statement to the ASX that it would simply "continue to consider the matter".

It is understood that Kirin isn't looking to take over WCB; rather, it is seeking to protect the viability of its cheese brands Coon and Cracker Barrel. WCB supplies Lion with its entry-level cheeses. In return, Lion cuts and wraps WCB's cheeses. It is an agreement aimed to create cost-efficiencies in a high-volume, low-value product, which is frequently the target of heavy supermarket discounting.

Kirin is therefore using its stake to gain a seat at the negotiating table to ensure its WCB agreement continues with any new owner.

Jensz says the Kirin block of votes has made the chances of a Saputo offer, which is conditional on 50.1 per cent acceptance, being successful more challenging. Bega, Murray Goulburn and Kirin own 45 per cent of the WCB's stock.

"A full takeover is going to be quite difficult. Someone trying to get 90 per cent-plus, I think, is looking to get a multi-part process. It would need to have [the support] of at least two of the major players involved to make it work, unless someone came over the top with a massive bid that was clearly superior to all the other bids out there.

"Someone controlling 50 per cent or just over 50 per cent is more practical, and you'd have to say that the Australians have their noses ahead in that game."

Back at his farm, Renyard is getting ready to wash his hands and go into Timboon to celebrate his mother Heather's birthday.

The fate of WCB will depend, in part, on the decisions of farmer shareholders.

But with institutional shareholders and non-farmer shareholders also in the mix, Renyard is unsure how it will all unfold.

"Some dairy farmers will have a lot more say than others because some dairy farmers have more shares than others. But there are a lot of people who are shareholders and will have a relatively small say.

"I'm not sure how much say that we are really going to have. I'm really sitting on the sidelines being a spectator - like at the footy."

with wire services
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