September 1997
Wane in co-op fever will actually benefit value-added ag
by Tracy Sayler
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Prairie Grains is the
official publication of
the Minnesota
Association of
Wheat Growers,
North Dakota Grain
Growers Association,
South Dakota Wheat,
Inc., and the
Minnesota Barley
Growers Association.
The 1990s saw a rash of interest among producers to invest in cooperatives or businesses to add value to the farm commodities they produce. There was a flurry of value-added seminars, meetings, and prospectuses. Each commodity seemed to have its own mad dash for investment cash, and with every new-venture blueprint came the speculation of "OK, what's next?"
However, the value-added express has taken a slower pace. Part of the reason is that the sensation has subsided over some ventures; equity drives have been completed, plant sites have been selected or built, products are being made and the value-added honeymooners are quietly going about their business of becoming established, and making money on behalf of their investors.
"I agree that value-added is not on the lips of everyone like it was a year or two ago. But that's because the emotion has died down a bit. People have invested, projects put in place, and work has begun," says Tim Dufault, a Crookston, MN producer who serves as president of the Minnesota Association of Wheat Growers, and is an investor in the start-up United Spring Wheat Processors (USWP), American Crystal Sugar Company, and Glacier Frozen Foods, a vegetable processing co-op.
The value-added movement has matured, says Dufault: there's only so many growers who will invest, and only so much capital to be invested. There's also been bumps in the road for some ventures, ranging from market ups and downs to equity drives that have fallen short. But those are the realities of any business, says Lee Estenson, vice president and lending team manager of the St. Paul Bank for Cooperatives.
"Just because you form a co-op doesn't mean instant success. A cooperative is only a structure for assisting growers to pool capital and distribute returns. Equity investments truly have to be considered risk capital. There's going to be cycles, and you shouldn't be betting the whole farm. The key is, have a good project with staying power, and good management," Estenson says.
Just like the stock market, value-added investments may rise and fall in value, but still offer a better return over the long-term, as opposed to selling raw farm commodities conventionally in the open market. "You have to be prepared to be in it (a value-added investment) for the long run," says Estenson.
The St. Paul Bank knows this first-hand: a downturn for some co-op ventures that the bank finances prompted it to put $26 million into the bank's loss reserves in the first quarter this year. But that doesn't concern Estenson, as the bank's value-added investment portfolio has already rebounded from its first-quarter setback. "Operations have been generating earnings, and we did not see a need to make any transfers into our loss reserves in the second quarter," Estenson says.
He says there are several options for cooperatives to work through tough times, on a case-by-case basis. It might require a change in management, or recapitalization. "And sometimes, there's a need to consider, 'when should I stop my losses and sell the business?' But mostly, it's a business cycle situation. Sound businesses have the staying power to weather through it," says Estenson. "To enjoy good times, you're going to have to weather through the bad."
CO-OP COOL-DOWN WELCOME
The value-added concept may have lost its status as a phenomenon, but not as an economic opportunity, says Bill Patrie, rural development director for North Dakota's Rural Electric Cooperative in Mandan, N.D.
"The underlying need and desire to add value to our farm commodities is still there. I don't see cooperatives receding in importance. The notion of local ownership, and cooperative enterprise development, remains a viable option that I think a number of groups will continue to pursue, and pursued correctly, find success."
Patrie says there are some "we'll try anything" value-added ventures that have fallen on tough times. But that, nor the slow-down in the value-added ag movement in the Northern Plains, doesn't distress Patrie. In fact, he's encouraged by it.
"It is the bad planners and the ones that hastily formed that have fell by the wayside. We ought not form cooperatives easily. All value-added businesses should be launched only after careful thought and a sound business plan is in place," he says. "The fact that the process is slowing down only means it's returning to the fundamentals necessary to form a long-term successful venture, and those that do form are more likely to survive."
Allen Gerber, president of the Minnesota Association of Cooperatives, agrees.
"The rationale for awhile was 'build it, and they will come.' But you can't expect that. To assume that people are going to buy something simply because it's 'farmer-owned,' or to assume that you'll have an institutional market to bank on is a mistake. There's just as much interest in value-added agriculture, but co-op fever has subsided, and I don't think that's all bad. The cool-down will help people make better decisions," says Gerber.
Those that have their markets established have a good chance to succeed, says Gerber. The odds become even better with a sharp board of directors and sound management. "I have a gut feeling that although a business plan is important, people are more important. No matter how good the concept, it's not going to work without people."
As the former vice president of Cargill's worldwide dry milling division, Gary Lee, now the CEO of USWP, knows what it's like to "swim with the sharks," as one non-fiction best-seller put it.
"Business is faced with cycles and competitors. That's where the test of management and leadership comes in," says Lee.
USWP has been studious in the evaluation of its marketplace, he says, and has a carefully-measured business plan, guided by leadership with proven experience in value-added agriculture. "Our members realize the value of being involved in a business of this potential," says Lee. Indeed, those factors are cornerstones to success, as Patrie and Gerber both pointed out.
However, USWP will soon announce its business plan and embark on an equity drive across Minnesota, North Dakota, South Dakota, and Montana. If the drive is successful, USWP could become the largest spring wheat processing cooperative in the Northern Plains. Is Lee daunted at going forth with an equity drive, at the same time other ventures are going through growing pains, and after a spring wheat harvest that will be less than stellar?
Not at all, says Lee. For one thing, he says that measuring the potential success of one cooperative venture based on the performance of others would be flawed. "You have all sorts of market dynamics at work, in the processing of one commodity to another. Even in adding value to one commodity such as wheat, whether it's frozen dough manufacturing or flour milling, one industry may be fragmented and the other tremendously consolidated, and each has different opportunities with different levels of risk."
Further, Lee says this year's disappointing spring wheat harvest will no doubt impact individual USWP members. But it also reveals a key overall advantage as a cooperative.
"Members of a cooperative, in effect, hedge against low prices through ownership in the processing business," says Lee. "That's because the low prices that make wheat production less profitable can make their processing business more profitable. Shortfalls in production income can be made up by increased profits from the processing side." Lee says this harvest will also demonstrate how involving a four-state region will be a clear advantage for USWP. "What may affect one growing area may not affect another," he says. We are structuring a business that's strong enough to withstand cycles in the weather or business climate, over the long term."n
NEW-WAVE CO-OPS OFFER DISTINCT ADVANTAGES
Leave it to Benjamin Franklin. In addition to being a Founding Father, renowned author and publisher, and extraordinary inventor, Franklin also found time to organize the first successful U.S. cooperative in 1752: the Philadelphia Contributionship for the Insurance of Houses from Fire, which remains America's oldest continuing cooperative.
Today, there are more than 4,000 local co-ops across the country, with a combined membership that includes most of America's nearly two million farmers, according to the National Council of Farmer Cooperatives (NCFC) in Washington, D.C. Many of those co-ops provide members with supplies, including electricity, and perform marketing services such as moving grain to processors.
During the past two decades, agricultural producers in this region have shown renewed interest in the cooperative form of doing business and have begun establishing processing co-ops, through which member-shareholders are able to add value to raw commodities. And however you want to call them - "new generation," "new wave," or "closed" - the new class of co-ops, with American Crystal Sugar Company, Moorhead, MN (one of the first new-wavers), and Dakota Growers Pasta Company, Carrington, N.D. as examples, offer distinct advantages:
The term closed cooperative is kind of a misnomer," says Frayne Olson, assistant director of the Burdick Center for Cooperatives at North Dakota State University. "If I wanted to start producing durum for the pasta growers in Carrington, I can do that tomorrow by buying stock... as long as there's a willing seller."
The sale of stock in processing co-ops establishes immediate equity, which can make financing these value-added ventures easier than traditional co-ops, explains Olson. However, the money producers invest to purchase stock represents up-front risk capital, because if a new wave co-op fails, the shareholders can lose their entire investment. When traditional co-ops fail, shareholders will lose only those earned patronage dividends that remain undistributed.
On the other hand, if a new wave processing co-op is successful, shareholders can begin receiving a percentage of their patronage refund in cash the same year the co-op shows a profit. And that dividend will be a current reflection of how much stock (equity) a shareholder owns.
One problem with patronage distribution under the traditional co-op structure is that members who currently may be delivering 10 percent of an elevator co-op's volume receive retained equity reflecting a previous volume, which may have been only 1 percent, explains Brooks Wilson, research associate with NDSU's Burdick Center for Cooperatives. In contrast, co-op members who are nearing retirement may now be contributing a smaller volume of product, but receiving retained equity reflective of when they delivered larger volumes.
In detailing another problem he sees with traditional co-ops, Wilson offers this scenario: Suppose an elevator cooperative is comprised of two broad groups of members: farmers who are nearing retirement and those who are 20 to 25 years from retirement. The co-op is considering a facility expansion, but in order to finance this investment, it will have to increase retains for the next three years. Would a farmer who's going to retire in three years approve the investment?
"The answer is probably 'no,' because it would cost him more money for the remaining three years he's going to deliver, and he will derive none of the benefits after that period," answers Wilson. "And, the cooperative is going to keep his equity, until it's paid out - four, five, six or seven years down the line."
Another problem a traditional elevator co-op faces is that members are not required to maintain their volumes. Therefore, under Wilson's scenario, members could avoid some of their investment responsibility by delivering a portion of their typical volumes elsewhere during the three-year period the co-op increases its retained equity. The end result is that the co-op's expansion project may be under capitalized.
Taking his scenario a step further, Wilson assumes the completed expansion project allows the elevator co-op to pay its members 50 cents a bushel more for their product. Simply by paying the nominal membership fee, non-members can become members and begin delivering and receiving that same higher payment.
"There's no cost for sitting on the sidelines," says Wilson. "That in itself is not a real problem. But, what often happens is that enough neighbors join so that the volume is pushed past the efficiency point of the facility."
New wave value-added cooperatives, on the other hand, link volume with operating efficiency by limiting stock offerings. Each share of cooperative stock a member purchases represents the right to deliver a specific amount of product. Value-added co-ops then go one step further and turn that right into an obligation by entering into marketing agreements with shareholders.
Wilson says members of value-added co-ops, regardless of age, would be more willing to invest in facility expansions, because if a particular project makes the co-op more profitable, the value of their stock will increase immediately. Also, because members are contractually obligated to deliver product, shareholders can't avoid their investment responsibilities by selling a portion of their volumes elsewhere.
And finally, those who aren't initial investors in successful value-added co-ops will be required to pay a higher market-value price for stock if they decide to invest later. "It penalizes people who are avoiding risk." says Wilson. Because shareholders can sell their stock and thereby transfer their delivery rights, there is a liquid value associated with the stock of these newer co-ops, says Wilson.n
(Dean Hulse is a freelance writer in Fargo, ND)