Kerry Co-op to offer €480m for majority stake in Kerry Group’s dairy business

The board of Kerry Co-op is set to formally submit an offer of €480m to buy a 60% majority stake in Kerry Group’s primary dairy business, the Irish Farmers Journal understands.

As we go to print on Wednesday, a board meeting of Kerry Co-op was still ongoing but it is expected a historic bid to buy a majority stake in Kerry’s primary dairy business will be approved, which values the business at €800m in its entire.

Kerry Group’s primary dairy business is understood to have annual sales of €1.2bn and makes profits of €80m to €100m per year.

If it goes ahead, this joint venture deal will be one of the largest corporate transactions in Ireland in 2021 and will see Kerry farmers assume control of their milk processing assets once again.

The expected offer from Kerry Co-op comes after more than a year of protracted negotiations between both sides that looked to be making little progress recently

For Kerry Group, the joint venture deal is part of an internal strategy known as “Project Seafield” where the company is seeking to exit some of its lower margin heritage businesses in dairy processing and consumer foods. The expected offer from Kerry Co-op comes after more than a year of protracted negotiations between both sides that looked to be making little progress recently.

Urgency

However, a renewed sense of urgency was injected into the negotiations in recent days after it emerged that a third party had submitted an offer to buy Kerry Group’s primary dairy business in its entire. It’s believed this offer is around the €800m mark.

This news prompted a flurry of activity at board level of Kerry Co-op in the days that followed with the co-op board meeting every day so far this week.

A cohort of board directors at Kerry Co-op have been firm in their views that they would like to settle the leading milk price issue once and for all

A meeting between co-op directors and Kerry Group CEO Edmond Scanlon on Tuesday about the contentious “leading milk price” issue appears to have been instrumental in progressing events.

A cohort of board directors at Kerry Co-op have been firm in their views that they would like to settle the leading milk price issue once and for all before they backed any joint venture negotiations.

This intervention seems to have appeased the majority of the co-op board

At Tuesday’s meeting, the Irish Farmers Journal understands Scanlon outlined to the co-op board that Kerry Group was very close to finalising the amount of money owed to Kerry milk suppliers under the leading milk price agreement for milk supplied in 2019 and previous years.

This intervention seems to have appeased the majority of the co-op board. Additionally, Scanlon explained to co-op directors how he saw the legal procedures and timelines for completing the joint venture deal.

Due diligence

Once a formal offer is on the table, it’s understood a process of due diligence can begin shortly, which is likely to take up to six weeks to complete. This means there is now a relatively short window for the board of Kerry Co-op to agree how it will raise the €480m needed to fund this very significant transaction.

Kerry Co-op could potentially raise debt to fund the transaction. However, there is considerable resistance among Kerry milk suppliers to borrowing too heavily to fund this joint venture deal as many fear sizeable debt repayments for the business would only drag down future milk prices.

[...] it is estimated that Kerry Co-op has cash reserves of circa €100m on its balance sheet

Instead, the most likely option will be for Kerry Co-op to sell a portion of its 12.3% stake in Kerry Group plc as a means to generate the cash needed for the transaction. For instance, if Kerry Co-op sold 2% of the shares in Kerry Group plc it would raise almost €400m for the co-op based on the current price of Kerry Group shares at €112.

Alongside this, it is estimated that Kerry Co-op has cash reserves of circa €100m on its balance sheet which can also be used to fund the remainder of the purchase price. The option of raising a small amount of debt plus a share sale could also be looked at.

Dilution

However, by selling a significant portion of Kerry Group plc shares to fund the joint venture deal, Kerry Co-op would dilute the value of its own shares, ie the value of a Kerry Co-op share would reduce as the value of these shares is directly linked to the number of Kerry Group plc shares held by the co-op.

For milk supplier shareholders in Kerry Co-op, there is a clear trade-off in this scenario. However, for dry shareholders (non-milk suppliers) in Kerry Co-op the joint venture deal will mean the value of their investment in Kerry Co-op will be reduced, potentially by as much as 10% to 15% (see Table 1 for more detail).

At present, Kerry Co-op shares are valued at a ratio of 1 co-op share is equal to 5.9 shares in Kerry Group plc. The higher the percentage of shares that Kerry Co-op has to sell to fund this transaction means reducing that ratio, potentially down to 1=5.5 or even as low as 1=5.1.

In simple terms, the dry shareholders in Kerry Co-op will be asked to take a haircut on the value of their co-op shares in order to fund the joint venture deal, which will really only benefit dairy farmers. And while some will argue that a co-op should only be for active trading farmers, there is a loyalty around the board of Kerry Co-op to its dry shareholders, particularly as so many of them are retired farmers or relations of former milk suppliers.

In order to make this joint venture deal attractive to dry shareholders, the Irish Farmers Journal understands an agreement has been reached with the Revenue Commissioners that will allow these shareholders to swap their old co-op shares for new shares in Kerry Group plc under a capital gains tax (CGT) arrangement.

CGT liability

However, this CGT liability may have to be paid upfront meaning Kerry Co-op is likely to offer dry shareholders a “cash plus shares” option so they can acquire the shares while also having some cash to pay the associated tax bill.

It’s not clear how many shareholders would take this option but the Revenue Commissioners are potentially in for a tax windfall that will run into the hundreds of millions of euro from this deal.

Under the rules of Kerry Co-op, the board of directors can approve this joint venture without holding a shareholder vote on the deal.

However, given the scale of this transaction it’s likely the co-op board will come under pressure to put this historic deal to a vote of it’s A and B shareholders.

There’s still a long way to go before this joint venture deal becomes a reality but events are expected to move very quickly from here on in.

Aside from agreeing a funding model, the board of Kerry Co-op will also need to clarify the following points for its shareholders:

Finally, and most importantly, the co-op board must now examine this business very closely to determine whether it really is worth investing in and whether it can deliver increased milk prices for Kerry milk suppliers.

Every extra 1c/litre paid on Kerry’s milk pool of 1.2bn litres costs an additional €12m, meaning the co-op board will need to be satisfied whether there is sufficient profit in this business to pay more for milk.

When all is said and done, the investment case for this business requires it passing that simple test if it is to make sense for Kerry milk suppliers.

The Irish Farmers Journal will continue to analyse the merits of this potential joint venture over the coming weeks as further detail emerges.

Any shareholders in Kerry Co-op with questions can send their queries to lallen@farmersjournal.ie.

What is Kerry Group’s primary dairy business?

As revealed last year by the Irish Farmers Journal, Kerry Group’s primary dairy business includes Kerry’s three Irish milk processing facilities in Charleville, Newmarket and Listowel, and also includes its dairy spreads manufacturing site in Ossett in the UK (see graphic on facing page).

The business includes Kerry Group’s infant formula manufacturing business in Charleville as well as its range of well-established dairy brands such as Cheesestrings, Dairygold, Low Low, Charleville Cheese and Golden Cow.

The main dairy products produced by the three sites in Ireland are casein and cheddar

In total, Kerry Group processes about 1.2bn litres of milk every year making it one of the “big four” milk processors in the country.

The main dairy products produced by the three sites in Ireland are casein and cheddar.

Indeed, about one-third of all the milk collected by Kerry Group is processed into a range of milk proteins including rennet casein, making Kerry one of the largest casein producers in the world.

Another third of Kerry’s milk supply is used to produce up to 40,000t of cheddar at its Newmarket plant every year.

The final third of Kerry’s milk pool is used for butter, skimmed milk powder (SMP) and a range of high-value specialised protein ingredients

The whey left over from making cheese and casein is then further processed into demineralised whey, which Kerry Group uses in its own infant formula plant in Charleville but also sells to infant formula companies in Europe and Asia.

The final third of Kerry’s milk pool is used for butter, skimmed milk powder (SMP) and a range of high-value specialised protein ingredients. The joint venture deal would also include Kerry Group’s agri-trading business, which comprises its animal feed mill in Farranfore and the network of agri-stores.

This row ultimately led to an arbitration ruling in September last year

The root of this joint venture deal is the row that erupted between Kerry Group and its milk suppliers over the so-called “leading milk price” contract. This row ultimately led to an arbitration ruling in September last year, which subsequently triggered these current talks as a means to settle the leading milk price issue for good.

The leading milk price dispute started in recent years over the interpretation of a 10-year milk supply contract first signed in 2015, which said Kerry Group would pay milk suppliers the “leading milk price” in Ireland.