A willing buyer does not mean an easy sale of Kerry Dairy Ireland

On the surface, it all looks very simple. Kerry Group has long outgrown its roots in the dairy farms of the southwest of Ireland.

The multinational group is keen to get out of the low-margin business of collecting and processing Irish milk, allowing it to fully concentrate on its taste and nutrition business, which accounted for 85% of revenue and over 95% of earnings before interest, depreciation, taxation and amortisation (EBITDA) in 2023.

Speaking after the release of annual results for last year, group CEO Edmond Scanlon said that he is open to inbound enquiries which could lead to an offer for the Irish dairy business.

He further made the point, when speaking to investors, that he is “open-minded in terms of how best to create shareholder value”.

To put this another way, Kerry Dairy Ireland, as the division is now called, is definitely for sale.

On the other side of the fence, the farmers who supply to Kerry Dairy Ireland are very keen to control the processing of their milk. A survey which was presented to the board of Kerry Co-op last week showed that 87% thought that the control of processing was either somewhat or very important.

On the face of it, this all seems very simple. There is a willing seller in Kerry Group, and a willing buyer in the farmer suppliers. A deal should be done, once a price is agreed.

However. We’ve been here before. Back in January 2021, there were reports that an offer was close to being made by Kerry Co-op to take a 60% stake in the dairy business.

The deal, which valued the Irish operation at €800m, would have meant Kerry Co-op purchasing an initial 60% for €480m and then buying out the balance for €320m plus interest five years later.

By April of that year, the deal had collapsed. There was disagreement on the price, with farmers thinking €800m was too much to pay, and considerable unease expressed over some of the other details of the proposed deal.

Since then, there has been at least one more attempt to re-enter talks, but no concrete proposal has emerged.

Motion

At the Kerry Co-op AGM last summer, 90% of attendees approved a motion which would bar the co-op board from spending more than €50m in any five-year period. This vote effectively ties the board’s hands on any takeover ambitions they might have.

There is also a significant timing issue at play through all this. Currently, milk suppliers to Kerry Group’s Irish dairy operations are under contract effectively until the end of the 2025 milking season.

Kerry Group put those suppliers on notice that their contracts would be terminated at the end of the current agreement period in 2021 – the contract requires a five-year notice period for termination. This means that those suppliers will soon be free to send their milk elsewhere, should they desire.

At the time, Kerry Group suggested it would start new negotiations with milk suppliers and the co-op board. As yet, there is no fresh contract in place.

A group of Kerry milk suppliers have taken action themselves, setting up a producer organisation, which would allow them to negotiate as a block with processors for milk contracts.

While members of that producer organisation who have talked to the Irish Farmers Journal expressed a preference for sticking with Kerry, they are open to talking to any processor.

Valuation

All of this matters for the valuation that can be put on Kerry Dairy Ireland.

If there is no certainty over how much milk might be coming into processing facilities in 2026, that will seriously curtail the attractiveness of the business as an investment.

If Kerry Co-op’s milk-supplying members are fully united on their plans for the future – and there is nothing to suggest that is the case – then this might be looked through by the co-op when discussing a valuation.

It does mean, however, that whatever chances there were of another bidder emerging for the business, which were always very small, are probably at zero.

The co-op has its own difficulties when it comes to its share structure. The co-op’s shareholders are a mix of those who have a close connection to farming, and those who are long distanced from milking cows, or may have no family connection to dairying.

The milk-supplying members (and those who have recently stopped supplying milk) have a vote on co-op decisions as members. Those with no connection to dairying have no vote on co-op matters.

As the co-op’s main asset is the approximately 11.3% it holds of Kerry Group’s shares. Any sale of those shares in order to fund the purchase of Kerry Dairy Ireland risks reducing the value of the shares held by non-voting shareholders.

After such a sale, they would own a share of a smaller pool of Kerry Group plc shares and a share of the Kerry Dairy Ireland asset.

While the Kerry Group shares are liquid and have a market value, there may be little value for non-milk supplying shareholders in the dairy business.

Speaking at the ESG in Dairy event last week, Kerry Dairy Ireland CEO Pat Murphy described dairy processing as a “low-margin” enterprise, and data from his own company shows that he is not wrong.

Last year, Kerry Dairy Ireland reported earnings of €53m on revenue of €1,283m.

That’s a margin of just over 4%, before interest, tax and depreciation costs are factored in.

Seeing as dairy processing is not a high-growth industry either, there is little in Kerry Dairy Ireland which would attract the kind of private equity buyer who would try to increase profitability and margins.

Also, the lack of milk contracts beyond the end of next year would be a major hurdle to interest from outside buyers.

Looking at the processors who already operate in Ireland, there is only one – Tirlán – which has the balance sheet to fund a theoretical takeover. Could they be a buyer? In the interest of completeness, we rang Tirlán where a spokesperson would not dignify the question with an on-the-record response.

The survey results last week and recent comments from Kerry CEO Edmond Scanlon have certainly reignited interest over the future of Kerry’s Irish dairy operation.

It seems certain that for Kerry Group, there is only one potential buyer and for the farmers who are so keen to own their processor, there is only one potential seller.

There might be some thoughts that the Glanbia-Tirlán split might serve as a kind of template for a Kerry deal, but it is fair to say that there seems to be considerably more distance between the parties in this case than what we saw in Kilkenny.

For the farmers, there are also plenty of other factors to consider. They have little to no expertise on how to actually run a multinational dairy processor, and would have the challenge of retaining key management staff during a takeover.

There would have to be considerable due diligence undertaken to properly establish the value of the plants they would be buying.

A large investment would require many years to be repaid.

It may quickly become apparent that we will end up having a re-run of events in 2021 where the deal broke down due to failure to agree a price, but also failure to agree on terms and conditions.

There is no reason to think that having both sides willing to do a deal will be enough to get a deal done.