The board culture established by former Fonterra chairman Henry van der Heyden and his successor John Wilson, both intense executive chairmen and micro-managers, is at the heart of the company’s problems, writes Rod Oram.

Fonterra’s three-hour AGM yesterday at one of its Waikato plants was filled with complaints and questions from shareholders about the co-op’s dismal, loss-making performance last year, and apologies from the board and management and promises to do much better.

But one little nugget told shareholders more about their co-op’s deep malaise than all the rest of the words and slides put together.

Some 100 days a year was how many Nicola Shadbolt said she’d spent as a director on Fonterra business over the past nine years.

The only working group “I wasn’t on was the Beingmate due diligence one,” she said, drawing a faint, dark laugh from shareholders who are paying a steep price for the co-op’s incompetent and heavily loss-making $755 million investment in the Chinese company.

Only a badly governed company could demand such effort from a director, particularly a highly competent one who is a professor of agribusiness at Massey University; and then “reward” her by deciding in its director nomination process that she didn’t have the requisite skills to stand for re-election.

Nicola Shadbolt at the Fonterra AGM. Photo: Rod Oram

Nor was she alone in the prodigious workload. Yet the outcome speaks for itself. The board had met only one of the seven key performance indicators in the Statement of Intent it had agreed with the co-op’s Shareholders Council, Duncan Coull, the council’s chairman, told shareholders. That was a farmgate milk price of $6.69 per kg of milk solids, against a target of $6.50.

Some of the big commitments it failed to deliver in the last financial year were return on capital (8 percent versus a target of 14 percent); earnings per share (24 cents versus 45-55 cents); gearing ratio (48.4 percent versus 40-45 percent); consumer and food service volumes (5.2 billion litres of milk equivalent versus 5.5b); and to retain and grow Fonterra’s share of New Zealand milk supply (81.8 percent versus 82 percent).

The heart of this governance failure is the board culture established by Sir Henry van der Heyden, chairman 2002-12, and his protégé and successor John Wilson, who stepped down in July because of ill health. Both of them were intense executive chairmen and micro-managers.

Under this style of governance, the board failed to exert stringent due diligence on strategy and investments, or on management performance. Because the chairmen so strongly owned the strategy, they brooked little or no dissent when problems arose.

“Auditors getting too close to an organisation is dangerous and that’s why long tenures are not recommended by any institute of directors anywhere in the world..”

A compounding factor has been the role Pricewaterhouse Coopers has played as auditor. It is in its eighteenth year in the role, which is completely contrary to good governance guidelines and, in some jurisdictions, laws setting maximum terms.

At the AGM yesterday, shareholders approved PwC’s reappointment but only after a strongly worded demand for a term-limited auditor. This came from Greg Gent, a Fonterra farmer shareholder who was a founding director and first deputy chairman when Fonterra was created in 2001.

Gent said it was important that the co-op’s accounts should have a “bias towards conservatism” and be read with confidence by shareholders.

However, PwC ‘s judgment on Beingmate’s value “had been incredibly wrong”, he said. Rather than take the market price of Beingmate’s shares it had taken two forward-looking internal views on Beingmate’s potential value.  “In my gut, I suspect history will repeat itself” with Fonterra’s farms in China because of over-optimistic views on the price they will get for their milk, Gent said.

Moreover, the co-op’s relationship with PwC was too close. “Simply being a PwC executive is a runway to the Fonterra board.” (Two current directors, Bruce Hassall and Brent Goldsack, are former senior PwC executives.)

“Auditors getting too close to an organisation is dangerous and that’s why long tenures are not recommended by any institute of directors anywhere in the world that I am aware of,” Gent said.

His criticism drew perhaps the loudest and longest applause from shareholders during the meeting.

In reply, John Monaghan, the co-op’s new chairman, said the board had a request for proposals out for the provision of auditing services. Gent asked if the board would look at the issue of tenure. “Yes, we will, Greg,” Monaghan replied. Nonetheless, PwC will remain the auditor at least for the rest of this financial year.

… they made it clear that Beingmate was a divestment candidate in part or entirely.

According to several current and departing directors speaking privately, Monaghan has begun to improve the board’s processes and culture. He seems an unlikely person for the task given he has been on the board since 2008, and was a loyal supporter of van der Heyden and Wilson as chairmen.

One of his first steps was to simplify the proliferation of sub-committees and other working groups. He also seems to be trying to be less of an executive chairman than his predecessors, although he did dominate the AGM proceedings, giving Miles Hurrell, the interim chief executive, only a few brief opportunities to speak.

Neither of them said much new about the asset review under way. However, they and chief financial officer Marc Rivers made it clear that the co-op needed to reduce its debt this year by some $800 million in order to keep its high credit rating. Asset sales, they said, would contribute significantly to that goal.

To that end, they made it clear that Beingmate was a divestment candidate in part or entirely, with Goldman Sachs hired to find a buyer and to rework the joint venture ownership between Fonterra and Beingmate of Darnum, a major milk powder and ingredients plant in Australia.

Whether Fonterra can extract any value from exiting Beingmate remains to be seen. One sign of the deep dysfunction of their relationship and its lack of value to Fonterra is the strong recent growth in sales of Anmum, Fonterra’s main infant formula brand. Since Fonterra took back its distribution from Beingmate in May, ecommerce sales have jumped 43 percent, Monaghan said.

But Fonterra’s farming joint venture in China with Abbott, the US infant formula maker, was not on the block, they said. This implied, though, that the rest of the China Farms assets were.

However, the co-op is working the wrong way around in its attempt to achieve greater clarity of purpose. It should be sorting its strategy first before selling assets. On its current course, it could dispose of an asset it later decides was useful for its refreshed strategy.

Again, it was Shadbolt in her valedictory comments that homed in on this. “I’ve not seen capital as a constraint. What I have seen as a constraint is our ability to invest wisely and turn it into a profit. So that’s something we have to do a lot better.”

She also made a powerful case for good governance and for the co-op. From its establishment in 2001, a clear distinction was built into its structure. The shareholders’ council is the co-op’s representative body. Its large membership is elected from wards around the country, a system designed to give farmers a sense of close connection to the co-op and of being heard.

The council is entrusted with holding the Purpose of the co-op, which it is currently revising. To execute that Purpose it runs the country-wide elections for the board and agrees with the board a statement of intentions. It then leaves the board to govern management, and the management to run the business. The council is meant to keep a watchdog role over the board on behalf of shareholders. But so far in Fonterra’s 17-year history, the board has dominated.

As Shadbolt told shareholders: “We have a unique structure with our governance, our representation and our management. We need to make sure that triangle absolutely functions the way it is intended. Governors should always be governors, representatives have a very clear role and should be respected in that role…and be impactful…and management should be empowered to deliver.

“As soon as you have people delving into places where they do not belong – and I have seen that in the past nine years – you disempower management and you basically make the board redundant…and the shareholders’ council too.

“Shareholders’ council: you are the guardians of the faith, you will protect the co-operative. It is the best business model that exists in the world for our business and the way we function over many generations. So, it is absolutely in your court to make sure the co-operative is strong.”

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