Synlait’s sad decline: Capital injection won’t get firm out of the woods

Synlait Milk’s aggressive growth ambitions have brought the Canterbury dairy processor to its knees as the debt it racked up became insurmountable.
Shareholders will vote next week on a rescue plan that will see its cornerstone investors pump in more money to keep it going.
A special meeting at the company’s Dunsandel headquarters on Wednesday is expected to approve a plan for Bright Dairy and A2 Milk to buy $218 million more shares in Synlait to help reduce its debt from about $550 million to $300 million and keep it afloat. 
The company itself is only valued at $650 million to $730 million, excluding debt, according to an independent appraisal by Northington Partners.
“They can’t continue because of that level of debt, and effectively are in an insolvent situation,” said Dr Nic Lees, a senior lecturer in agribusiness management at Lincoln University who uses the company as a case study for students in his third-year strategic management course.
“It’s a very sad story in many ways.”
Synlait was founded in 2005 by Canterbury dairy farmers and entrepreneurs Ben Dingle, Juliet Maclean and John Penno – one of a handful of independent dairy processors set up following the establishment of dairy giant Fonterra in 2001.
Penno led the company as chief executive for 12 years and served as a board director and chairman. He stepped down in May and has been in a public spat with the company over what he called a “sweetheart deal” allowing Bright Dairy and A2 Milk to vote for each other at next week’s meeting – a battle he lost last week.
In Penno’s view, Synlait should have been put into administration and the assets sold off.
Lees said: “I imagine it’s probably a bit of a sad story for him.” 
“It was something that he set up and led and at the time he was CEO it was highly profitable.
“I think for him it’ll be highly disappointing and sad that what he started has got to this point.”
Synlait reported a $4.3 million loss last year and will announce the result of its latest year on September 30. It withdrew its earnings guidance to the market in July, warning it would be weaker than previously thought.
When it first started, Synlait was producing high-value, differentiated products and developed a reputation as a premium supplier to other businesses in the global dairy market. 
Early focused investments meant it was one of only two manufacturers globally capable of producing high-value lactoferrin as a spray-dried powder and it was able to manufacture infant formula and nutritional products tailored to the unique specifications required by leading global infant formula brands.
But Lees said the company lost its way as it grew, diverting from its high-value strategy as it chased a $2 billion revenue target after reaching the $1b milestone in 2019.
“That led to a number of investments that were driven by growth, as opposed to focusing on profitability,” he said.
“It wasn’t because that high-value strategy was wrong, it was just that they made decisions that were outside of that strategy, which eventually pulled them down.”
Concerned it had become too reliant on a single product (infant formula), a single site (Dunsandel) a single market (China) and a single customer (The a2 Milk Company), Synlait invested in diversification.
It poured money into a liquid dairy packaging facility at Dunsandel which allowed it to supply Foodstuffs South Island with homebrand supermarket milk, bought consumer brands Talbot Forest Cheese and Dairyworks, and built a new factory in Pōkeno in the Waikato.
Lees is critical of the moves, noting the expansion into consumer businesses marked a departure from its high-value differentiated strategy and into the realm of low-margin, high-volume products, while the Pōkeno factory was a large, high-risk bet largely funded by debt.
Forsyth Barr senior analyst Matt Montgomerie said the North Island expansion has been the biggest contributor to the company’s woes.
Plans for Pōkeno to produce English-label infant formula that could be shipped to China through informal channels came unstuck when Covid-19 closed borders, Chinese consumers turned to local brands and the country’s birth rate slowed, impacting demand in the world’s largest infant formula market.
And the new customers that Synlait had hoped for at Pōkeno didn’t eventuate, apart from US company Abbott – and that required another $100 million of investment to enable the production of plant-based proteins.
All up, Synlait has invested about $450 million since 2018 setting up its North Island operations but Northington Partners estimated they were now worth just $80 million to $100 million. 
Its Pōkeno factory, operating in a highly competitive region with more than 15 rival processing plants, was estimated to be operating at less than 15% capacity.
Synlait chief executive Grant Watson announced this week the company would stop collecting and processing fresh milk at Pōkeno because it was not financial viable. 
Lees laments that Synlait invested in a big asset that now isn’t worth much.
“There were some basic strategic missteps along the way, particularly relying on debt to fund a plant where you didn’t necessarily have a long-term agreement with a customer,” he said. “When that unravelled, they really didn’t have much other option as to what they could do.”
Even if the injection of capital from its major shareholders is approved at next week’s meeting, Synlait still has some major hurdles in front of it. 
It will still be carrying a significant amount of debt and needs to find new customers, particularly as A2 Milk moves ahead with plans to push more of its production through its own factories.
“This equity raise effectively gives breathing space to turn things around,” Lees said. “It’s not going to get them out of the woods.”