Examination of Witnesses (Questions 40
- 59)
WEDNESDAY 16 SEPTEMBER 2009
MR STEPHEN
OLDFIELD AND
MR KEVIN
ELLIS
Q40 Mr Drew:
My other point is in talking to someone who was previously on
the Board of DFB there is a view that one of the difficulties
of the structure of the organisation was it was very difficult
to increase the capital, that it was under-capitalised. I would
add to that that this is a very difficult market segment with
over-capacity in terms of processing. I suppose I am not leading
you too far, but to what extent was it bound to fail because of
historic and structural problems to do with its organisational
form but also the fact that it is in a very difficult market?
Mr Oldfield: Picking up your question
on over-capacity, I was surprised by the speed at which customers
could switch from their reliance on the dairies, on the liquids
part of the division, on receivership to other providers. They
switched within 10 days and 60% of our customer base disappeared.
To go to your question on over-capacity, there must have been
capacity out there for them to be able to switch that quickly.
Absolutely there was capacity available within the liquids business
in the UK. I am aware that a number of dairy companies have invested
in what are called the "super dairies" and I know those
are big beasts that can bang out an awful lot of milk very efficiently.
I am aware of a number of investments in that over the last five
or six years.
Q41 Mr Drew:
In terms of the structure of the IPS in relation to their ability
to raise capital you talk about capex and this is an organisation
that needed to radically restructure itself and yet it did not
have the capital apparently to achieve that. Is that a fair statement?
Mr Oldfield: If you look at the
funds flow you can see that there was a funding gap absolutely
and the members could only be asked for so much.
Q42 Mr Drew:
Is that a specific weakness that you think the IPS put on them
or was it just the fact that it was always under-capitalised anyway?
Mr Oldfield: I believe there is
a limit in relation to the amount that a member can invest in
an IPS. I think that number is £20,000. If that is the case
then clearly that provides a cap on co-operatives' abilities to
raise capital.
Q43 Chairman:
That piece of formula does not apply to the retention of monies
from the milk chain, does it?
Mr Oldfield: I think there is
a definition, Chairman, called "Members' Interests"
and it is what the members' interests cover. I have got some papers
on this that I am happy to try and explain to you in a further
written submission if that would be helpful.[5]
Chairman: That would be very helpful
because I am a little bit confused as to the difference between,
if you like, putting money in and money being kept in the co-operative
which I thought was part of the members' guarantee arrangements
because the sums of money which some members have lost are obviously
considerably in excess of the £20,000 limit.
Q44 Lynne Jones:
Before I come on to the line of questioning I want to take, in
your report on page 28 you say that DFB had invested heavily to
support Tesco and the Local Choice brand and yet it seems in early
2009 Tesco was in the process of delisting the Local Choice product.
In the Ernst & Young report they tell us that Tesco attended
the DFB Council meeting in June 2008 and seemed very bullish about
their continuing the Local Choice line and Ernst & Young referred
to information on the Tesco website which referred to "Tesco's
plans to expand the availability of Local Choice milk". Was
there any obvious reason why Tesco suddenly changed their mind
on this because that played a significant role in the financial
difficulties that DFB were having?
Mr Oldfield: Obviously I do not
know the specific answer to the question because I was not there
and was not, therefore, party to the discussions between the company
and Tesco. Just on reflection I would merely say that with the
onset of the recession and the difficulties that brought with
it for consumers, there was undoubtedly, with my agri-business
hat on, a switch to value for food and I do not know to what extent
that would have had an effect upon the relative merits of Local
Choice or, indeed, one of the other initiatives which I know this
co-operative were really pushing on, which was regional milk.
I merely reflect that from my knowledge of the industry.
Q45 Lynne Jones:
Presumably the Local Choice milk had a price premium on it, did
it?
Mr Oldfield: Yes.
Q46 Lynne Jones:
A little earlier in response to a question from Gavin Strang about
when it first became clear that the future of the business was
in jeopardy, which was "At what point was it clear that DFB's
survival as a going concern was no longer possible", I think
you said it was at your attendance at the meeting in April.
Mr Oldfield: In March, 27 March.
Q47 Lynne Jones:
Sorry, on 27 March.
Mr Oldfield: I am saying that
was a critical moment in the life of the co-operative because
its Member Council had said that it would not go to the members
and ask for £20 million. That left the co-operative with
a funding gap and what happened was the funding gap was filled
by the bank, they put £13 million more in to try and exhaust
the opportunities to try and find a solution. That was what happened.
It created a funding gap that then had to be sorted out between
the Board and the bank, and that was what was then done.
Q48 Lynne Jones:
I also have information about a letter which was sent from Lord
Grantchester to DFB members on 12 February that said: "DFB
has engaged leading corporate mergers and acquisitions advisers
(M&A) from PricewaterhouseCoopers to help us review their
approach", that is in terms of their restructuring. Could
you outline PwC's role as an adviser to DFB prior to the receivership
and when you actually took on that role?
Mr Oldfield: Referring to that
letter[6],
we were aware of some (M&A) activity by the company prior
to that date. The company had consistently engaged Smith &
Williamson as mergers and acquisitions advisers and in particular
ran strategic options. I mentioned earlier that there were a number
of projects that the business had engaged on since the acquisition
of Associated Co-operative Creameries (ACC) over a numbers of
years and it is referred to in my report. I think I talk about
35 different projects. When it became clear that there was a need
for some more impetus in relation to the M&A activity to try
and find a strategic solution to the co-operative, and also because
they had been approached as well, and I think that letter talks
about an approach which the co-operative had received, we consulted
with the bank and we were advisers of the bank and they encouraged
the company, and the company agreed, that we would be engaged
to take on that role to seek to try and find a strategic solution
to the difficulties faced by the co-operative. I remember I used
the term at the time of turning over the stones, "We have
to turn over the stones to try and find a solution for this co-operative".
It was felt that our engagement in February would accelerate that
process from where it was previously because they had not found
a solution up until then and we needed to accelerate that.
Q49 Chairman:
When you say, "find a solution", they embarked on Project
523, which was the restructuring of the business. Just fill us
in on what it was you were trying to find a solution for because
that was prior to this March 2009 worsening financial position.
In other words, you came in, they knew that things were not going
well so they were asking you to look at the business and see if
there was a way out of the mess. What were the options?
Mr Oldfield: Chairman, if you
think about February and March, in March they went to the members
asking for £20 million. One of the ways to try and reduce
the amount of money asked of members was to try and find some
buyers for certain of the businesses of Dairy Farmers of Britain.
That was in the thinking of the Board and the bank, that in order
to fill the emerging funding gap of the co-operative the stones
needed to be turned over to see whether there was value in parts
of Dairy Farmers of Britain that could help to meet that funding
gap. That was where the impetus came from. It came from trying
to find some nuggets of value in the Dairy Farmers of Britain's
portfolio of businesses to try and help meet that funding gap
to avoid asking the members for everything or, indeed, the bank.
Q50 Lynne Jones:
Who in PwC took on that role as advisers to DFB?
Mr Oldfield: We had a separate
M&A team involved in that. The idea was that there would be
a transaction team dealing with that piece of work with a prime
duty of care to the bank because that was the way in which that
engagement was structured and is typical in these situations.
The company had its own advisers—Ernst & Young have
been mentioned already in this Committee hearing—and also
a firm of lawyers as well who were advising the Board and PwC
were advising the bank in connection with what was going on in
terms of the transaction team. The information from the transaction
team flowed down into two separate camps for interpretation as
to what the position was.
Q51 Lynne Jones:
So you were not part of this advisory team then?
Mr Oldfield: I was only part insofar
as my industry knowledge, and we have already talked about it
a number of times this afternoon. All the discussion and all of
the M&A work was done by a separate team, absolutely.
Q52 Lynne Jones:
How did you ensure that conflict of interest was avoided with
yourself as the bank adviser? Okay it was a different team but
how rigid were the walls between the two sets of advisers?
Mr Oldfield: There were walls
that recognised that our M&A role was with a prime duty of
care to the bank who we were working for.
Q53 Lynne Jones:
The M&A role for DFB?
Mr Oldfield: The engagement letter
is between the company and the bank and ourselves with a prime
duty of care to the bank.
Q54 Lynne Jones:
Let me just get this clear. So when PwC were appointed as advisers
on mergers and acquisitions your prime duty of care was to the
bank and not to DFB?
Mr Oldfield: In the event of conflict,
yes.
Q55 Lynne Jones:
Okay. Can we just go back? You seemed to imply that in March 2009
at the meeting you attended you saw that the writing was on the
wall when the members themselves were not prepared to put up money
to keep the business going and yet the business did not go into
receivership until June 2009 and kept going during a period when
the farmers were producing milk which was then being processed,
money was being received presumably from those contracts and yet
none of that money was paid over to the farmers. Could it not
be argued that that advice was to protect the interests of the
bank and to keep it going protected the bank's interests and not
those of the members of the co-operative?
Mr Oldfield: There are three key
points. The first key point was remember what I said about 27
March was not that the writing was on the wall, it was that there
was a funding gap and it needed to be bridged and that was why
the bank put more money in, the £13 million of new funding.
That is point number one, there was a funding gap identified on
27 March. I was not saying that the writing was on the wall.
Q56 Lynne Jones:
A funding gap to do what?
Mr Oldfield: A funding gap because
the company needed more money.
Q57 Lynne Jones:
You thought there was a reasonable prospect of that investment
actually yielding results?
Mr Oldfield: Remember what I said
about the spring flush and the discussion that I did share with
the Committee about—
Q58 Lynne Jones:
I heard you say you had got to get over the spring flush and avoid
damaging the dairy industry as a whole rather than DFB.
Mr Oldfield: It also gave the
opportunity for the Board's proposals in relation to trying to
find a solution for Dairy Farmers of Britain to have a further,
in effect, nearly three months of time.
Q59 Lynne Jones:
At that time as well they knew that the Co-op contract was going
to be ended and you knew that Tesco had changed on the Local Choice,
so what realistic prospect was there that DFB could be brought
into a situation where it was a going concern?
Mr Oldfield: There were a number
of interested parties around in March. Remember we kicked off
that M&A activity in February, so it was not as if it was
without hope. There were interested parties, albeit the interest,
and it is in the report, in the liquids part of the business was
not strong. The second thing, and it goes back to your question,
is you also said how did the co-operative continue to take in
milk after March. It took in milk after March but remember—
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