Meeting weighs value of
co-ops in fast-changing
business climate
By Lynn Pitman,
University of Wisconsin Center for Cooperatives
nderstanding the true value of a cooperative
is crucial to meeting the many strategic
dilemmas facing cooperatives as they adapt to
a changing business landscape. To explore
this critical issue, more than 180 U.S. and
Canadian co-op leaders (a record attendance) gathered in St.
Paul, Minn., in early November for the 10th annual Farmer
Cooperatives Conference. The University of Wisconsin
Center for Cooperatives (UWCC) presents the annual
conference, funded by the Farm Foundation and other
organizations, to provide co-op directors and managers,
professional organizations, government representatives and
academics with information on major trends and issues
affecting agricultural cooperatives.
Do co-ops create or destroy value?
Chris Peterson, professor at Michigan State University,
provided a solid framework for the conference with his
presentation: “Do Cooperatives Create or Destroy Value?”
Each cooperative is built around a value proposition, said
Peterson. Whether value is gained or lost is determined by
how well the cooperative fulfills that proposed business
arrangement.
The traditional value proposition — in which a
cooperative business is organized and run for the mutual
benefit of its members — provides market access for
members and deals with them fairly. Public policy provides
these co-ops with some preferences (as in areas of anti-trust
exemptions and tax treatment). Problems with this model
occur when capital needs for either business investment or
member equity redemptions exceed equity generated from
members. As market conditions evolve, the co-op may not be
the only avenue for “fair dealing.”
Another type of value proposition is based on the
economic value created by the cooperative enterprise. Here
the annual return of investment, adjusted for a given risk
level, is the key metric for assessment. It was on this basis
that the 2002 McKinsey report concluded that agricultural
co-ops had destroyed more than $1 billion of value in 1999.
Under this scenario, there is no value added by the use of the
cooperative business structure, because financial measures do
not reflect or encompass the mutual benefit provided to
members.
A third type of value proposition recognizes that a
cooperative can create value both at the member-farm level
(which was not considered in the McKinsey study), as well as
at the co-op business level. While returns at the co-op
business level can be measured by the net income used for
patronage refunds and dividends on capital, the returns at the
member-farm level are more difficult to quantify.
There are other variations of the cooperative structure
that are being used to create and capture value, but these
structures use trade-offs in member control to gain broader
market access, alternative sources of equity or other
opportunities. Peterson concluded that co-ops can create
value when the value proposition both fits member needs and
performs well as a business. Some cooperatives are
successfully accomplishing both, but this continues to be a
challenge.
Doug Sims, retired CEO of CoBank, focused on economic
valuation. He stressed that a cooperative must first function
successfully as a business before it can deliver the other
benefits that are also associated with the cooperative business
model. Sims said he believes that cooperatives historically
have coasted on the value of member refunds without
addressing inefficiencies within the business.
A co-op’s value proposition must be able to generate a
return on investment that meets or exceeds the cost of
capital, Sims said. Given that ability, however, a memberowned
and controlled co-op can be an exceptionally strong
model for a customer-oriented business.
Valuing assets during changing times
The co-op business structure can meet both economicand
member-benefit criteria. A change in market conditions
was compelling enough for a group of Michigan Sugar Co.
(MSC) producers to buy the company and create a producerowned
enterprise. When the parent company went into
bankruptcy and put MSC up for sale, sugarbeet growers were
faced with the possibility of losing demand for their crop,
which produce a higher net return per acre than other crops.
Mark Flegenheimer, CEO of MSC, described how producers
bought shares based on acreage and raised $24 million in
equity to start this new-generation co-op.
United Producers Inc. — a livestock marketing co-op that
also offers risk-management and production management
services – decided to maintain its core cooperative structure
after a lawsuit wiped out the co-op’s equity, forcing it to
reorganize. CEO Dennis Bolling pointed out that the
cooperative previously had been structured so that the risk to
farmers was limited to their retained earnings. But the future
of the business depended on greater equity participation by
members.
Because they recognized the value the co-op brought to
their individual operations, farmers were willing to continue
to patronize the co-op and provide equity for refinancing its
operations. UPI is implementing cooperative-based solutions
to meet its capital requirements through new capital retains
and preferred membership programs. It has also created a
community markets program to organize new cooperatives
around its local facilities. While these efforts are not
sufficient to meet all of the co-op’s capital needs, they have
provided significant member value while addressing financial
requirements.
In other cases, the evaluation of the cooperative’s value has
led to the conversion to other business structures. FCStone
CEO Pete Anderson described the rationale and the process
of converting from a cooperative to a public corporation.
FCStone was created in 2000 when the Farmers
Commodities Corp. and Saul Stone and Co. merged to form
one of the nation’s largest volume commercial grain
brokerage firms. The business needed increased capital to
finance expansion while maintaining member service levels.
However, annual payments to members limited the
company’s ability to raise and retain equity.
The cooperative structure also did not provide liquidity or
a means for members and employees to benefit from the
company’s growth, in both market value and income
generation. After a comprehensive strategic assessment, the
cooperative converted to a stock company controlled by
existing members. The new company included an employee
stock ownership plan (ESOP) and increased investment
opportunities for members. Two years later, the company
converted from a private to a public corporation, with an
initial public offering (IPO) of common
stock.
Case study measures benefits
Kansas State University Professors David
Barton and Michael Boland, in their
accompanying case study of FCStone,
evaluated member benefits, before and after
the conversion. Access to risk management
services was similar, and for the next few
years, at least, the original local co-ops will
maintain control of the board. However,
FCStones’s IPO generated unparalleled
multiples of book value, with the possibility
of large equity payouts to co-op and
producer owners, a scenario that was unique
to this conversion and its business position.
Rodney Christianson, CEO of South
Dakota Soybean Processors (SDSP),
described how SDSP converted from a
closed new-generation cooperative to an
LLC in order to expand into the
burgeoning field of vegetable oil
technologies. Projected growth would
threaten the cooperative’s single taxation
treatment, required more equity for
expansion and a larger pool of producers.
In Barton and Boland’s case study,
expectations that drove the conversion were
compared to the results. The growth in
non-patronage-sourced business has not
been as strong as expected, although
business growth has been sufficient to
increase the demand and the price for
soybeans in the area. While producers and
the plant are now both free to pursue the
best respective buy/sell relationships, the
actual transactions continue to follow the
pre-existing pattern.
Equity liquidity has increased, as has
access to new equity capital. Stock prices
have fluctuated, but have remained above the
original equity drive purchase price. Whether
these changes would have occurred under the
co-op structure is unclear.
Gold Kist conversion
The Gold Kist transformation from cooperative to public
company to takeover target was described by Dan Smalley,
past board chair of the cooperative. Gold Kist had evolved
into a major poultry production and marketing enterprise
with a homogeneous board and membership. Its financial
success raised member expectations for payouts at the same
time that the cooperative began to lose market share, faced
large equity redemption obligations and needed access to
capital.
Serious conflict ensued among board members, and the
board eventually recommended converting to a public
company with an IPO. The conversion was intended to
provide flexibility, liquidity for equity holders and an
independent board with expertise and perspective (which
Smalley believed was particularly needed by the cooperative).
The membership approved the conversion, Gold Kist went
public and a new board (with a majority of independent
directors) was formed.
But the now-public company was soon sold to Pilgrim’s
Pride, a privately held enterprise. Smalley felt that the
outcome ultimately benefited cooperative members,
allowing them to capture the full market value of their
company. But former members, who continue to be contract
producers for Pilgrim’s Pride, have no investment in, or
control over, the company.
The issues that commonly lead to conversion can be
strategically addressed, said John Schmitz, CHS executive
vice president and chief financial officer. He described the
advantages of CHS’ cooperative structure as four-fold: a
single level of income taxation, an orientation toward longterm
planning, potentially closer customer ties and earnings
that ultimately benefit the member. CHS equity and
enterprise valuations are similar to an average of publicly
held agribusiness corporations; earnings are the most
important source of capital for creating value for the
shareholder and for the business.
Valuing assets and measuring performance
Performance measures and asset valuation are also key to
assessing a cooperative’s value. David Holm, executive
director for the Iowa Institute for Cooperatives, described a
new cooperative benchmarking project, which will provide a
powerful tool for assessing results of management decisions.
Harry Fehrenbacher, president of Effingham Equity,
described the co-op’s decision-making process for capital
assets, which analyzes how well an investment will profitably
support core business strategies and systematically evaluates
the return on assets by facility and department. Amy Gales,
regional manager of CoBank, reviewed financial perspectives
on valuation, which establishes a present value for the coop’s
relevance and viability both now and in the future.
Member-value proposition
The value proposition for members was part of Swiss
Valley Farms’ structural reassessment, undertaken when a
50-year sunset clause in the bylaws kicked in. Gordon
Toyne, co-CEO, and Don Peterson, a director, provided
perspectives on the process of reincorporating under the
new Iowa cooperative law as a stock cooperative, rather than
a membership co-op.
The board compared the limits of traditional bank
lending practices to the impact of new sources of equity
needed for maintenance and growth. The new law also
allowed co-op boards to add outside (non-member) directors
who could provide needed expertise in areas such as finance,
mergers and acquisitions. The governance committee and
the attorney worked to define and codify in the bylaws the
different interests allowed under the new law and provided
for member voting rights and a producer-member board
majority.
The new structure gives the co-op the ability to issue
preferred stock, which provides equity flexibility and a way
for both employees and co-op members to invest in the coop.
The co-op’s mission statement has been broadened to
recognize its commitment to its workforce and customers, as
well as to its owners and members.
Because the change was so significant, extensive
membership communications on this issue began five
months before the vote, allowing time for members to ask
questions. Peterson felt that this step was critical to member
engagement and the eventual success of the reincorporation
effort.
Kevin Sexton, manager of River Country Cooperative,
explained how the co-op redefined its member-value
proposition in response to changing demographics. The coop
repositioned itself to serve both consumer and farmer
needs. Almost half of its earnings are now from petroleum,
with the remaining earnings from farm supply activities.
The co-op is attempting to maintain its program of cash
refunds to members while building its unallocated reserve to
support its growth.
Branding and corporate responsibility
A broader perspective on the cooperative value
proposition was provided by Jean-Marie Peltier, president
and CEO of the National Council of Farmer Cooperatives
(NCFC). Peltier pointed out that traditional cooperative
values — farmer ownership and control, economic viability
of farm businesses, stewardship of natural resources and
rural community — fit in well with the current emphasis of
sustainability and social responsibility in the corporate
realm.
NCFC is developing a cooperative stewardship initiative
by working with Wal-Mart on a producer score-card
program, and by exploring other tools for self-regulation,
rather than using a third-party certification process for
sustainability compliance.
To market this initiative, NCFC is developing a
communications program that will capitalize on the desire
by consumers to buy products that are values based. Peltier
urged farmer cooperatives to create a vision of sustainability
that is aligned with grower needs, saying that “you can’t go
wrong by doing good!”
Value creation critical
to future co-op viability
It is clear that the ability of a cooperative to create
economic value, as measured by standard financial metrics,
is critical to the ongoing viability of the business. But the
value proposition for members can encompass a wide range
of benefits that may be difficult to accurately assess. Benefits
may have a patron- or investor-orientation, which may
change over the life cycle of the cooperative. This can be
further complicated by market valuation increases that can
be difficult for members to capture.
Cooperatives continue to explore structural alternatives
that can support the value proposition for members and
meet capital formation challenges, while weighing the
potential impacts of the trade-offs in member control.
Value definition can evolve
during co-op’s life cycle
The definition of a co-op’s value to members can change over
the course of a single cooperative’s life cycle, said Michael Cook,
professor at the University of Missouri. He noted the many
different member-value propositions that were described during
the Farmer Cooperative Conference.
The range of member-value propositions reflect the
complexity of the cooperative structure, while value created by an
investor-owned firm is assessed by just a few measures. Cook
pointed out that co-op value propositions can treat members as
patrons or as investors, and the cooperative should understand
where along the patron-investor spectrum its membership wishes
to be.
Traditionally, farmer cooperatives have been formed to secure
producers a larger portion of the proceeds from the sale of their
product, or “a larger piece of the pie,” and the co-op supported
their efforts as individual entrepreneurs. The current shift in
cooperative business strategy is to “create more pie” by enlarging
markets through value-added efforts. Members look to the
cooperative to serve a more “collective entrepreneur” function,
and capital formation becomes a larger issue, Cook noted.
Because there are many ways to create value, cooperative
members need to share a common interest. Cooperative life
cycles can be seen as a process in which divergent interests
develop within the membership as the result of growth, and the
subsequent actions the co-op takes is a process for realigning the
members’ common interests. From this perspective, Cook said, a
cooperative can have multiple life cycles.
