Milco pounced on a solidly performing company with a weak share price

It’s been one of the tropes of government policy for the past zillion years that SA should focus on beneficiation of its raw materials. Dairy company Clover is a good example of how difficult this is to achieve, and in some ways the buyout offer is both a consequence and a possible solution to those difficulties.

The short history of Clover is extremely long. The company was started by Mooi River dairy farmers over a century ago, as a buyer and processor of their main product, milk. The first thing the company did was build a butter factory. This was the beginning of a long process of beneficiation of milk into cheese, yoghurt and flavoured drinks, something government types would normally applaud.

Except it wasn’t easy because in supplier-dominated companies, the incentives are all a bit mixed up. The farmers were really looking for a kind of balancing system to mitigate the huge volatility in the milk price.

What happened with Clover has been a progressive process of the corporatisation of the farmers’ asset; the buyout offer by Milco signals, more or less, the end of that process. The company was really a bit of mess until an attempted takeover by HCI in the late 2000s. HCI’s strategy was to break the company up, but they were foiled by dairy farmers who had a hold on the board.

The battle did, however, encourage farmers to be more aggressive in corporatising the company, and it was at this stage better management was brought in, including CEO Johann Voster. That process culminated in a listing in 2011.

At the point of listing, the farmers took a step back, becoming large stakeholders but not dominant shareholders. Having more or less solved the problem of the farmers being too dominant in the system to the detriment of the company, Clover discovered it had a problem on the other side of the equation; shareholders.

The share did increase nicely in the early years, moving from R10.50 on listing to about R17 a few years later. But then, for all kinds of reasons, it got stuck. And it was stuck despite the fact that turnover was improving at a respectable pace.

Independent analyst Anthony Clark says the problem was that the market saw Clover as a former co-op in transition and was anticipating a margin increase in line with a more corporate ethos of a normal food company. That took some time to achieve, but it remained a cyclical business, which shareholders struggled to appreciate. Clover tried to remove this cyclicality by establishing an arm’s-length milk seller called Dairy Farmers of SA (DFSA) and establishing a kind of system of crossguarantees for production volumes and milk purchasing. year, For’Clover, it s crucial which to have buys a secure 600-million litres of milk a supply, so in some ways the problems with the DFSA structure were always going to be their problem. The result was recently visible in Clover’s results since it was effectively forced to bail the structure, which threw the company in its first loss over the past year.

Ironically, Clark points out, milk products have an excellent prognosis. This is partly because of urbanisation, which increases electricity use, which in turn increases the number of fridges. Of all food group categories, dairy products are growing the fastest, which is why Clover has generally performed pretty well over the past decade despite the shocking economy.

The consequences of a contradiction between a solidly performing company and a weak share are absolutely inevitable; a takeover. It’s pretty incredible that any company can offer a 31% premium over the share’s average price over 30 days prior to the release of the original cautionary. If that is possible, you have to ask why the market was not seeing the value. As for shareholders, they are more or less obliged to accept the deal and go off to drink their champagne, which in this case they have done.

But this is not the end of the story, because, if I have it right, the farmers exit at this point.

That further shifts the balance of power between the producers of the raw material (in this case milk) and the sellers of the beneficiated product. This may be a good thing; it may be a disaster. There are some successful vertically integrated dairy product companies around the world but, arguably, its better for primary and secondary producers to be separate, and for the market to establish the relationship between them. But it does show how difficult it is for a primary producer to also be a secondary producer.

It will be interesting to see how this will work out. For Milco and its partners, which now include Brimstone, the challenge will be to produce products to compete with the dazzling array of alternatives.

They have good international relationships so it seems possible. But it is also possible to argue that Milco is scooping the cream off the top (sorry, irresistible) and leaving the farmers adrift. The deal is certainly going to cause ructions in the dairy industry; let’s hope they are ready for it.