Rod Oram warns in this week's column that Fonterra shareholders should brace for more bad news about the cooperative's disastrous investment in Beingmate Baby and Child Food.
By design or accident, Fonterra triggered on Monday the endgame in its relationship with Beingmate Baby and Child Food, the Chinese infant formula company in which it invested $750m less than three years ago.
The breaking point came when Fonterra went public with criticisms of aspects of Beingmate's corporate governance made by Fonterra's two board appointees. The news alarmed some Beingmate's investors and deepened the distrust and dysfunction between the co-op and the company.
By many accounts it has always been a difficult, unfulfilled relationship. Some things are obvious. Fonterra said it would receive $16m of dividends a year on its Beingmate shares. But just as it bought the shares in 2015, the company reported plunging profits then losses, and hasn't paid a dividend since.
At an operational level, there are reports of great tensions between the two companies over the likes of formula supplies and sales, and over Fonterra's use of other channels in the formula market.
Despite Fonterra's constant reassurance to its shareholders their investment was progressing, the real state of affairs began to seep out last September in Fonterra's briefing to media on its year-end results.
Fonterra chief executive Theo Spierings conceded only 2,000 tonnes of its Anmum infant formula were sold through 8,100 of Beingmate's 40,000 plus stores in the past year. Based on Fonterra's typical revenues on formulas, that's worth only around $10m. Last year, Fonterra's total Chinese sales were $3.4 bn.
I examined this and other issues about the Beingmate/ Fonterra relationship in my NewsroomPro column on September 30.
Yet when Fonterra announced in August 2014 it was taking a stake in Beingmate, it touted the investment as a cornerstone of its Chinese strategy. As recently as last September's briefing, it was still talking up seven strategic synergies between the two companies across their businesses.
But so far it has executed fully on only one -- the sale of a half share in its Darnum processing plant in Australia to Beingmate. Yet, if the relationship between the two companies continues to deteriorate, that commercial arrangement could become fraught too.
Two disconcerting patterns stand out in the Fonterra-Beingmate relationship. First, Fonterra expresses high hopes for Beingmate; Beingmate disappoints; Fonterra says the problems are with the market not the company, Beingmate has competitive advantages other companies don't have to overcome them, and the market opportunity remains huge; Beingmate disappoints again; Fonterra blames the market again.
Fonterra was at it again on Monday after Beingmate announced more bad news: "The Chinese market is growing rapidly and within five years, forecast demand for infant and baby dairy products will be more than the total for other global markets, so the potential remains."
This is a classic mistake that many foreign companies make in China. Seduced by the scale of the market, they pay insufficient attention to the way they're doing business there.
But in a sharp break from its past positive responses, Fonterra said on Monday it was "extremely disappointed" by Beingmate's forecast that its loss for 2017 would be between yuan 800m and 1bn ($171m-$214m), double its forecast three months ago.
The heavy loss was a shock. Fonterra had long said Beingmate was a front-runner in the market. For example, under a new Chinese regulatory regime it won last year approval for 51 of its infant formula recipes, more than many of its competitors.
"We are disappointed that Beingmate is not maximising the opportunity created by the
early registration of its 51 formulations under the new registration rules," Fonterra said on Monday in its first public rebuke of the company.
The second worrying pattern is that Beingmate has revealed enough publicly over the past three years to raise questions about its capabilities. This is notable given the limited, and not always reliable information, Chinese companies, even stock market listed ones like Beingmate, are required to make.
Yet, Fonterra, at least in its public pronouncements, seems to have ignored the warning signs from Beingmate. This raises crucial questions about how well Fonterra understands the business on the inside.
For example, when Fonterra was buying Beingmate shares from February 12 to March 13, 2015 to accumulate its 18.8% stake, the company reported its 2014 results. Operating profits had fallen 90% to yuan 104.4m from the prior year, on a 17% drop in sales to yuan 5.06bn.
Fonterra had given "due consideration" to the results when it went ahead with its $750m investment, Lukas Paravicini, the co-op's CFO, said five days after the deal closed. He is currently the co-op's Chief Operating Officer Global Consumer and Foodservice.
The final sum Fonterra paid was 22% higher than the $615m estimate it had given the previous August when it announced its interest in a 20% Beingmate stake. Some 42% of the shares it bought came from the Beingmate parent company, rather than the market.
Fonterra said Beingmate was a "game changer" for it because the company was a leading Chinese maker and distributor of infant formulas. But the business has deteriorated markedly, racking up considerable losses in the time Fonterra's been an investor with two representatives on the board.
For example, dependent on its bricks and mortar strategy with a few owned and many franchised stores, it was side-swiped by the rapid shift to online sales. It has lost its market leadership in domestic brands, its core strength, to others such as Fei He and Jun Le Bao.
Beingmate also suffers from internal conflicts, such as fierce disputes over whether selling Fonterra's Anmum formula through its channels, or even heavily sourcing powders from overseas to formulate into Chinese brands, is a good or bad idea.
"You don't want to raise other people's babies," one senior executive told the writers of a Harvard Business Review case study of the company. First published in 2002 and most recently updated last March the study is a far more comprehensive explanation of Beingmate's history, travails and strategic challenges than Fonterra has ever supplied.
Through all this turmoil during Fonterra's involvement in Beingmate, the company has significantly underperformed its peers. The chart at the top of the column, for example, shows its share price versus Chinese dairy market leaders Yili (in blue) and Mengniu (in orange).
It's notable how sharply the performances have diverged, particularly since the middle of last year when the new infant formula registration regime was coming into effect. Clearly, Mengniu and Yili have fared far better than Beingmate in this drastic shakeup of the market.
But Beingmate's under-performance dates back some years, according to analysts' reports comparing the likes of its sales, profits and profit margins with its peers.
Can Beingmate Baby and Child's owners and managers turn it around? It would be a Herculean task, given its long string of losses and its strategic shortcomings.
More importantly, does its parent company, Beingmate Group Co. Ltd., believe the listed subsidiary, in which Fonterra is invested, has a future?
There are signs the parent, a private company still controlled by its founder Xie Hong, is losing faith and interest in the formula business.
For example, Xie is enjoying success with BGI Genomics, a company he has been nurturing for some years with the likes of a major US acquisition, which has had a spectacular performance since it was floated on the Shenzhen Stock Exchange last July. Beingmate is also branching out into health and insurance with BGI.
Meanwhile last year, Beingmate Baby and Child proposed selling some of its major tangible assets such as farms to Beingmate Group.
On Monday, Fonterra said questions over the valuation of those assets had been raised by its two directors on the board, Christina Zhu and Johan Priem. The former is President of Fonterra Greater China. The latter was her predecessor and also a colleague of Spierings at Royal FrieslandCampina, the Dutch dairy co-op, a decade ago.
During this debate between Fonterra and Beingmate over asset values last year, Beingmate lacked a designated chief financial officer. Shen Lijun quit the company in May and Chen Bin was not appointed in his place until mid-December.
Broadly speaking, Fonterra has three options with its stake in Beingmate Baby and Child:
Take control: There were some media reports in China this week that Fonterra had gone public with its governance concerns in order to depress the company's share price so it could acquire it on the cheap. Fonterra issued a statement strongly denying any such intention. Good. It's not clear how much value's left in Beingmate. Anyway, running it would be well outside Fonterra's skill set.
Make peace: Given Fonterra's public criticism of the company's governance, their fraught relationship, and meagre rewards for them from their collaboration to date, that would be a challenge.
Sell: Finding a buyer would be an even bigger challenge; getting a face-saving price harder still.
Fonterra's shareholders have long had plenty of questions about Beingmate but their board has denied them the answers. Now the board is promising to report on Beingmate at its interim results in late March.
But having finally broken its silence this week on some of Beingmate's deep problems, Fonterra could find events are now out of its control. Shareholders should brace for more bad news sooner rather than later.