OPINION: Synlait represents the best and worst about the dairy industry. On one hand it is admirably ambitious. On the other, it has been far too dependent on debt.
Its three founders - John Penno, a farm systems scientist, and Juliet Maclean and Ben Dingle, dairy farmers, had big plans when they moved from the Waikato to Canterbury in 2000 to establish Synlait.
They have achieved a great deal since. They have built Synlait Farms into a large corporate farming business with assets worth around $215 million (or about $90m net of debt). As a leader in farming practices, the company was Lincoln University Foundation's 2012 South Island Farmer of the Year.
As the founders intended from the outset, they have also built an innovative processor of the milk from their farms and others.
Synlait Milk, which floated on the NZX in July, has a market cap of $520m.
Farmers and primary processors need lots of capital to acquire and build a big portfolio of physical assets. In contrast, a software company can leverage much less capital into much greater value, if it develops world leading intellectual property, as Xero is doing.
Synlait was able to attract a few domestic equity investors. Currently Synlait Farms is 50.2 per cent owned by the founding trio with the balance held by another 100 investors, many with farming backgrounds.
But it has struggled to attract wider equity support locally. Instead it has been heavily dependent on foreign investors, such as Japanese trading house Mitsui and Bright Dairy, the dairy processing company owned by the Shanghai Government.
Synlait has always carried a heavy debt burden, on farm and in processing. Synlait Milk finally achieved financial stability with its float in July, with Bright Dairy taking a 39 per cent stake, down from its 51 per cent pre-float.
Now it is Synlait Farms turn to bring in a big equity owner to give it financial security. The company hired Cameron & Co to find one. It got 15 responses from the 100 or so potential investors worldwide it canvassed. From those, Synlait Farms did a deal with Shanghai Pengxin, the Chinese conglomerate that paid some $200m for the 16 Crafar farms last December.
Shanghai Pengxin is offering Synlait Farms' shareholders $2.10 a share. The founding trio have committed their stakes totalling 50.2 per cent; and Maclean, chief executive of the farms, says the offer is being well received by other shareholders.
If the deal succeeds, Shanghai Pengxin will own 74 per cent of Synlait Farms and Penno and Maclean will own 26 per cent. Dingle is selling out. The capital injection will enable Synlait Farms to pay down debt and invest in improving existing farms and potentially adding more.
"We'll grow again," Maclean says. Ambitions include qualifying its 13 farms under the top category of Synlait Milk's environmental programme so they earn a premium price for their milk; developing farm management skills adapted from lean manufacturing disciplines; and extending the scope of the farm's Synlait Vets animal health subsidiary.
The urgent need for the Shanghai Pengxin deal is clear from Synlait Farms accounts. In February it took on even more debt under its separation from Synlait Milk before the latter's float.
A presentation to Synlait Farms' shareholders in March showed debt rising on a pro forma basis in the 2012 accounts to $128m, making debt 68 per cent of total capital, up from $112m, or 62 per cent, in the actual 2012 accounts.
The company's accounts for the year ended May 2013 show how heavy the debt burden is. Revenues of $31.6m generated earnings before interest and tax of $7.94m. But interest costs of $7.51m, left only $430,000 in net profit before tax.
Plenty of other dairy farmers around the country are running the same tax-efficient model of high debt and slender profits. It allows them to grow their farms fast so they can take their final reward by selling out, rather than earning large profits along the way.
Global milk prices are getting increasingly volatile; interest rates are exceptionally low now but will certainly rise; these days fewer New Zealand investors can provide the capital to give farm owners an exit at a price they want; and the local dairy industry still struggles to work its way up the value chain from commodities.
There are, however, some eager foreign buyers with three big competitive advantages: a much lower cost of capital; a long-term strategy; and an integrated business model that enables them to create and capture value right up the value chain to the end consumers.
Shanghai Pengxin is one. If its bid for Synlait Farms succeeds, the 13 Canterbury farms will complement the 16 North Island farms it bought last year, says Andy Macleod, chief executive of Pengxin NZ Farms Group.
The deal will make Shanghai Pengxin one of the country's largest corporate farmers, only a year after buying its first properties. The Canterbury farms will continue to supply Synlait Milk and the North Island ones Fonterra.
Moreover, the deal would bring a talented farm management team, led by Maclean, to complement the relationship Shanghai Pengxin has with Landcorp, the SOE managing its North Island farms, Macleod adds.
Shanghai Pengxin has committed to the Overseas Investment Office that it won't invest in processing plants. But it will develop relationships with processors. For example, it has struck a deal to sell UHT milk produced by Maori-owned processor Miraka under one of its own brands.
The company has also pledged to export only finished products, rather than do further processing offshore; and to reinvest here all profits generated locally. It is interested in buying more farms if they come in geographically efficient groups with good management.
Without doubt, Synlait Farms and Synlait Milk are impressive. On farm and downstream they are fast-growing, industry leaders. But they can only be so thanks to hefty ownership by overseas investors.
New Zealand dairy investors had better watch out. If they can't wean themselves from their debt-driven commodity model, they will find themselves increasingly muscled off their home turf by foreign investors.
- © Fairfax NZ News