Retail shareholders swallowing dead rats at Synlait

NZSA Disclaimer

The recent announcement of the long awaited capital raise by Synlait represents an effective end-game for the future of Synlait as a listed investment opportunity for New Zealand shareholders. There is no doubt that a capital raise is required, as part of a wider restructure of a balance sheet that has is punch-drunk from the impacts of poor investment decisions, debt funding and less-than-stellar operating performance. And therein lies the issue – the balance sheet is so stressed that the Synlait Board has deemed that there is no room for retail shareholders in Synlait’s financial resurrection.

The proposal put to shareholders takes the form of a placement to Synlait’s two major shareholders. Bright Dairy will subscribe for $308m shares at $0.60 per share, for a total of $185m, while A2 Milk will pay $0.42 per share for 76.2m shares, for a total of $32.8m. The outcome will be that A2 Milk will retain its current shareholding (19.8%), while Bright Dairy’s ownership would increase from 39% to 65.25%. The two companies will control around 85% of Synlait’s voting capital, with retail shareholders share declining from around 41% to 15%.

And therein lies the ‘dead rat’ for minority shareholders. It’s an unholy trade-off: while the value of Synlait is likely to improve as a result of these placements, the level of dilution is at such a level where minorities are irrelevant to the conversation. Minorities will receive better value (compared to the current position) on their existing holding, but are essentially ‘locked out’ of the future upside associated with the new capital – that will accrue only to Bright and A2.

Synlait will become a private company in drag, pursuing the mutual interests of its two major shareholders. Well-known Kapiti stockbroker Chris Lee said as much this week in his Taking Stock newsletter:

And the solution provides the motivation for all shareholders to regard Synlait in the future as being the equivalent of a private company, run for the benefit of the major shareholders.

Chris also notes that if he were an investor, he would “sell immediately my shares at whatever price I could get.” NZSA hasn’t got that luxury – those shares will inevitably be bought by…other retail investors. We will always be duty-bound to look after their interests.

In any case, the ‘private company’ ethos forms a very limited proposition for new secondary market investors; in theory, that should be reflected in lower valuation multiples should Synlait return to profitability.

Capital structure alternatives

The dramatic slump in Synlait’s share price and the sheer scale of its debt mountain are likely to be telling factors in the decision of the Synlait Board to not extend the capital raise option to retail shareholders. Perhaps the optimist in me allows a thought that there is a gentle protective hand at play also – Synlait will remain a risky proposition for some time yet, even after its newly-minted balance sheet.

There are at least two root causes for the company’s woes: an ill-judged decision to invest hundreds of millions in creating a new plant at Pokeno, coupled with a further investment to upgrade said plant a couple of years later, and the longer-term impact of the company’s unique governance structure, with the company listed under an NZX waiver allowing Bright Dairy to have 50% of the directors on the Board, despite only holding a 39% shareholding.

NZSA has had a variety of conversations with Synlait over the years. A telling factor in our discussions is who we have been talking with – there has been a revolving door of Chair’s and directors during that period. The lack of stability in Synlait’s boardroom, faced with a constant Bright Dairy shareholding presence, is likely to have been an unconscious contributor to weakening the standing of minority shareholders.

One other series of conversations stands out. In late 2022/early 2023, NZSA conversations with Synlait were focused on the company’s debt and (later) the upcoming “debt review”. We were encouraging the company to take a much more holistic balance sheet approach – including an equity raise at that point in time (the share price was around $3.00, although it dropped to $1.60 late in 2Q 2023). At that time, NZSA also raised the prospect of the risk to minority shareholders of further deterioration allowing Bright to take control of the company at a further reduced price.

NZSA’s position was not about Bright taking control – they already had effective control via the Board arrangement – but was focused on the longer-term value of the company and the outcomes for all shareholders.

My frustration at what has now resulted is palpable.

It has meant that George Adams, the current Synlait Chair, has had limited cards to work with since his appointment – all drawn from a deck stacked against him and minority shareholders. In this context, NZSA believes that he has shown admirable leadership and an ability to execute to rescue the company, even if the resulting capital raise is at the expense of full exclusion of retail shareholders in future upside.

Other options the company and its advisors may have considered included a full entitlement offer (rights issue), which Synlait’s directors believe would likely have seen the company’s share price head into the low single digits (3-5 cents). Synlait would also have considered the likelihood of retail investors stumping up with further capital and assessed that as a low probability. This likelihood is where assessments become murky: NZSA has heard from many who would have been prepared to invest in the company’s future. Synlait’s advisors, who likely also control DIMS funds utilised by many retail investors, are likely to have reached a different opinion. Regardless, NZSA accepts that this would have been unlikely to have occurred at the same level of value as the placement structure adopted by the company.

This is one situation where NZSA would have endorsed a placement + share purchase plan structure, similar to that recently used at Infratil. From a pricing perspective, this would have provided an option for minority shareholders to invest at the same placement price of $0.43 as A2 Milk, with Bright Dairy subscribing for any shortfall. Even if inbound interest from minority shareholders is low, this at least respects the right of existing shareholders and provides them with an option to avoid dilution. Synlait just needs to look up State Highway 1 from its Dunsandel offices into St Asaph Street – in a recapitalisation context, Syft Technologies (USX: SYF) are doing something similar right now. Just like Synlait, Syft also has two major shareholders. And just like Synlait, Syft’s balance sheet and operating performance are under some pressure.

Control – and an alternative

NZSA has been vocal when it comes to “controlling shareholders” of NZX-listed companies. Around a third of the companies on the exchange have a shareholder with a 30% or more shareholding – easily enough to control outcomes.

The Synlait situation should ram home to investors the potential risk they face when investing in such companies.

Synlait, with Bright’s 39% holding, was already on this “controlled” list. The percentage shareholding is compounded by Synlait’s constitution and the related NZX waiver (see above), which in effect gave control of the company’s Board – equivalent to a 50% shareholding – to Bright. At a technical level, this allows Bright to ‘equity account’ Synlait’s financial outcomes on its own balance sheet and P&L. From a geopolitical perspective, this treatment allows Bright and the Chinese government to control a key food source for Chinese consumers.

NZSA has been a vocal critic of this arrangement. The inexorable deterioration of Synlait’s financial position, juxtaposed against its failing strategic and financial performance would seem to support NZSA’s opposition to a governance arrangement that prioritised control over the rights of shareholders. The fact that the provision is now on the cusp of being removed as Bright takes majority ownership of Synlait feels like a hollow success.

We fully recognise Bright’s role in supporting Synlait – from 2010 to 2024, it has been a steadfast supporter. As recently as July, it provided a $130m shareholder loan to Synlait, as a means of the company beginning its complicated journey to financial resurrection.

In this situation, however, we can’t help noting that a 65% ownership position for Bright Dairy seems to extend well beyond the 50% threshold generally accepted as ‘control’. NZSA would be highly supportive of a public commitment by Bright to sell down that incremental 15% to the local market within, say, three years. Such an arrangement would provide liquidity, restore minority shareholder interest to 30% and allow Bright to recoup some of the significant investment it has made into Synlait – all while retaining that all-important control.

It also provides Bright a clear incentive to improve the share price.

Last, it also preserves Synlait’s (and Bright’s) optionality for the future. Perhaps there may come a time again when Synlait needs capital for the right reasons; ie, in support of future growth. Any action that Bright can take to preserve the credibility of Synlait as a trustworthy investment for minority shareholders will be invaluable for Bright in this context.

When it comes to Synlait, we continue to live in hope.

Oliver Mander