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December 2005 Edition ---- to page back through Previous Editions click here

Its year end and we have decided to publish a stage play in an attempt to give some substance to year end accounting office parties. No royalties but this site should be acknowledged to the audience as the source, or a source if it is partially used. We will have our Auditors out and about. Lets go:

Gr Yes and I well remember that great write up of John at paragraph 217 of the 2001 Hedley v Kiwi judgment of the high court. They don't come much better than that either.

Gr No indeed. But John, by way of a little boarding school type initiation ceremony; many of us are products of boarding schools I would suspect; by way of such a ceremony perhaps you can explain the statement at the end of paragraph 226 of that judgment where you are said to have said that the Ernst and Young analysis showed that the Tui shareholders were projected to be approximately 90 c per kilogram of milk ahead because of the merger.

Gr This is not the army cadet school. We are not as tough as that.

Gr You must have read paragraph 226 without having read 217 about John. You wouldn't question 226 if you had first read John's credentials at 217. These things have got to be read in order.

Gl2 But a kilogram of milk is one of those one litre containers. If they were going to get an extra 90cents for every one of those things they produced no-one in their right mind would vote against the merger.

Gr That would be the message of the judge. Those spoilt farmers were quite over the top to ask for more.

Gr But come off it, 90 cents more for every litre container of milk. There would have to be huge economies from the merger if that was the case.

Gr Its OK to say it if all the main players know that it is just rough expression.

Gr But the judge is relying on public opinion for general acceptance of the finding. And you can't really expect the public know it is rough expression.

Gr Well John, in good technical language what did the Ernst and Young report really show in relation to what has been expressed as being "90cents per kilogram of milk ahead".

Gr I will answer for him as best I can as I have looked into it a bit. If you check it out the report showed that the Tui farmers stood to gain the equivalent of 70 cents for each kilogram of the solid matter in milk for their first year of production after the merger only, provided they continue to produce milk at this level of production indefinitely. And that is provided the models from which the data was taken were realistic. John had some reservations about the depreciation policies.

Gr So how much extra did they stand to get for each kilogram of milk thereafter produced if they merged on the terms offered to them, as they did?

Gr Well for a start Ernst and Young talked about milk solids, not milk. Hey Barman! Could we have the milk container with the milk for our tea please. We are accountants and must count our calories and everything you know.

Gr Yes well a litre of water weighs a kilogram by definition I think. Milk will be a trifle lighter.

Gr Yes the light bit is the cream which is usually part of a trifle.

Gr John must have been misquoted about a kilogram of milk.

Gr In a big judgment like that he is sure to have got the chance to look it over for anomalies I would think.

Gr Here is our container, a litre of full milk. What does it say? 3.3grams protein, 3.3 grams fat, 4.9grams carbohydrate. That is all per 100mls. Doing addition and times 10 that is 115, say 120 grams of solids in the container. Now Ernst and Young took the gain from the merger to be 16 cents extra per kilo of solids after the first 3 years. For the first three years the gain varied a bit and of course a "retention" was be charged by Kiwi Co=operative Dairies who were virtually doing a takeover. The retention was 20cents per kg of solids for 2 years followed by 10cents for one year. That is why Ermst and Young were justified in using Net Present Value analysis. The retention reduced the present value of the gain from 141c to 90c per kg of milksolids produced annually according to their calculations but they did not do it right and each of those figures needs to be reduce by 20cents so proportionally the 16cents reduces to 10 cents per kg milk solids which is 1.2cents per kilogram of milk.

Gr I think what has happened is that John has been faced with how to handle highly misleading presentation of the results of nett present value calculations by Ernst and Young. They should have said "The nett benefit of the merger to Tui shareholders over the years is the equivalent of receiving 90 cents per kilogram of annual milk solids production as a once only payment at the time of the merger". Instead they said the benefit was 90 cents "per kg milksolids for the years 1996 to 2015".

Gr Yes and the farmers who took the action said nothing about this because they did not wish to suggest that a farmer could be silly enough to think they would get 90 cents extra for every kg of milk solids supplied thereafter. But farmers are entitled to think that accountants will express themselves accurately in important reports, and if they have little time to spend studying the matter would likely vote for the merger just in case.

Gr The trouble with Nett Present Value analysis is it is so critically dependent on the interest rate used. They picked upon 11% which was the going overdraft rate. Probably the inflation rate should have been deducted from that. The result seemed a bit low so they presented it as being the extra to be obtained on each kilogram produced from then on. Anyone who confronted them on that would get the "you wouldn't seriously think it could be that much would you?" treatment. But the uninitiated would take it at face value, and I think many farmers who were not motivated to study the matter deeply would vote for the merger just in case as was said.

Gr Yes it was just bandying about of figures to give the impression of being very scientific and there being a very big benefit. The 70 cents was a bit low so it seems a little mistake slipped in. The first few years were calculated individually then they did a bulk calculation for another 15 years of production since an extrapolation of 16 cents per litre was to apply to all these later years. The second year they divided by 1.11, the third year by 1.11 squared, the fourth year by 1.11 cubed so the bulk calculation should have started at 1.11 to the power of four but they went back a couple of places to squared again.

Gr Yes and then they. Ernst and Young, calculated an average benefit which they applied to the surplus which Tui's manufacturing is purported to have made so that they could say that the benefit represented a 16% increase in this surplus. But they got this average benefit by dividing the 90 cents by the 20 years they went out to get 4.5 cents per kilogram. If they had gone out a hundred years their net present valve would only have been about a dollar so the average would have been about one cent. The process was completely illogical.

Gr Yes it can be great playing around with figures until you get a somewhat plausible answer which points in the direction that you want. If you won't be ridiculed that is. John sort of took on the job of justifying these figures on behalf of the defendants. However it was not these calculations that were being challenged directly. But he saw the need to have to mention it as he did with his "90 cents per kilogram of milk" statement.

Gr One point two cents is still quite a bit perhaps, but a lot different from 90cents, John. And that is not allowing anything for the allegations of unfair comparisons which the farmers who took the court action make. You thought that there might be substance to their depreciation argument didn't you John? Coopers and Lybrand seemed to think that there were quite a few issues in their report according to paragraph 254.

Gr Anyway if it is 1.2cents and not 90 cents per kilogram of milk social considerations in having more say in a local company come into play. In paragraph 227, after mentioning the 90 cents per kilogram of milk in 226 the judge says "Without [the differential] the merger would not have proceeded. It was, therefore, in the best interests of the Tui shareholders to pay a differential." Is that valid when it is 1.2 cents per kilogram of milk and possibly less?

Gr It was stretching it to say Kiwi would not make an offer without the retention if the proposal had been turned down. The directors can all say that they would not make another offer but until they are in that situation they don't really know. I think Hedley was right when he said at para 327 "they wanted the power which would come with the 25% of the industry", but John is not responsible for that. He just agreed to appear for them.

Gr But this judgment was appealed wasn't it?

Gr Yes but this did not seem to be a issue. There were lots of other matters that troubled the farmers which went to appeal but without success.

Gr So what is our verdict?

Gr It is that John as an expert witness said that the Ernst and Young analysis showed the Tui shareholders were projected to be 90 cents per kilogram of milk ahead whereas if you have a close look at it, as he might have been expected to do, the shareholders were only about 1.2 cents per kilogram ahead and could reasonably have decided not to merge. The judge has used the 90 cent figure to say the offer was too good to turn down.

Gr And then at paragraph 219 it was inferred that John said 10cents of the retention didn't count because it went to the reserves. If it was going to be paid out and now it is shared with a company twice as big it is quite a loss I would have thought.

Gr So what are we going to do with him?

Gr Its OK John, its just a boarding school prank. Your one of us now. Expert witness are allowed to say whatever they like. Is that not right Michael? Anyway "90 cents per kilogram of milk" sounds like just a figure of speech, like people say zillions and humungous. Accounting is about convincing not the logical processing of figures these days.

Here is a change of underwear, have a shower and we will get some of that milk into your tea. Then we might get on to 1990 Bank of New Zealand and you should be able to get some of your own back. We have two expert witnesses for the defendants on hand for that.

There ends part one It should be sufficient to get on with while further parts are refined. .

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