A few comments need to be made about Fonterra’s contamination scare before revealing how a number of shareholders have hit the jackpot at King Country Energy.

Fonterra’s website boldly states that: “Our board of directors is responsible for the leadership and direction of Fonterra.”

This “leadership” was sadly lacking this week as there was no public sighting of the chairman until Thursday, the fifth day after the crisis broke.

Fonterra’s board composition is a major issue.

The dairy co-operative has 13 directors, nine are elected by supplier shareholders and the remaining four are appointed by the board and approved by shareholders at the annual meeting. There are currently only 12 directors following the resignation of former chairman Sir Henry van der Hayden in May.

The elected directors must have a milk supply relationship with Fonterra while the appointed, or independent, directors “are selected to ensure our board has the appropriate skills and competencies to lead our organisation effectively”.

One of the board’s major roles is to “determine the company’s risk profile and ensure that management has appropriate policies and internal controls in place in respect of risk management, regulatory compliance, health and safety and environmental sustainability”.

It was clear that Fonterra had no predetermined crisis management plan as earlier in the week Gary Romano, the company’s main New Zealand based spokesman, was casually dressed in an open-necked shirt but later in the week all of the company’s spokesmen, including Romano, were formally dressed in suits and ties.

The belated move to formal attire was just one of the indicators that Fonterra didn’t have a clear crisis management plan.

In light of this why hasn’t the board appointed independent directors with hands on experience of crisis management, manufacturing and food safety issues?

Simon Israel seems to be the only one with this background as he had 10 years of downstream dairy industry experience with Danone as a senior vice-president and a member of the group executive committee.

The 12 directors may be as talented as Dan Carter but all successful teams need a variety of skills and no rugby coach would fill his team with 15 Dan Carters.

The Fonterra board needs to be restructured and have a far wider range of skills befitting a major global group. The number of supplier directors should be reduced from nine to seven and independent directors raised from four to six. These independent directors should have a much wider range of expertise with a particular emphasis on individuals who have had extensive executive involvement in large-scale manufacturing and food safety issues.

In addition the chairman should be the individual with the widest range of experiences and expertise rather than being automatically selected from the supplier group.

There is nothing radical about these suggestions, it can be argued that they are just best practice corporate governance.

New Zealand cannot afford another botch up by our largest company and export earner. A botch up is more likely to recur if the board is completely dominated by dairy suppliers and independent directors with limited crisis management, manufacturing and food safety experience.

Royal result

King Country Energy (KCE) was incorporated in January 1991 when it took over the King Country Electric Power Board’s electricity operations. Under a 1999 restructuring it ended up with generation assets and the largest electricity retail operation in the Waitomo, King Country and Ruapehu/Waimarino districts.

After the restructuring the company’s largest shareholders were Todd Energy with 20 per cent, King Country Electric Power Trust 10 per cent, Waitomo Trust 8 per cent with the remaining 62 per cent held by nearly 10,000 retail customers.

Todd Energy, which is controlled by the Todd family, increased its holding to 35.4 per cent before the introduction of the Takeovers Code.

In December 2006, Todd made a takeover offer for 100 per cent of KCE at $4.40 a share but this was unsuccessful.

In February 2007, Todd made a partial offer at $5 a share to reach 50.01 per cent but this was also unsuccessful and the bidder remained on 35.4 per cent.

In March 2012, KCE reached an agreement to acquire the remaining 50 per cent of the Mangahao Power Station from Todd Energy. This would give KCE 100 per cent ownership of the former government commissioned hydro-electric power station on the Mangahao River.

The consideration was $70 million, consisting of $33.76 million of cash and 7,629,474 King Country Energy shares issued to Todd at $4.75 a share. As a result Todd’s shareholding in KCE would increase from 35.4 per cent to a controlling 54.1 per cent.

The directors of KCE not associated with Todd Energy or the King Country Trust, which has raised its stake to 20 per cent, were required to commission an independent adviser’s report. This was in accordance with Rule 18 of the Takeovers Code because Todd would be moving to a controlling 54.1 per cent stake.

Simmons Corporate Finance determined that KCE shares were worth between $5.41 and $6.39 each.

The two independent directors, Toby Stevenson and Brian Needham, recommended that shareholders vote in favour of the transaction even though shares would be issued to Todd at only $4.75 a share.

Shareholders approved the Mangahao transaction on May 31, 2012, even though a large number of shares were cast against the proposal, and Todd became the controlling shareholder of King Country Energy.

However, under the Companies Act 1993 shareholders who vote against a “major transaction” at a special meeting can require the company to purchase shares that were cast as a negative vote.

The provision was first used by Infratil in 2000 when it voted its 6.7 per cent shareholding in Natural Gas Corporation against a shareholders’ resolution to approve the latter’s takeover offer for TransAlta NZ. Infratil then required Natural Gas to buy back its 26.6 million shares and was offered $1.30 per share.

Infratil objected and was paid $1.68 a share after the issue went to arbitration.

Immediately after King Country Energy’s special meeting in May 2012 shareholders – holding 1,069,197 shares or 5.7 per cent of the company – that voted against the Mangahao proposal required KCE to buy their shares back.

The shareholders were offered $4.75 a share and were paid out on that basis.

The dissenting shareholders objected and the issue went to arbitration.

The claimants argued that KCE was giving Todd control at a significant discount to the Simmons’ valuation and Todd would receive the 12c a share dividend for the March 2012 year on the new shares even though they would be issued two months after the end of the financial year. They also claimed that the transaction would have a negative impact on KCE’s share price and would result in a significant transfer of value to Todd at the expense of the minority shareholders.

The arbitrator determined that the dissenting shareholders should be paid $6.39 a share plus interest and costs. KCE’s March 2013 annual report shows that the arbitration cost the company an additional $2,121,000. This was $1.98 a share, including interest and costs, above the original offer of $4.75 a share originally paid to objecting shareholders.

Credit must be given to shareholders who were prepared to utilise their rights under the minority buy-out provisions of the Companies Act and to Craigs Investment Partners, which funded the shareholders’ arbitration costs.

However, the other minority shareholders are not as fortunate because KCE shares were trading on the Unlisted share trading facility this week at only $4.31 a share, $2.08 below the $6.39 realised by the dissenting shareholders.

Brian Gaynor

Portfolio Manager

Disclosure of interest: Milford Asset Management holds shares of Infratil on behalf of clients.