When Fonterra, the world’s biggest dairy exporter, paid $553m for a minority stake in Chinese infant formula maker Beingmate, it represented a second run at the world’s largest formula market after its previous partner was shut down in a safety scandal.
But the 2015 deal that it described as a “game changer” has turned sour. Its Chinese partner has lost 70 per cent of its market value in three years. Both companies have been critical of each other and some of Fonterra’s 10,500 farmer shareholders are questioning whether the co-operative should dump its investment.
Beingmate was profitable when Fonterra acquired an 18.8 per cent stake in March 2015. Yet by the end of that year its operating income had fallen 10 per cent to Rmb4.5bn. It reported profits of Rmb104m, bolstered by state subsidies of Rmb124m.
Revenue for the year ending December 2017 fell 4.2 per cent to Rmb4.2bn ($664m) at the Shenzhen-listed company as it made a loss of Rmb964m — the second consecutive year of losses.
Fonterra said it was “extremely disappointed” by the poor performance of Beingmate, whose market share in China has fallen from 9 per cent in 2013 to 2.5 per cent now.
Problems at Beingmate, which amassed large debts as it expanded rapidly, have raised questions about decision-making at Fonterra, New Zealand’s largest company with a NZ$9.4bn ($6.8bn) market value and NZ$19.2bn revenues, while also highlighting how minority investors in Chinese companies struggle to influence management.
The stakes are high for Fonterra, which is crucial to New Zealand’s economy, supplying almost a quarter of its NZ$53.7bn total exports. China is its biggest market, consuming a quarter of the milk produced by Fonterra farms — prompting the co-operative to work hard to find a new long-term partner after its previous disastrous joint venture. Fonterra’s Chinese business generated NZ$3.4bn revenues last year.
Its China difficulties have raised questions over corporate governance at the co-operative, with criticism of its board composition. And there are concerns about Beingmate.
Four Beingmate directors, including Fonterra’s two designated directors on the board, Johan Priem and Christina Zhu, said in January that they could not guarantee the accuracy of the company’s financials “because of risks in the company’s internal controls”.
In February, China’s securities regulator in Zhejiang province, where Beingmate is based, said in a letter that there were unexplained risks in the company’s internal controls, and that its management was flawed.
Beingmate hit back in a letter reportedly sent to Chinese regulators, criticising Fonterra. “It has come to a point that the two parties could not reach agreement, which is seriously affecting the company’s business operation and development,” state media reported the letter as saying.
The apparent breakdown in relations between the two and the worsening financial situation at Beingmate are alarming farmer shareholders, who under the co-operative structure must invest in the company to be a Fonterra supplier. Late last month Fonterra Shareholders’ Council — an elected national body of farmers — met management to discuss the situation.
“There is some anxiety among the shareholder base. We are expecting the chief executive and chairman [of Fonterra] to give some clarity at the results at end of March,” said Duncan Coull, the council’s chairman.
He says the situation at Beingmate is concerning, but that it is too early to determine whether Fonterra should abandon its investment.
Fonterra is no stranger to the challenges of operating in China. In 2008, Sanlu, in which Fonterra held a 43 per cent stake, was at the centre of a high-profile scandal involving powder tainted with the chemical melamine, which led to the deaths of six babies and the hospitalisation of tens of thousands of others.
Sanlu went bankrupt, while two people were executed and a number of others, including Sanlu’s chairwoman, were jailed for their roles in the scandal.
The scandal helped overseas companies to dominate China’s powdered milk market. Foreign brands account for about three-quarters of powdered milk sales in China — worth $19.7bn last year, up from $12.5bn in 2012 as wealthier consumers upgrade to more expensive varieties, according to Euromonitor.
Mr Coull says there are no parallels with the Sanlu situation and Beingmate.
Fonterra’s management says it remains committed to Beingmate. “There is no talk of backtracking or exiting,” says Kelvin Wickham, head of sales and marketing of Fonterra’s global ingredients business.
“Our view is that the strategy was correct. We felt for us to extend our Anmum infant formula business in China we needed a partner and Beingmate had a fantastic distribution network.”
However, analysts say that Beingmate continued to focus on its own brands, and did little to boost the market share of Fonterra’s products. Now some shareholders are beginning to question the robustness of the co-operative’s governance structure and the due diligence it conducts on deals.
“It’s understandable to make a mistake once, even one as dramatic as Sanlu,” says an adviser to foreign dairy companies in China. “To have invested in Beingmate and to be a minority in another infant formula maker — you have to question that judgment.”
There was a rush among foreign dairies to find Chinese partners. “Fonterra bought into a company with big questions about its management and its place in the market,” the person adds. “The other main dairy companies in China had been already spoken for . . . Fonterra began very late in the day.”
Fonterra’s minority stake in Beingmate gave it limited influence, the person says. “There needs to be a structure where there is a right to influence as much as you need to . . . there’s an unwarranted degree of dependence on the Chinese partner.”
Fonterra took its first impairment charge — of NZ$35m — on its Beingmate investment in September 2017. One industry insider says the total loss to Fonterra could hit NZ$1bn.
Leonie Guiney, a farmer shareholder and former Fonterra director, says: “What we need to do is write the thing [Beingmate] off and move on and really question our investment culture.”
Fonterra obtained a high court injunction on March 2, preventing news outlets served with it from using or publishing any “confidential” material from Ms Guiney. Fonterra later wrote to its shareholders stating the injunction was to prevent the publication of “leaked” details of board discussions.
Colin Armer, another former Fonterra director and a farmer shareholder in the conglomerate, says dairy farmers are struggling and lossmaking investments do not help their plight.
In 2015 Mr Armer joined Greg Ghent, a former deputy chair at Fonterra, to call for reform of governance at the group, including reducing the board’s size from 13 to nine directors. Their proposal attracted 54 per cent of the shareholder vote but not the 75 per cent required to implement change.
A year later, Fonterra reduced its board to 11 directors but, according to Mr Armer, the reform does not go far enough. “The board is still too big and unwieldy,” he says.
However, others offer a less harsh assessment of Fonterra.
“It looks terrible in hindsight but there were few red flags raised at the time. No one expected the Chinese dairy market to consolidate so much,” says Oyvinn Rimer, director at Harbour Asset Management.
China’s authorities have tightened regulations, closed unqualified dairy operations and encouraged industry collaboration in a drive to improve milk quality and safety.
Mr Rimer says the partnership must also be seen in the context of Fonterra’s difficulties with Danone, the French food giant which sued the co-operative following a recall of infant formula linked to a false botulism scare in 2013. In November last year an arbitration panel ordered Fonterra to pay Danone $125m.
Fonterra lost Danone, one of its biggest customers, and needed a new partner to buy milk powder from its Darnum plant in Australia. This was a key aspect of Fonterra’s tie-up with Beingmate, which agreed to buy a 51 per cent stake in the plant.
Beingmate’s woes have been compounded by a new registration system for milk powder products launched in January, which has left the company with Rmb233m of stock which cannot be sold in China, according to its latest report.
Beingmate’s deteriorating financial performance and the growing tension between the two companies underline the risks for Fonterra in remaining in a partnership where it lacks control.
“The question farmers are asking is, why Fonterra didn’t learn any lessons about owning a minority stake in a Chinese business after Sanlu?” says Ms Guiney. “Did we not learn how difficult it is to actually have influence on a partnership in China? And we went and did the same thing again.”
Analysts say signs of trouble at Beingmate predate Fonterra’s investment. Founder Xie Hong began to expand production from 2011, racking up huge debts.
Production capacity grew rapidly to reach 200,000 tonnes annually, making it the world’s biggest baby formula manufacturer, according to independent dairy analyst Song Liang. That came as industry margins were hit by a global dairy supply glut beginning in 2013.
Meanwhile, the Chinese government in 2013 fined six baby formula manufacturers, including US company Mead Johnson, more than $100m for price fixing. This prompted several companies to drop prices including Beingmate, which reportedly achieved 20 per cent reductions through measures aimed at distributors rather than lowering wholesale prices. The company also attempted to bring its distribution network in-house in 2014, which analysts say alienated both distributors and retailers and cost it market share.
“They listened to the government too much. The company did not lower its wholesale prices so put pressure on retailers. It lost a lot of trust,” says Mr Song.
Beingmate’s management has appeared “chaotic” — the board chairman has changed three times in the past four-and-a-half years — and the continued influence of the family of founder Xie Hong means professional managers are often excluded from key decisions, says Mr Song who formerly advised the group.
In 2016, Shanghai police found a batch of counterfeit Beingmate-labelled powder. The company said the incident was partly responsible for a decline in revenues.
By: Jamie Smyth in Sydney and Tom Hancock in Shanghai
Source: THE FINANCIAL TIMES