Sensitive hold keeps Bright in control

17:00, Jun 29 2013
RED DRAGON KONG: By holding on to Synlait’s sensitive parts Bright Dairy retains board control without investing any more money.

In Eskimo wrestling, or iqiruktuk, opponents wrap their right arms around each others' necks, place a finger in the corner of the mouth and pull hard. The loser is the one whose head moves first.

Iqiruktuk may look strange to us, but every culture has its own form of wrestling. China, it is said, has a contest of strength and speed in which the players vie to seize an opponent by the balls. The first to achieve the scrotum hold, or red dragon kong, naturally has an unassailable advantage and is the winner.

The sport has spread into many areas of culture and commercial kong is now a common goal in the business world. A fine example can be observed in the work of Cayman Islands company Bright Dairy, part of Shanghai-listed Bright Dairy & Food Co, which has Canterbury dairy processing company Synlait by the balls.

Bright Dairy owns 51 per cent of Synlait, having acquired its stake for $82 million in November 2010. The investment helped Synlait develop its plant at Dunsandel and the company is growing into a significant exporter of milk powder and infant formula.

The next stage of Synlait's development requires more money, so the company is offering new shares in a public offer to raise $75m and list on the NZX.

Bright Dairy is not taking part in the capital raising, so its stake will be diluted down to between 38.5 and 40.7 per cent.


Bright Dairy currently controls Synlait with four representatives on the seven-person board - Zongbo Dong, Ke Li, Shang Yang and Ruth Richardson.

After the capital raising, Bright Dairy will still control Synlait with the same four representatives on the board, although an eighth independent director is due to be appointed within three months of the share offer.

Normally this arrangement would be in breach of NZX listing rule 3.3.8(a), which says the proportion of directors appointed by a shareholder can't exceed the proportion of votes the shareholder holds.

However, Bright Dairy said it would not support the share offer unless it could continue to consolidate Synlait's results into its accounts - a convention that allows Bright Dairy to count 100 per cent of Synlait's revenue and profit as its own.

Normally you don't consolidate numbers like that unless you own most of the shares, but accounting rules say Bright Dairy can do this with a minority stake if it has control of a board.

In the upshot the NZX has waived the listing rule and allowed Bright Dairy to control Synlait's board with a minority stake.

How much practical difference in power there is between a 51 and 40 per cent shareholding is debatable, but in my view it's a shame Synlait and the NZX had to bow to Bright Dairy's demand.

Why Bright Dairy wants to be able to consolidate Synlait's results is not stated in the NZX waiver request or in the share offer prospectus. The Shanghai company has a market capitalisation of $3.6 billion and reported revenue last year of $2.9b and net profit of $65m, so Synlait's revenue of $377m and net profit of $6.3m last year doesn't appear to move the dial enough to warrant such foot-stamping.

As a result, it's hard to see the consolidation thing as anything but a fig leaf for Bright Dairy's urge to retain board control without investing any more money - a desire it can satisfy only via a tight grip on Synlait's sensitive parts.

Synlait has a history of stubborn overseas shareholders. The last time it looked at raising money from the markets in 2009, when it wanted $165m, Synlait had to work around its then 22.5 per cent shareholder Mitsui which was set against a public share offer.

In the end that offer was canned because investors were not keen enough, but it is interesting to note Synlait's performance in relation to the forecasts in the 2009 draft prospectus.

Back then it was expecting revenue to reach $334m by 2012 and the actual number it achieved was $377m. Net profit was expected to be $30m and the actual number was $6.3m.

Those numbers don't compare like with like because Synlait had a different structure in 2009, but they do point to a young business where growth is yet to be fully realised as profitability.

The new prospectus reinforces that view. No dividends are in the offing in the forecast period to the end of July 2014. Net profit for the 2014 year is expected to be $19.7m on revenue of $524m, up from $11m and $426m this year.

The growth is due to come from producing and selling more milk powder and infant formula, particularly in China.

While this is seen as a hot market at the moment, investors should be aware that Synlait is at the milk processing end of the value chain, making products for others to brand and sell. That's a good place to be right now, but businesses in that position are often the first to be squeezed when big customers want to cut costs.

Investors should of course digest the wealth of information in the prospectus. However, the general thrust of it suggests this is one for those with a growth focus.

But whatever our individual investment outlooks, the pending float of Synlait is another welcome addition to the market and a credit to the efforts of co-founder and managing director John Penno.

Maybe he can help me with my idea for a chain of Chinese wrestling academies.

Tim Hunter is deputy editor of the Fairfax Business Bureau.