Memorandum submitted by David Wilkinson
(DFoB 35)
INTRODUCTION
I am submitting this evidence at this 11th hour
because, having viewed the evidence given thus far, I fear there
is a danger that the wrong conclusions may be drawn and an opportunity
missed for some real progress. I believe much of the evidence
has been governed by continued vested interests both commercially
(understandably) and politically.
I intend to cover the following points
1. Board structure and governance.
2. Strategy.
3. Capital structure of DFB.
5. Financial reporting of co-ops.
6. Development of the liquid business against
a changing market.
But first a short background.
BACKGROUND
DFB was formed at a time of low milk prices
and massive oversupply with UK annual production running well
ahead of its current position. A particular issue was the spring
flush and the ability to process all the milk in May at all, never
mind profitably. Coops at that stage had done little but broker
milk and farmers seemed to be at the mercy of the PLC processors
who used the oversupply of spring milk to control the price for
the rest of the year. In general co-op milk prices lagged the
other prices by 0.5-1ppl. There was general agreement that milk
prices were unsustainable and that the way forward was to copy
the successful model of the continental co-ops.
There are some large figures attached to the collapse
of DFB but please keep in mind the size of the prize. Continental
farmers have by processing milk and having just a little control
of the market achieved better milk prices throughout the last
decade. Every 1ppl is potentially worth £140 million per
year on farm, across the whole of UK milk.
BOARD STRUCTURE
AND GOVERNANCE
The myth that modern dairy co-ops are run by
farmers, who have little experience beyond the farm gate, needs
to be put to bed. Modern co-ops recognise these shortcomings and
fill the Boardroom with experienced professionals from the food
industry. DFB was no exception. At the time of the ACC acquisition
the Board consisted of eight plus one advisor. The advisor was
Norman Coward ex- head of agricultural banking at HSBC. Of the
eight directors, three were non-farmers. Rob Knight was ex-CEO
of Masterfoods and main Board director of Mars. Philip Moody is
a corporate financier and sat on Boards at Warburton Bread, Bolton
Wanderers and the very successful co-ops of Centaur grain and
Berry Foods. George Risley was ex CEO of Greencore and had extensive
experience at Board level in many food businesses. Of the five
farmers, two had considerable Board experience in large non-agricultural
organisations. After the ACC acquisition the Board was further
enhanced with the addition of Richard Fisher, an industrial production
specialist, and David Felwick, ex-CEO of Waitrose and vice-chair
of the John Lewis Partnership. David is also a Board member of
the £2 billion turnover Premier Foods.
The council took great pride in not only training
itself, with all council members going to numerous courses in
conjunction with the Plunkett foundation and EFFP but also training
future directors. The council had identified the lack of future
potential farmer directors and introduced the innovative scholarship
scheme which, using DFB and Defra matched funds, trained young
people in business skills. The scholars not only met DFB and UK
business leaders but also undertook study trips abroad to study
the large European Co-ops.
Nor did the council take the job of electing
the farmers to the Board lightly, employing an outside specialist
to chair a selection panel.
Board governance was most certainly not taken
lightly throughout the 6 years I spent on the Board. I could spend
time describing the checks and balances that both the chairmen
took a great deal of time to put in place, however I feel this
time would be better spent elsewhere.
Ultimate company governance lay with the council,
and it is my opinion they undertook this well. There is no doubt
this is a difficult job relying to a large extent on information
fed from the Board. However what is most certainly true is that
they were party to more information and more external advice than
any individual member, shareholder or shareholder group in a PLC
could ever dream of getting. It is for this reason that I believe
the council system is the right and proper way for future co-ops
to be structured.
Those who point to an inexperienced or untrained
Board and Council have been lazy in tripping out tired lines.
The Board may well have been at fault, but poor structure and
governance was not DFB's problem.
STRATEGY
All co-ops brought in business leaders from
outside the Dairy world to identify and hopefully solve the problems,
which made the UK dairy farmer the lowest paid in Europe. There
were three strands to our strategy:
— Create a broad based dairy business to
create value for the farmer out of a basic raw commodity.
The lease of Westbury by the three co-ops and
the subsequent purchase of all the major cheese plants bar one
(Davidstow) delivered the first strand.
The joint milk haulage agreements DFB struck
with First Milk, Arla and Milk Link started to deliver the second
although this has largely unwound with the supermarket specific
contracts.
To settle for this was never an option for DFB
since the majority of its producers were close to chimney pots
and expected their milk to go to premium markets and achieve a
premium price. Whilst branded products were an aspiration, short-term
premium meant getting into the liquid market. Determined not to
replicate the mistakes of Westbury and Amelca by building assets
with no market for its products. Nor wanting to drive down the
market by buying our way in after a super Dairy build as Wiseman
has done on several occasions, the Board of DFB looked to buy
an existing business. Availability/affordability led us to ACC.
Vertical integration was deemed necessary and indeed welcomed
by all in government, farming politics and indeed industry commentators.
Clearly ACC alone was not meant to be the end game. Consolidation
through integration with other more efficient businesses was the
goal with farmers being the beneficiaries not the casualties of
the process. At that time the availability of those businesses
was believed to be a reality.
This strategy was spelt out to the membership
in a series of meetings held throughout the country in November
2003. The CEO and a director fronted these meetings.
CAPITAL STRUCTURE
OF DFB
To raise funds to enact the strategy all the
co-ops retained money from the milk price following a model that
had been successful in the Dutch and Danish co-ops. In principal
the retained money should have been split at the year-end with
part into Company reserves, part into member accounts and part
returned to members as a bonus. In practice with little history
of this in the UK and the speed of retention needed, this system
was "Anglicised" at DFB and all the monies ended up
in the members' name with the member able to leave with the funds
some time after he left the co-operative. This compromise led
to an inherent weakness with "investment " from members
appearing as debt on balance sheets and leading to three fundamental
issues:
— Debt restructuring issues later with
Banks unwilling to accept the co-op model.
— Without the huge general reserves (1 billion
euro at Arla) the continental co-ops held (the "dead hand"
as they call it) DFB was always going to be in trouble if business
plans were not met.
— An inability to sell the business without
the debt. This most serious issue meant that without the ex members'
permission for a debt for equity swap, which the Board failed
to get, the company as a whole was too expensive. Even in the
last few days DFB had bids on the table for the liquid business.
Without the ex-member debt burden a solvent solution was possible.
A major obstacle to member investment is the
UK tax treatment of co-ops. For help understanding this issue
and what can be done about it, I suggest a conversation with EFFP.
PURCHASE OF
ACC
The ACC business was purchased for £72.8
million. This is an audited fact.
It included a 580 million litre liquid business,
a cheese factory with £18 million worth of cheese and a canning
factory.
Any figures quoted above this figure are unaudited
and must include bank fees, legal costs, costs of due diligence,
advisor costs etc. As a director I do not recognise the figure
quoted by PWC.
Much has been made of the price paid. The bid
price of £75m (adjusted down at purchase to reflect stock
and cash valuations) was arrived at in conjunction with two teams
of advisors, Rabobank and Solomon Hare. It was recommended to
the Board by a sub group, which contained all the non-farmer directors,
the advisors, and one farmer director, which for the record was
me.
Whilst it seems high now the board were aware
that there were other bidders and that those other bidders had
considerable synergies and ready funds. Our weakness was our questionable
funding.
At the time, the going rate for a liquid business
was 10 pence per litre. Our bid net of the cheese stock was for
less than that. Dairy Crest later paid £20 million for a
200 million-litre business and promptly shut it at a cost of £9
million.
Again, much has been made about the tired state
of the factories. Whilst this is true it is a mistake to believe
that all the rest of UK processing was taking place in shiny boxes.
In 2004 of the 6 billion litre liquid market less than 2 billion
would be going through top class facilities to big supermarkets.
The rest, the vast majority, was being processed in lesser facilities
and sold through convenience stores or doorstep. In 2009 whilst
these sales channels have altered (see later) there still remains
some 2 billion litres processed in facilities no better than those
DFB have just closed.
My point here is that the price paid for ACC
was high and no doubt we could have paid less but that was not
the reason the business failed. The Board hoped that the Co-op
would want to sell to a fellow co-op but could not depend on it.
Price paid did affect the amount farmers lost, but it was what
we were able to do with the business that caused the failure.
The Board and the advisors also had to place
a high reliance on the vendor due diligence provided and in some
instances appropriate warranties were negotiated into the sale
and purchase agreement. Subsequent to the purchase, and the reliance
on vendor due diligence, some aspects of the business were not
as described and a number of warranty and legal claims were prepared.
Legal action dragged until the renegotiation of the CRTG contract
in 2007 when unsurprisingly it was dropped.
At the time of the purchase the business plan
and the funding model including what it meant to the individual
farmer was explained in a series of meetings held throughout the
country in August 2004. The CEO and a director fronted these meetings.
Some members did not like what they saw, put their notice in and
left the following April. The money they had invested thus far
was returned to them with interest over the next two years.
FINANCIAL REPORTING
OF CO-OPS
Another red herring!
Co-ops have to present an audited set of accounts
at the year-end just like any PLC. This is not cheap and involves
a large independent team "living" in the business for
two weeks every year until they are satisfied all is correct.
Anything, which goes in the annual report, including the chairman's
report; has to be passed by the auditors.
Two years ago the plcs had to swap to using
the IFRS set of accounting principles away from UK GAP. Despite
there being no requirement to do this until much later, DFB adopted
IFRS in 2008, the only co-op to do so.
Whilst co-ops do not have to produce half-year
figures or trading statements DFB did so (until the change to
IFRS made interim accounts cost prohibitive).
The directors were available all the time and
spoke regularly to members, far more so than in any PLC.
There is a fine line between commercial confidence
and being open with shareholders.
The NFU in their vision document called for
more accountability in producer owned businesses with no idea
what this means or how it can be done practically. They have persuaded
Dairy Co to carry out an exercise that will be futile and will
be only as in depth as a normal analyst's report, which is in
any case carried out from time to time. Any company will be acting
against its shareholder interest if it allows access to information
not in the public domain, and therefore it will be an analyst's
report by another name. Potentially farmer members of a weak co-op
will be paying through the levy to have their own business abused!
DEVELOPMENT OF
THE LIQUID
BUSINESS AGAINST
A CHANGING
MARKET
Within the DFB group of companies, the DFB liquid
business was a large and complex business employing 2,500 people,
delivering many different products through even more different
supply channels. The control systems inherited were poor as were
many of the contracts. Nevertheless the business had great potential
and we should bear in mind the strategic goal of folding it into
one of the bigger liquid businesses.
Over the next few years the business suffered from
several market place changes. These were:
— The big four supermarkets reducing supplier
numbers to one or two (2004-05).
— The competition authorities letting the
big four onto the high street (2005).
— The NFU vision document encouraged farmer
specific pools. These are great for those involved but robbed
the co-op members of the benefit of the affect of the income from
the best payers, who were and are the big four. This money trickled
throughout the industry and its effect can best be seen by following
the price rises companies managed following the series of 2ppl
price increases in the early part of this decade. The vision document
also spoiled the funding models both the two biggest co-ops had
prepared, sowed mistrust of co-op finances and changed the view
the PLCs had of their own businesses.
— The growth of the food service industry
left our supply chain inefficient with others delivering milk
more cheaply on the back of other groceries. This led to competition
from larger dairies able to deliver to the regional distribution
centres (RDC) of the food service companies. Whilst DFB responded
well to this challenge. It meant more competition in this sector,
price erosion and costs for our depot rationalisation.
The business continued to be developed and grow
with the successful addition of the Lincoln dairy. Investment
was made but the level has been exaggerated by PWC. Remember capital
investment is only real investment when it exceeds the ordinary
level of depreciation in any business. Also much investment was
made at the cheese factory in North Wales which is now an efficient
modern facility, the benefit of which will be felt by farmers
for years, through the Milk Link co-op who I am glad to say now
own the plant.
In 2007 it became clear that the opportunities
to merge our business into one of the big three, for the benefit
of farmers had disappeared and DFB quietly started to try to divest
itself of its liquid business. Our major problem was our major
customer, the Co-op, who took any opportunity to drag its heels
on milk price as industry prices had moved over the last three
years and had opened a competitive tender process for the next
contract period.
Keen to lower the Co-op's influence DFB entered
into an agreement with Tesco to produce "Local choice"
branded milk, Tesco were very enthusiastic about its prospects.
They aspired for it to be 20-30% of sales (200-300m litres) in
two years and were so confident their head of chilled sales and
head of dairy products came and spoke to the member council in
spring 2008. DFB budgeted for half these figures and had that
been met we would still have been trading today.
The Co-op tender process was the beginning of
the end. DFB's competitors, all now with good core well paying
supermarket contracts bid low for what would be marginal business
for them. DFB was expected to match this and subsidise the direct
to store delivery whilst the Co-op sorted out its Thurrock RDC
in South East England.
The effect on our on farm milk price was massive.
Whilst the industry was paying 25ppl on farm the fully costed
co-op business was worth 20-21ppl. Clearly it dragged our on farm
price down at a time when commodities were booming. The Co-op
talked about a farmer pool but was not prepared to pay the high
cost of segregation let alone a premium price. Claims that DFB
were unwilling are false. By 2009 we were operating four such
customer specific pools.
In August/September 2008 the market place changed
again. Local, organic, added value was replaced by cheapest and
discount. Tesco introduced a discounted milk product and declared
itself "Britain's biggest discounter". Sales of Local
Choice suffered, and it was clear that rationalisation of our
own business was essential. The "5 to 3" plan was born.
LAST FEW
MONTHS
Once PWC entered the business in late autumn
2008, from then on the Board were struggling for control. Costs
rose as the Board were asked to pay the costs of "advice"
the bank were demanding. Whilst Bank borrowing was falling; our
ability to borrow fell faster. Covenants were breached to pay
the milk cheque and the bank demanded extra fees and punitive
interest rates for this. Any suggestion that HSBC lost money out
of the collapse of DFB is plainly wrong.
The only solvent solution was to sell parts of the
business. If a buyer could be found for the liquid business then
the rest of the business could have been easily merged with a
fellow co-op where there were obvious synergies. Despite several
serious discussions a buyer was not found and the bank instructed
PWC to put the whole business up for sale in January 2009.
In evidence, Gerry Smith (DFB Liquid MD) said
that business is about confidence. He is right. The gossipmongers
had been peddling half-truths about DFB for 12 months dragging
that confidence out of producers, customers and eventually the
bank. Perception of DFB was always ahead of reality. But as Gerald
Ratner taught us, eventually reality catches up. The "For
Sale" sign was confirmation that DFB were in trouble.
The "coup de grace" fittingly fell
to the Co-op who awarded their contract elsewhere. They will say
that they were being commercial and we were inefficient. I would
point to one fact that contradicts this and belies their "Fair
Trade " tag. For the identical product, delivered in an identical
way, Tesco were paying 40 pence per gallon, that's over eight
pence per litre more than the Co-op were prepared to pay in the
final contract!
SUMMARY
In 2003 the Dairy industry was in a mess with
unsustainable milk prices and oversupply. On farm milk price varied
by up to 2ppl. There were great inefficiencies in transport and
commodity production. The co-ops brought in industry outsiders
to identify the problems and create solutions.
In 2009 those people have gone, the problems remain.
For 15 to 20% of farmers the supermarket specific
pools have delivered sustainable milk prices. For the rest the
outlook is less rosy. The on farm price difference is now an unbelievable
7ppl for what is an identical product. Transport inefficiency
is worse.
DFB consisted of 3000 farmers who instead of
protesting or "going cap in hand" to the government
set about creating their own solution. A business capable of adding
value to milk which at the end of the day is just a basic commodity.
Ultimately for whatever reason we failed, and for that I am personally
sorry. However what I am certainly not ashamed to have given it
a try.
David Wilkinson
October 2009
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