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Market News 10 June 2024

Johnny Lee writes:

If there was a single stock responsible for ‘’water cooler talk’’ this year in New Zealand broking houses, that stock would be Synlait Milk.

Synlait’s future – or potential lack thereof – has spawned numerous speculative news articles recently and seen volatile share (and bond!) pricing in Synlait.

Last week saw an important update to these share and bondholders, adding yet another piece of the puzzle ahead of the December repayment date for the retail bond.

Synlait intends to propose a related party transaction to its shareholders, whereby major shareholder Bright Dairy agrees to lend $130 million to Synlait. Material, related party transactions require shareholder approval. The date of the shareholders meeting to approve this transaction will be announced soon. 

The $130 million from Bright Dairy would be used to meet Synlait’s debt obligations to its bank lenders, which are due on the 15th of July after being extended in March. 

The terms of the proposed loan from Bright Dairy are not yet publicly known.

Synlait also again flagged its intention to raise equity from shareholders. Shareholders are now very much on notice – anyone remaining a shareholder at this point can expect to be tapped for additional cash in the near future. 

Dairyworks is no longer actively on the chopping block. Synlait has indicated that no bids were received at a level it would accept, although it left the door open to the idea of further offers. 

EBITDA guidance was maintained but Synlait has indicated that it is likely to arrive at the lower end of the range. The range previously indicated was $45 to $60 million. Last years EBITDA was nearer $90 million.

Perhaps most importantly, Synlait has confirmed that ‘’a significant majority’’ of its farmers have issued notice that they intend to cease supplying with the company, beginning the two-year exit period.

Synlait, clearly, needs to convince these farmers to withdraw their cessation notices and remain with the company. Feedback from the farmers so far has indicated that most are leaving due to fears around the company’s balance sheet, which, in theory, is an issue that can be resolved. The bigger question may be: if this issue is resolved, will they return to the fold?

The next step for Synlait shareholders will be the vote. Bright Dairy, as the related party, will not be permitted to vote. This means a2 Milk’s vote will be proportionally larger and could end up determining the fate of the company. a2 has not yet indicated its intentions with regards to the vote, no doubt waiting to see the terms of this related party loan. It is well known that a2 Milk has nearly a billion in cash on its books, and has seen its share price climb 70% this year. a2 Milk’s market capitalisation is now over $5.5 billion.

The loan terms, once disclosed, will be crucial in determining whether this plan succeeds. There is clearly an array of different objectives at play with the vote – between a2 Milk, Bright Dairy, smaller shareholders and, of course, bondholders (some of whom will be voting as shareholders) – each grouping will have a different desired outcome for the company. 

It is worth highlighting that the proposed $130 million loan would be many times greater than the value of Bright Dairy’s holding in Synlait (nearer $30 million). Indeed, $130 million is greater than the entire value of Synlait (nearer $80 million). Bright Dairy will prioritise one exposure over the other.

The equity raise will also be important. Assuming it is discounted, the value of the raise may be either insignificantly small, or of a size that sees shareholders asked to commit multiple times their current exposure. Will an underwriter commit to backing such a raise in this climate? 

For now, it is ‘’wait and see’’. Clearly, Bright Dairy sees value in Synlait – at the right price. Shareholders will need to determine whether this price is fair relative to their own expected gains over the same time period. Other options do exist, as unpalatable as they may seem.

In the meantime, the water cooler will remain a popular destination.

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There was a second announcement from Synlait that preceded this one.

Synlait successfully applied for a waiver from the NZX, effectively allowing the company to breach the NZX listing rules.

Waivers are not unheard of and are usually made when situations occur that result in a particular rule no longer making logical sense. Waivers commonly see conditions attached that protect shareholders from the consequences of the permitted rule breach.

In this case, Synlait fell afoul of rule 5.1.1 b, which effectively states that shareholders must approve transactions above a certain threshold. Specifically, the threshold is 50% of a company’s average market capitalisation.

Synlait’s market capitalisation is currently around $80 million.

The rule exists for good reason. It protects shareholders from companies agreeing to deals, considered to be significant to shareholders, without their consent. Normally, a transaction greater than half the value of your company would be considered significant. 

Synlait’s argument is that it routinely enters deals involving more than $40 million of dairy (or dairy-related) products. It would be absurd to ask shareholders to approve each individual sale. Realistically, almost all shareholders would find such meetings to be a waste of time.

The NZX granted the waiver, on the explicit condition that the deals entered into are in the best interests of shareholders, do not change the nature of Synlait’s day to day business, and are transactions that are in the ordinary course of their business. The waiver lasts 12 months.

The waiver, and the protections granted alongside it, make sense and provides a picture of the precarious position Synlait finds itself in.

Synlait, and its shareholders alike, will be hoping that the waiver does not need to be renewed next year.

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The other update of note last week was from casino operator and entertainment provider Sky City, which provided a guidance update, following on from the previous update issued in February.

The share price fell once again following the announcement, reaching near 25-year lows. Millions of shares changed hands, suggesting that there at least remains some conviction on the buy side at these levels. 

Sky City has dealt with a number of wounds in recent history. The share price was amongst the hardest hit during COVID – when tourism dropped to zero - and has had to adapt to the trend of ‘’investor activism’’, with some investors choosing to distance themselves from the gambling sector.

Some wounds were self-inflicted. Penalties from various regulators have actively diminished shareholder value, and there remains some possibility of further shareholder pain in August, when a hearing is scheduled to take place regarding its New Zealand licence.

The update last week included yet another downgrade. Both earnings and net profit are expected to be lower than guided just months prior, with Auckland highlighted as operating within a particularly challenging environment.

Part of the downgrade was due to transitory factors – one off items including the delays with Horizon Hotel, and various investments into compliance obligations.

The update also included confirmation that the company was suspending its dividends going forward. The company declared a dividend in its February result but now believes the worsening conditions justify another suspension of dividends.

The company hopes to reinstate dividends in 2026. 

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Travel

Our advisors will be in the following locations on the dates below:

19 June – Lower Hutt – David Colman

19 June – Christchurch – Johnny Lee

25 June – Napier – Chris Lee

11 July – Tauranga – Johnny Lee

12 July – Hamilton – Johnny Lee

Please contact us to arrange a meeting.

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