Chairman Roadley To The Wellington Rotary Club

Chairman John Roadley To The Wellington Rotary Club

1.00 pm

Monday 3 September 2001

We’re now less than a month away from the formation of Fonterra Co-operative Group Ltd – New Zealand’s biggest company. I’m pleased to have this opportunity to update you on progress towards the creation of Fonterra, and the road from there.

If you are one of those asking what “Fonterra” means, my answer is that it may well mean very little to you right now. I hope by the end of this lunch it starts to mean something to you. Within our first year of operations, we plan that you will see it as a synonym for excellence and as a true New Zealand national champion.

The story towards the creation of Fonterra starts at the end of last year when the two big manufacturing co-ops signed our merger agreement. We were very clear on why the creation of one large co-op was far-and-away the preferred option for our industry. We had debated our future for several years. We had studied the full range of options. But, ultimately, one point overwhelmed the other considerations: scale matters on international markets.

We look around the world and we see our customers becoming bigger and more powerful. The Economist magazine predicts that ultimately there will be just ten major food retailers in the world. It is forecast that, this decade, Wal-Mart will achieve annual sales of over a trillion US dollars.

As we see our customers getting larger, we see our competitors getting larger too. Dairy companies all around the world are seeking scale to have leverage with global customers. They are seeking ever-improving economies of scale, particularly in areas such as research and product development. And they are looking for arrangements to operate in parts of the world where they would otherwise be shut out because of trade barriers – with dairying being one of the most protected and distorted industries in the world.

All those factors mean there is now a major merger, acquisition or joint venture in the global dairy industry every two and a half days. The pace of consolidation in the industry is extraordinary.

Our message to the Government, after we signed our merger agreement in December, was that we simply had to have scale to compete and profitably grow our business in that environment. We said that the only way we could have scale was to be unified at home. Two smaller New Zealand companies were not a realistic option. They simply wouldn’t be big enough to compete. We explained that we needed the uncertainty surrounding our industry to end, because it was preventing us from being able to secure opportunities overseas. Nobody was going to sign a major deal with a company that couldn’t predict its future a year or two out. And we were able to offer the Government a commercial deal that had already been agreed by the board of our two main co-ops. Previous attempts to restructure our industry had failed because they had been Government- not industry-led.

Our merger agreement meant we had a sound foundation on which to start talking with the Government. Both the Prime Minister and the Minister of Agriculture worked with us very constructively to sort out all the regulatory and domestic market implications of the merger. A Joint Working Party was established for officials and industry executives to study and resolve the issues. We were able to agree on a Regulatory Package that will allow for the merger and promote competition in the domestic market. We believe it will lead to more vigorous competition that we have now.

Deregulation of the export industry means it will be far more likely that strong domestic competitors will emerge. The Regulatory Package promotes immediate competition by requiring us to sell our shareholding in the company with the New Zealand rights to use the Anchor and Fernleaf brands. That company will start out with 40 percent of the market. We have to make it easy for our supplying shareholders to leave us to supply a competitor, and pay them the fair value of their investment when they do. And there are provisions to ensure our competitors have access to milk. We have to supply them at a commodity price. I had said before that I believe many people are underestimating the profound changes we will see in our local dairy industry as a result of fair value exit for our farmers and the deregulation of the export industry.

It was only when regulatory issues were agreed with the Government that we could put the issue to our shareholders. In June, they spoke loudly. Turnout was record-breaking, at 85 percent. The vote in favour was overwhelming, at 84 percent. It was the mandate we needed to establish the new company on a sound footing.

Immediately after the vote, the Government introduced legislation to make it happen. It is now before the Primary Production Select Committee, which we expect will report back to the House on 11 September. It is anticipated that the legislation will be passed a week or two after that, to allow us to be formally in business by the end of the month.

There has been a huge amount of complex work over the last nine months to achieve the merger. I want to turn now to the sort of development the merger was all about, and which the creation of Fonterra is now allowing us to do. I want to talk about the deals we have announced in the Americas, and why we see that part of the world being such a big part of our future.

We look around the world and we see a landmass that has 13 percent of the world’s population but as much as 32 percent of its GDP. On average, its people are relatively well-off compared with some other parts of the world, and in the USA we have the worlds wealthiest economy. Total GDP for the region is estimated to be thirteen trillion US dollars a year. Within that, the dairy market is valued at something like ninety-four billion US dollars a year. There is plenty of scope for growth above our FOB earnings of around two billion New Zealand dollars a year.

The United States market, of course, stands out in the region, with a dairy market of over fifty billion US dollars a year. But there are other very significant markets as well. The Brazilian dairy market is valued at over ten billion US dollars a year. The Mexican market – at nearly nine billion US dollars annually – is, on its own, a bigger market than all the countries of South East Asia, combined. The culture and diet in the region is one that is receptive to dairy products, more so than in some other parts of the world.

We also see the Americas as a growing market. Across Latin America, annual growth in demand for dairy products is forecast to be four percent over the first half of this decade. To put that in perspective, growth in Europe is expected to be just one percent annually over the next five years. In percentage terms, Latin America is growing four times faster than that traditional market. In addition, because Latin Americas is a relatively well-off market, we can expect to see much of that growth in liquid milks and higher value products, such as chilled products.

Taking a global perspective, Latin America is an obvious part of the world to want to expand our operations, and the Dairy Board has been doing that successfully over the last five years. We face two problems in maximising our returns from the market, though. The first is that it isn’t possible to export liquid milk from New Zealand. The second is that the region has highly protected markets that make exporting other dairy products from New Zealand difficult. It has been clear for some time that our best strategy for the region is an acquisition and joint venture programme.

Last month, we announced three major deals. The first was an agreement with Dairy America to export their skimmilk powder out of the United States. It will make us the major marketer of skimmilk powder out of the US. The second deal was our acquisition of La Mesa and Eugenia in that huge Mexican market. It will make us the number one player in the Mexican cheese market and number three in spreads. Those were important deals. The alliance with Nestle announced on Thursday dwarfs them. It is almost certainly going to be New Zealand’s biggest-ever offshore commercial deal. The deal is more than a year in the making.

When we were considering the best possible partner for the region, Nestle stood out. It is the world’s largest food company and the largest marketer of dairy products in the world. It owns some of the world’s most respected dairy brands and has more than a century’s experience in the Americas, and with a network that spans the entire region. We see in Nestle a company with a worldwide research and development, and product development capability We were also attracted to Nestle because of its reputation as a JV partner. It is partnered with Coca-Cola globally except for Japan. Its partnership with General Mills has knocked Kelloggs off the number one perch internationally in cereals. It says something about our industry’s success over the years and the importance of the creation of Fonterra that it is now sees us as an equal partner.

From its perspective, Nestle saw us as the world’s largest exporter of dairy products. What we bring complements Nestle’s strengths. They regard our expertise in farming and milk technologies to be the best in the world. We have built the world’s best skills in large-scale milk procurement, processing and management. We have leading market positions in Chile, Venezuala and Central America already. And our experience over the last decade here in New Zealand means we are recognised for our skills in industry consolidation.

The two partners have agreed on the ownership and governance of the proposed alliance. It will be a partnership of equals and it says that in the very first sentence of the Memorandum of Understanding. The alliance will be a stand-alone entity, owned 50:50 by Fonterra and Nestle. There will be a Joint Supervisory Board, with equal representation from both sides, and co-chairmen. Executives will be drawn from both companies, on merit. The alliance will cover every country in the Americas, from Alaska to Cape Horn.

The alliance will include dairy products, including shelf-stable and liquid milks. Excluded are infant formula, evaporated and condensed milks, some speciality products, and cheese and butter. We will market products under whichever brand will make the most money for our shareholders. Neither we nor Nestle are going to be precious about that. Product will be sourced from our existing suppliers in the region and new suppliers as we need them. That’s the only way we can get into the liquid milks market in particular. Quality ingredients will come from New Zealand.

We are looking at a strong starting position. When the alliance begins, we will start out number one in chilled products in Latin America. We’ll be a major player in liquid milk products in Latin America, and the largest manufacturer of milkpowder in the Americas. It will give us a strong platform for further aggressive growth in the region.

I don’t want us to get ahead of ourselves. What we have announced with Nestle is a plan to develop a joint business. Due diligence starts next week. We’ll be looking at Nestle’s operations in the Americas and they’ll be looking at ours. We have to formalise the alliance, and then we need to identify opportunities in the Americas for JVs that we both agree on.

We complement one another in the market, but there will still be regulatory issues to address in various markets. We have to agree on the valuation of the businesses that will go into the alliance. And we need to be satisfied that the JVs will return dividends to Nestle shareholders and a higher milk price to Fonterra shareholders than could be achieved elsewhere. We hope to have the first JVs up and running in the early part of next year.

While there is still much work ahead, I am enormously proud that the world’s largest food company now sees us as an equal in the dairy business. We couldn’t have done it without the commitment of at least three generations of dairy farmers, supported by successive Governments, to be united in order to have scale. We couldn’t have done it without excellence performance by our industry’s executives over the years, to build such a solid platform for the future. And we couldn’t have done it without our shareholders and the Government making the merger happen.

We now have an obligation to perform; to deliver the benefits we have promised our shareholders, the Government and all New Zealanders. We plan to be a national champion; we plan to earn that status.

My directors and I are now spending the rest of my week explaining the path forward to shareholders in a series of meetings throughout the country. There is time for your questions. Thank you for your interest in our company. I look forward to meeting with you again in the future.

END

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