28 October 2004 Fonterra Bid for National Foods Shows Company in Serious Growth Model

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Date28th October 2004Lincoln University

The bid by Fonterra to purchase National Foods in Australia is the biggest strategic move in the New Zealand dairy industry since the formation of Fonterra itself.

The move signifies that Fonterra is very serious about developing the consumer products side of its business.

The bid price of $A1.62 billion represents full pricing. This price has been judged necessary by Fonterra's advisors to attract a sufficient number of the existing shareholders to sell.

Fonterra has a sufficiently strong balance sheet that it will be able to finance the purchase from borrowings. However, given a price to earnings ratio of 19:1, it is unlikely that in the short term the investment will return the cost of capital to Fonterra. Accordingly, Fonterra must be making the move because of the strategic opportunities it believes it offers as a platform into Asia. In the short term it is likely to cost farmers money.

National Foods has a strong stable of brands including Fruche, Yoplait, Yogo, Big M, Pura, Farmers Union, and Feel Good. However, some of these will be franchised brands and so Fonterra will not necessarily be getting international rights to all of them.

In recent years a number of prominent commentators have been urging Fonterra to move more decisively into the consumer products market. But making such a move is easier said than done. The opportunity to purchase National Foods is one of those opportunities that only comes up very occasionally.

Currently there is another proposal on the Board table at National Foods. This is to amalgamate with SPC Ardmona, which is a non-dairy company. Fonterra is not interested in SPC Ardmona. Therefore for Fonterra it was a case of acting now or never.

If the purchase goes ahead it will undoubtedly cause New Zealand dairy farmers to focus more strongly on the question of what is the best long term capital structure for Fonterra.

The proposed investment means that Fonterra is planning to go into serious growth mode. This means that farmers will be making ever larger investments beyond the farm gate, and that will create its own pressures and tensions.

Professor Keith Woodford, Professor of Agribusiness, Lincoln University, Canterbury, New Zealand

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28 October 2004 Fonterra Bid for National Foods Shows Company in Serious Growth Model