Clover - proposed restructure & cautionary
Shareholders are referred to the "Proposed Restructure, Cautionary Announcement and Further Voluntary Operational Update" released on SENS on 5 December 2016 ("First Cautionary Announcement"). In the First Cautionary Announcement, shareholders were advised that Clover is in the process of restructuring its business ("Restructure") to give effect to its stated objective of developing higher margin, value added products in dairy and other related food categories and to eliminate Clover's exposure to the cyclical nature of its low margin business.Clover advises shareholders that the Restructure is ongoing. The purpose of this further Cautionary Announcement is to:
- provide further clarity as to the rationale for the Restructure;
- expand upon, and provide more details as to, the terms of the Restructure; and
- update shareholders as to progress made in respect of the Restructure.
Rationale for the Restructure
Clover's business presently comprises two main elements. Firstly, it has a low margin business where profitability is primarily driven by volumes ("the Low Margin Business"). The Low Margin Business relates, inter alia, to the marketing and selling of non-value added fresh milk, Ultra Pasteurised Milk and Ultra-high temperature milk to third parties (customers and/ or consumers) in various forms. Secondly, Clover sells and supplies certain high margin or value-added products ("the High Margin Business") including (but not Ltd. to) custards, yoghurts, certain cheeses, infant products and the like to third parties (customers and/ or consumers). Unlike the Low Margin Business where profitability is driven primarily by volumes profitability in the High Margin Business is less dependent on volumes.
The key objectives for the Restructure are as follows:
1) To address misconceptions about the pricing of Raw Milk
Clover presently determines the price paid to producers ("Producers") for raw milk ("Raw Milk"). There is a misconception by capital market investors and other market participants that Clover, in setting the price for Raw Milk, may favour Producers at the expense of profitability. There is likewise a misconception by Producers that Clover, in setting the price for Raw Milk, is improving profitability at the expense of Producers. The Restructure, as more fully described below, will result in the Raw Milk price being determined by a party other than Clover, namely Dairy Farmers South Africa (Pty) Ltd. ("DFSA").
DFSA will determine the price at which it purchases Raw Milk from Producers as well as the price at which it sells Raw Milk to third parties (customers and/ or consumers). Importantly, DFSA will be entitled to sell Raw Milk to parties other than Clover. This will result in the price of Raw Milk being unequivocally driven by market forces. Clover will purchase milk from DFSA at the average national milk price at which DFSA purchases the Raw Milk from Producers. This should result in the unfounded speculation that Clover is favouring profitability over the interest of Producers (and vice versa) being dispelled.
2) To improve access to new volume based growth markets
Clover's attention is currently split between driving the High Margin Business and, to improve profitability in the Low Margin Business, by driving volumes. It is anticipated that a second entity focussed exclusively in driving volumes in the Low Margin Business will enable Clover in line with its stated objectives to focus on the High Margin Business. The focus on the High Margin Business is in keeping with Clover's stated objectives to promote and develop value added products in dairy and other related food categories, to expand its non-alcoholic beverages portfolio and to develop and enhance its key competencies in brand development, production, distribution and merchandising. This is not to say Clover will not benefit through DFSA's focus on driving volumes through the Low Margin Business. Increased volumes will benefit Clover as such volumes will result in the use of capacity which currently exists in Clover's infrastructure pursuant to the provision of services by Clover to DFSA for which Clover will be paid additional service fees.
3) To facilitate the formation of synergistic partnerships and/or alliances
Clover has been approached by various parties with whom partnerships or alliances may be possible to the benefit of shareholders. Clover has built significant capacity in its infrastructure and if such capacity were used by third party partners with whom Clover formed alliances, the scale of Clover's business could be significantly increased. To date parties that have approached Clover have ultimately decided not to pursue matters based on Clover's exposure to the cyclical Low Margin Business.
Further details relating to the Restructure
It is anticipated that the Restructure will comprise the transfer of the Low Margin Business to DFSA for a nominal amount. The Low Margin Business transferred to DFSA will include:
- all delivery/supply agreements which Clover has with its Producers. The position of Producers should remain unchanged;
- employees attached to the Low Margin Business; and
- customer agreements relating to the Low Margin Business, milk collection agreements etc.
Pursuant to the transfer of the Low Margin Business to DFSA, DFSA will have the ability to focus on driving volumes to grow the profitability of the Low Margin Business. Inextricably linked to the transfer of the Low Margin Business to DFSA, Clover will enter into a suit of agreements with DFSA pursuant to which, inter alia, –
- DFSA will be obliged to meet Clover's requirements for Raw Milk to be used in the High Margin Business;
- Clover will provide certain essential management and support services to DFSA including warehousing services, distribution services and merchandising services; and
- Clover will enter into a licence agreement with DFSA pursuant to which DFSA will pay Clover a royalty on turnover in respect of products sold by DFSA under the Clover brand.
It is anticipated that:
- 74% of the shares in DFSA will be made available to Producers on or after 30 June 2017 and that Clover's initial 100% shareholding in DFSA will, accordingly, be reduced to 26%. The Producers will be allocated shares based on the Raw Milk supplies to Clover over the last three years; and
- DFSA will have its own independent board of directors comprised of nine directors of whom two will be representatives of Clover in light of its 24% shareholding. The new board of directors will be free to appoint their own management team. DFSA, with its own board and management team, will be an appropriate entity to focus on growing volumes in the Low Margin Business for the benefit of Producers.
The financial effects of the Restructure
The financial effects of the Restructure will be more fully disclosed in due course. It is worth noting the following, namely –
- the Restructure will not affect Clover's profitability. In short, the current profit made from the Low Margin Business will be recovered through the fees payable (including but not Ltd. to a management fee) by DFSA to Clover for the services Clover will render to DFSA;
- DFSA will, at commencement of operations, be in a break even position in the sense that its profits will all initially be paid across to Clover for the essential services Clover will be rendering to it. DFSA will need to grow volumes in the Low Margin Business to become profitable. That DFSA will initially conduct business on a break even basis in keeping with the fact that DFSA will acquire the Low Margin Business for a nominal amount; and
- Clover's turnover will be reduced by approximately R1.75 billion per annum, but the impact on operating income/profitability should be neutral given the fees payable by DFSA to Clover. Clover's balance sheet may be immaterially impacted given the nature of some of the assets to potentially be transferred to DFSA as part of the Low Margin Business.
Protections
Clover believes that the Restructure will not threaten its ability to source Raw Milk in that it will merely be doing so through DFSA as opposed to engaging directly with Producers. DFSA will, in turn, source Raw Milk from Producers using the same delivery/supply agreement system as Clover currently has in place (and which DFSA will acquire as part of the Restructure). In addition, it is anticipated that Clover will, enjoy an option to reacquire the Low Margin Business from DFSA should certain predetermined events occur.
Approvals required
Shareholder approval is not required for the Restructure as it is categorised as a category 2 transaction in terms of the JSE Listings Requirements. Shareholders will nevertheless be regularly updated and advised of progress in giving effect thereto. A further meeting of the Board of Clover to be held on 28 February 2017 at which time the Restructure should be further advanced having regard to engagements with Producer representatives. It is hoped that the Board will finally approve the Restructure and all of its terms at that meeting.
Presentation
It should be noted that the Company expects to publish a more detailed presentation regarding the restructuring ("Presentation") on its website (www.clover.co.za) on or before Tuesday, 31 January 2017.
Amendments
Shareholders are advised that the terms set out in this Further Cautionary Announcement and the Presentation remains subject to the signing of the final suite of agreements between Clover and DFSA. The final agreed full terms of the Restructure will be set out in a SENS announcement in due course.
Further Cautionary Announcement
In light of the ongoing Restructure, Clover shareholders are advised to continue to exercise caution when dealing with the Company securities until a further or full announcement is made.
