ORAM Fonterra’s Chinese puzzle
New Zealand’s biggest company has so far failed to show how it or the country will benefit from its latest Chinese venture.
THEORETICALLY, FONTERRA’S investment of $700 million for a 20 per cent stake in Beingmate Baby & Child Food Company will solve two critical strategic problems for the co-op: how to make more money in the Chinese infant formula market; and how to recover from its whey protein concentrate disaster of last year.
In outline the deal is simple. First, Fonterra and Beingmate B&C will form a joint venture to own Fonterra’s state of the art nutritional powders plant at Darnum in Australia. The Chinese company will have priority for the output to use in its own infant formula manufacture in China.
Second, Fonterra will make its Anmum brand of infant formula in New Zealand and export it to Beingmate B&C for sale in China.
As a result, Fonterra forecasts its Anmum sales will rise to $100m by 2018. But Fonterra has yet to clarify if that’s the value of its exports as they leave here or when they sell in the retail market in China.
But either way, the figure is a tiny fraction of the market. Fonterra says the market is worth $18 billion now and will rise to $33b by 2017. These numbers are based, though, on a very wide definition of the market rather than the premium segment Fonterra should be targeting.
Fonterra says Beingmate B&C is the leading Chinese infant formula company with a 10 per cent market share and an extensive distribution network down to fourth tier cities across the country. Thus it makes sense to use this system rather than build its own.
Fonterra has completely missed the opportunity to build its own brand and distribution in China. Only late last year did it begin some pilot projects. Up to now it has ridden the Chinese boom by selling infant formula ingredients to other companies, Chinese and multinationals, and by making products for them under their brands.
This strategy, though, was deeply shaken by Fonterra’s whey protein botulism false alarm last year. For example, Danone, the French multinational, stopped buying products from Fonterra, with Fonterra’s Darnum plant in Australia being particularly hard hit. Based on the last news several months ago, Fonterra is still unable to export New Zealand WPC to China. Moreover, Chinese authorities have yet to approve resumption of Fonterra’s WPC exports from New Zealand to China.
Danone has also bought Sutton Group and Gardians here, which gives it substantial NZ milk supply and manufacturing capability of its own, thereby displacing supply from Fonterra. Danone is also seeking $1b from Fonterra for losses it says the scare caused.
Thus the Beingmate B&C deal seems to go a long way to solving both of these big strategic problems Fonterra has. However, while the deal is simple in outline, it is a great deal more complex in detail. The overriding questions are: how will Fonterra create and capture more value for its shareholders through its relationship with Beingmate B&C? Is the company the right Chinese partner for Fonterra?
As is often the case in China, it is difficult to understand the origins, current business and ownership of Beingmate B&C. Fonterra was unclear on these issues at its press conference announcing the deal.
It called the company Beingmate. But that turns out to be a far wider group founded in 1992 by Xie Hong. This is a large company with a wide range of businesses related to babies and children. One of its subsidiaries is Beingmate Baby & Child Food, which was floated on the Shenzhen stock exchange in southern China in May 2011.
Several conflicting news stories from China in the past two years suggest that Beingmate had sold off its peripheral baby equipment businesses and Mr Xie was no longer involved with the company.
It turns out that Fonterra is buying its stake in Beingmate Baby & Child, resulting in Beingmate Group’s stake in his company falling to around 33 per cent.
Beingmate B&C floated at 15 yuan ($2.91) a share. The shares peaked at 26.14 yuan in October last year, and fell back to 14 yuan on June 18. This seems to be the last day the shares traded.
Fonterra is paying 18 yuan a share for its stake in an on-market offer. This is a 25 per cent premium over the last apparent trade in June. The stake will cost it $700m.
Fonterra says it will earn a financial return on its investment through Beingmate B&C’s dividends. Last year’s dividend was 0.41 yuan a share, which would translate into a $16m, or 2.2 per cent return for Fonterra. The consensus of analysts’ forecasts for earnings this year, however, has fallen sharply in the past six months.
Fonterra says Beingmate B&C generated ebitda of $191m on sales of $1.2b in 2013, but it is not clear how much of those sales were infant formula. It seems the company is also a large seller of rice noodles and other baby foods.
Fonterra says its bigger return on investment will come from selling more infant formula and ingredients for them in China thanks to the Beingmate B&C relationship.
For its part, the Chinese company seems to be paying $85m for its half share in Fonterra’s Darnum plant in Australia. It is a state of the art but seriously underused plant, particularly since the departure of Danone as a customer.
Fonterra says it will export 50,000 tonnes a year of infant formula from Australia to China plus 30,000 tonnes a year of whey products from its European plants. It hasn’t clarified what share of those products will go to Beingmate B&C.
It is clear what Beingmate B&C gains. It has bought a half share in a valuable Fonterra plant and secured a favoured position in Fonterra’s global supply chain. But it is Australian and European milk, not New Zealand milk, which will largely fuel the relationship with Beingmate B&C.
Beingmate B&C will also get an exclusive licence to use Fonterra’s Anmum infant formula brand in China on product exported from here.
Fonterra has yet to make clear how it will benefit from the relationship. It says it will sell more, but at what price? Will it be merely a toll processor exporting to Beingmate B&C? Or will it share in the massive value created from formula sales in China?
If it doesn’t, this costly strategy will achieve little more than soaking up capital and capacity, leaving Fonterra as dependent as ever on commodity products.