New rules will fuel food companies' corporate plans

RADICAL restructuring of Irish agri food co operatives is being sustained with new reforms proposed by IAWS and Kerry. Both have brought forward proposals designed to unlock value for co op shareholders and provide future equity funding for the publicly quoted companies (plcs).

These changes mark a further watershed in the development of the Irish food industry and keep Ireland at the cutting edge of the global co operative movement.

Prior to these proposals, Kerry and IAWS co ops held majority shareholdings in their plcs since their respective stockmarket flotations in 1986 and 1988. A series of equity fundings over subsequent years in support of acquisition led growth has diluted the co op holdings.

Under rules adopted before their flotation, the co ops could not reduce their stakes in the plcs below 51 per cent without resort to shareholders. This created two barriers for the co op/plcs:

. it restricted the ability of the plcs to raise equity finance, and,

. the co op shareholders were unable to unlock the value inherent in their investment.

The latter problem has become a larger issue as the success of the plcs has been converted into higher share prices. In IAWS, for example, the plc share has risen from 63p in 1988 to 157p at present. Kerry's share price rise has been even more dramatic, rising 12 fold from 52p in 1986 to 625p at present.

As this has occurred, co op investors have held shares whose value has been largely unchanged since flotation. This is primarily due to legislation which stipulates co op shares can only be valued at £1. Based on current prices each co op share in IAWS has an underlying value of £5.59, while each Kerry co op share has an inherent value of £68.14.

The proposals being put before shareholders in the next three months are as follows:

IAWS:

. Co-op shareholders have an option to convert 3.4 million co-op shares into 12.1 million plc shares worth £19 million based on a quoted plc share price of £1.57 per share. This values each co-op share at £5.59.

. The co-op shareholding in IAWS plc will decline after this exchange from 54 per cent to 44 per cent.

. The co-op shareholding will not be allowed fall below 30 pear cent without further rule changes in IAWS Co-op.

Kerry:

. Co-op shareholders have an option to convert 1.96 million co-op shares into 21.37 million plc shares worth £133.5 million based on a quoted plc share value of £6.25 per share. This values each co-op share at £68.14.

. The co-op shareholding in Kerry Plc will decline after this exchange from 52 per cent to 39 per cent.

. The co-op shareholding will not be allowed to fall below 20 per cent without further rule changes in Kerry Co-op.

. Kerry is also to consider granting an option to the co-op shareholders allowing them to negotiate the purchase of the agri business division of Kerry plc at some future date. This option is to be debated over the coming months and is designed to assuage concerns about the theoretical prospect of a hostile bid for the company.

What would These Change Mean?

The implications of these changes in both co-ops are considerable.

The two companies' shareholding structures will evolve away from the co-op/plc hybrids towards those of conventional stockmarket quoted groups. Companies such as Fyffes, Smurfit and Independent Newspapers have sizeable minority shareholders which do not detract from the overall perception of their businesses.

The liquidity of shares in the plcs will also improve. A number of institutional investors prefer to buy and sell shares in companies where trading is smooth, allowing them to accumulate or dispose of holdings relatively quickly at pertaining prices.

A criticism often levelled against the co-op/plcs has been the difficulty in trading shares. Further, it is not easy for an institution to accumulate a shareholding in its portfolio that reflects the Coop/plcs' share of the ISEQ index.

For example, Kerry accounts for 5.7 per cent of the ISEQ but because the co-op owns 52 per cent of the plc, investors can have problems in spending almost 6 per cent of their portfolio on Kerry shares.

In some cases institutions wishing to obtain an index weighting are unable to buy shares at a price within their valuation criteria. One benefit of this restructuring will be some flow back of shares to the market.

Although neither company is issuing new shares, the exchanges will allow co-op shareholders to sell their plc shares in the market. Both companies expect this flow back to be relatively small.

Kerry farmers already own over 8 per cent of the issued shares in Kerry plc and have been unwilling to sell these in the past. The shares which they will now receive are also unlikely to be sold because (a) they would attract a significant capital gains tax liability and (b) the prospects for Kerry suggest the quoted share price will advance over the next year. Similar arguments will limit the flow of IAWS stock onto the market.

The unlocking of the 51 per cent restriction allows both companies to use their equity in support of further expansion. It is clear that

Kerry wants to acquire other businesses in the international food ingredient markets. IAWS, too, is clearly focused on significant growth over the next five years, of which acquisitions will form a central role.

At present both companies enjoy a supply of low interest borrowings that are more attractive than equity finance as a source of money. However, future increases in interest rates and the need to maintain strong balance sheets will undoubtedly make equity financing a viable option.

Either company could use equity in part consideration for acquisitions or as a direct source of finance via placings and/or rights issues.

The overall co-op/plc corporate structure was invented in 1986 and these latest changes represent an innovative and progressive response to challenges facing the Co-operative movement.

Many co ops in the EU food industry today face financial constraints similar to those incurred by Irish co-ops in the mid-1980s. By adopting new shareholder mechanisms Irish co-ops have secured finances to support aggressive expansion programmes. These new rule changes will further fuel the corporate strategies of IAWS and Kerry.