There have been many astonishing days in the history of The A2 Milk Company. If Cliff Cook, Geoff Babidge and Peter Nathan could pick just one, then February 21 of this year is a stand out.
It marks the announcement of A2’s strategic partnership with Fonterra, the giant New Zealand co-operative that is responsible for almost a third of the world’s total dairy exports.
A2’s share price jumped 25 per cent on the news, making it New Zealand’s biggest listed company, with a market capitalisation of $NZ8.5 billion ($7.8 billion). A2’s value had also topped Fonterra and, by nature of its dual listing, the company had firmly entrenched itself within the ASX100.
The company had risen from the outer reaches of the New Zealand Stock Exchange’s second board to become the country’s biggest company in under five years. From listing on the ASX to becoming one of the top 100 companies in Australia had taken a little over two.
“Not bad for a company that Fonterra tried to kill, and more than once,” laughs Cook, the former chairman and NZ Rich Lister who bought A2 on the brink of insolvency.
Babidge, who on Friday stepped down as chief executive of A2 after a decade at the helm, recalls the sense of achievement.
“The funny thing is, from the time I met Cliff, he always said this was going to be a multibillion-dollar business,” he says. “I saw the potential in it, that’s why I hunted down Cliff to get involved in the first place, but A2 has surpassed all our dreams.”
Peter Nathan, A2’s straight-talking Asia Pacific CEO, and the man who has driven A2’s push into China and the infant formula market, is more blunt about the success.
“We took risks. We gambled. But all the time we knew we had a product that was premium, was high margin, and had a definite point of difference in the health space. So am I surprised by the success? I am surprised at how fast it has come, but not that it has come.”
From Monday morning, Jayne Hrdlicka takes the reins of A2 and the former Jetstar chief has a tough job. Australian investors have watched the ASX shares soar from 85¢ in 2015 to $10.36 on Friday, but with the stock trading on a price-earnings multiple of 31 times, any divergence from strong earnings growth will be punished. And given much of A2’s growth is linked to China, the risk of that is high.
But Hrdlicka also inherits a company with a rich history of taking chances, fighting back and beating the odds.
Now the three men who masterminded its rise have sat down together to tell AFR Weekend the story, for the first time, of how fortune and fate helped them create an $8 billion company – one of the greatest rags to riches stories in recent times.
A life-changing conversation
To start with, it should be noted that Cook has never been a great fan of Australians. But in August 2001 he was particularly peeved with the neighbours from across the ditch.
Sitting in a corporate box at Carisbrook, Cook watched as the Wallabies notched the first ever Test win by a visiting side at Dunedin’s “House of Pain”.
The loss hurt, but what Cook didn’t realise was that he had been part of a conversation that would transform his life, his wealth and his business empire forever.
While John Eales led the Wallabies to victory, Cook was engrossed in a conversation with Howard Paterson, a Dunedin farmer turned businessman who made his fortune in dairy and eggs. “Howard told me he was in something that was going to change the world,” Cook recalls.
That something was called A2 Milk.
Paterson had for decades been a major stakeholder in Fonterra, New Zealand’s global dairy co-operative. Fonterra and the dairy boom had made Paterson a wealthy man, but in the late 1990s he stumbled on something he thought might change the face of the global dairy industry.
It was the work of a chemical engineer named Dr Corran McLachlan. McLachlan’s research had focused on the two natural beta casein proteins – A1 and A2 – that exist within milk.
His theory was that many dietary and digestive issues related to milk could be traced to the A1 beta casein protein, as well as medical conditions such as diabetes and heart disease.
McLachlan had developed and patented a simple genetic test that could identify cows that produced milk with only the A2 protein.
Paterson was hooked by A2’s possibilities, even though the theories were mostly untested. The chemist was even convinced there was a link between A1 and schizophrenia. The pair established A2 Corporation in 2000, with dreams of taking their milk to the world.
“I remember that day well, and Howard was the first person who ever spoke to me about this thing called A2 milk,” says Cook. “He thought he would change the world and make a fortune. I went back to Auckland and asked my lawyer Peter Hinton to check it out.”
A chance association
As chance would have it, Hinton had acted in establishing the business partnership between Paterson and McLachlan, forming the A2 Corporation. “Peter thought it was an interesting business,” says Cook. “But I really didn’t think about it much after that, except when I ran into Howard from time to time.”
Fonterra soon thought about it, and didn’t look kindly on the idea of a tiny upstart challenging its monopoly. The co-operative had exclusive rights to 98 per cent of New Zealand’s dairy farms, and used those contracts to effectively block A2’s milk supply.
Paterson countered with litigation and, in an audacious lawsuit, demanded that all milk sold in New Zealand that contained the A1 protein carry a health warning declaring risks of type 1 diabetes, heart disease and schizophrenia.
The court case and publicity threatened to undermine New Zealand’s entire dairy industry, which accounted for 20 per cent of the nation’s exports at the time.
“It was a huge deal in New Zealand,” says Cook. “Fonterra tried to threaten Howard, so he went to the Commerce Commission to try to force Fonterra to put a health warning on milk, just like on a cigarette packet. Can you imagine ‘This could be injurious to your health’ on every milk carton sold in New Zealand?
“A2 tried to do a distribution deal with Fonterra and they didn’t get the deal, so Howard decided to fight Fonterra. You had a $37 billion revenue company versus $0 revenue company in the High Court. Howard would have thought nothing of it. It would have been a normal day in the office for him.”
In fighting Fonterra, Paterson had taken A2 to the wall. To fund the litigation, he sold the rights to A2 to various players around the world, from Singapore to Australia. At the same time, he had managed to pull off the most important step in A2’s story – he managed to scrape together enough independent farmers to launch A2 Milk on the New Zealand market, in April 2003. A2 was on the shelves, but neither Paterson nor McLachlan would ever see the fruits of their labours materialise.
In August 2003, lawyer Peter Hinton jumped in his car and raced to Corran McLachlan’s family home. “Peter got to his bed just as Corran closed his eyes and passed away,” Cook says.
Cancer had claimed the life of one of A2’s founders. Just four weeks earlier, Howard Paterson had died in a freak choking accident while on holiday in Fiji.
With no leadership, mounting court costs and a bank demanding that A2 pay a $665,000 guarantee or it would foreclose, A2 was in crisis.
The McLachlan family had virtually no assets other than their unsaleable A2 shares, which amounted to 32 per cent of the company’s stock. Hinton feared the McLachlans would lose the family home, so he picked up the phone and called Cook.
The following weekend Cook drove to meet his lawyer and the McLachlan family.
“I arrived. It was a Saturday, and Peter asked if I would consider funding the company,” Cook says. “I met with the widow, Ulrike, and one of her daughters, Julia.
“I asked Ulrike how much debt she had. She had $380,000 of debt, so I paid her $400,000 for half her A2 shares, which was double the price of the last trade. The company had gone and everyone knew that, so I paid her $400,000 and I took 16 per cent of the company. I also insisted that she keep the remaining shares, but assign me the voting rights. I said to her ‘I’ll do this on the basis that you pay your mortgage off on your house, and you’ve got some money in the bank, but you also have to hold those last shares and go on the journey with me’.”
The truth is, A2 should have died with Paterson and McLachlan. Hinton had talked Cook into saving it, simply by wanting to keep the McLachlan family in their home. By mid-August, almost two years to the day after he had first heard the words “A2 Milk” uttered in a corporate box in Dunedin, Cook now controlled it.
An initial nightmare
Over the next three years, the investment proved a nightmare. Cook’s lawyers fought battles in New Zealand, England, Australia and the US to unwind the licensing deals that Paterson had struck.
“I paid off some guy in England $20,000 just to go away. I reckon it was the most money he had seen in his life. Then we got a lawsuit from Salt Lake City. Then one from Toowoomba. That was the worst. You Australians have the worst kind of nutcases on earth in Toowoomba.”
The global structure was so shambolic that the Australian licencee, Fraser and Nieve, had launched a massive television campaign promoting A2 in South Australia. The only problem was it didn’t have any milk.
“I was in Adelaide and I turned on morning TV and there was a great big A2 ad that came on,” Cook laughs. “They were doing a launch of A2 milk and quite literally they didn’t have the milk. They had the contract to get on the supermarket shelves. They had the marketing campaign. But they had no milk. It was unbelievable.”
Fraser and Nieve eventually managed to get A2 milk stocked in 600 supermarkets across four states, but was losing a fortune. “In the end they came back to me and I bought the company back for one dollar,” Cook says.
On the positive side, a peace deal with Fonterra was struck. “We were a tiny thorn in their side so I called the chairman and we agreed to make it go away,” Cook says.
A second positive came in the form of a phone call from Australia. “I had had the very good fortune to get a phone call from a very strong-accented Australian, who basically told me he was going to help me with A2,” says Cook. “I told him to f–k off, everything was fine. And I hung up. Thankfully he was a persistent bloke. He kept ringing back.”
The person making the calls was Geoff Babidge, the former head of Lion’s milk business in Australia, who was now running a health-food company called Freedom Foods.
Babidge had been tipped off about A2 milk by a friend. Not for investment reasons, but because both their sons had type-1 diabetes, and A2 promised health benefits.
“The more I looked at this company, the more I realised it could be huge,” he says. “That was December 2006, when I tracked down Cliff. I can assure you he said what he did, and it was a very brief phone call.”
Babidge persisted. He went to Cook with a plan for the Australian business that would secure production and supply channels. He then put Peter Nathan, an experienced executive from the fast-moving consumer goods world who worked at Gillette and Freedom Foods, in charge of securing the supermarket distribution network.
“It became evident to us that Cliff had never met a cow in his life, let alone been on a factory floor,” laughs Geoff. “Peter and I put the back end of the business in place and then set about marketing to build a premium brand.”
The Australian pair had a simple plan. “Own your domestic market, and the Chinese market will come,” says Nathan. “We set about being the premium milk brand in Australia.”
Nathan and Babidge had achieved that goal by 2012. By that time A2 was the top-selling fresh milk brand in Australia’s major supermarkets. A premium product in dollar terms had achieved almost 10 per cent of the supermarket milk market.
A2’s rise put a squeeze on rivals. The $1-a-litre milk wars between Coles and Woolworths had taken a large share of the bulk milk market, while A2 had taken the cream at the top. That meant Parmalat, Lion and Fonterra were being squeezed in the middle. The net result was an effort to kill A2.
The first salvos emerged in the form of a website that attacked A2’s health claims.
“It attacked the credibility of A2, but we could not trace ultimately the ownership,” says Babidge. “We ended up in Israel and then we couldn’t go any further than that.”
Then another conversation took place in a corporate box, this time at a cricket match at the SCG. This conversation was between a senior executive with a major multinational company and a well-known Sydney spin doctor.
The topic of conversation was not cricket. It was milk. Specifically, the men discussed a plot by Parmalat, the Italian-based multinational that owns the Pauls milk brand in Australia, to undermine A2.
Unfortunately for Parmalat, the spin doctor’s lips had been a bit loose.
“Interesting chat with someone at the cricket,” read the email that arrived at A2 headquarters, which detailed the work done by “Crosby Textor PR on a Parmalat campaign against your A2 brand”.
The content of the email shocked senior A2 staff.
“Basically, they are feeling the pinch and Pauls milk is suffering,” read the email. “They want to somehow communicate to the public that A2 isn’t what it is cracked up to be … The intention before Christmas was to use A Current Affair or something similar to get the story out. Just wanted to let you know you have obviously made an impact!”
Soon stories attacking A2 started to appear in Murdoch papers around the country. In one headline in The Australian, A2 was described as “snake oil”.
Just three weeks after that story, Parmalat relaunched its Zymil brand of lactose-free milk in Australia, aimed squarely at A2. Other rivals started labelling “contains A2 protein” in an effort to muddy the waters for consumers.
“All they were doing was affirming that our product worked,” says Nathan.
Unfortunately for the rivals, they had missed A2’s main game. While they were fighting A2 on the milk shelves, the company had been plotting its next move; a full-blown assault on the Chinese infant-formula market.
After a few months, the attacks on A2 stopped.
“You just can’t kill it, and trust me, we tried,” says a corporate spin doctor who worked for one of A2’s rivals. “We attacked the science, we undermined the marketing. We briefed stories against it. You just can’t kill it. If there’s ever a nuclear apocalypse, the only things that will survive will be cockroaches and The A2 Milk Company.”
Beginning of daigou
Cook, Nathan and Babidge first whiteboarded a plan for A2 infant formula in 2010. They put the idea on ice for three years as they established their milk brand in Australia. By 2013, the trio was ready to launch.
“The idea was simple,” says Cook. “We wanted to take the benefit of the A1 protein-free milk to infants to what is a very large market in China. You can’t do that with liquid milk. You can do that with infant formula, so that was the genesis.”
The trio wanted to build a strong domestic market then start to export to China via traditional channels.
To do it they needed capital, but A2 was still an outlier on the NZX’s second board. Cook was told by the major investment banks in New Zealand it would be impossible to raise the kind of cash they needed. Again Australia came to the rescue. UBS in Sydney backed the company.
“We completely transformed the shareholder base, and raised $20 million,” says Babidge. “We went from the NZ second board to the main exchange, raised $20 million and we took the shareholder base from under 1000 to 3500 investors.”
Nathan secured distribution deals with Coles and Woolworths and the marketing campaign was booked. In September 2013, the three men launched, sat back and held their collective breath.
“I remember ringing Geoff up after our first quarter and said ‘Geoff, things are not looking good buddy, because the initial sales were very slow’,” recalls Nathan. “But then all of a sudden we got the chemist sales.”
A new word was about to enter the Australian retail lexicon. It was daigou.
China’s mothers were starting to buy A2 formula. As word of mouth spread, the daigou grey market was starting to pick up A2 first from chemist shelves, then from supermarkets. By mid-2014, the Chinese infant-formula boom was in full flight. Nathan’s biggest struggle was meeting supply.
“We had Chinese buyers coming to us and paying cash up front for supply. Forget about 30-day or 60-day terms, they were paying cash up front for supply,” says Nathan.
From the launch of infant formula, A2 has rarely looked back. A2 shares will have made Babidge $50 million when he retires. Cook has made many multiples of that. From lows of 58¢ after listing on the ASX in 2015, A2 share price has at times pushed past $13.
The company warned this week that it would need to invest more in marketing to grow in the US and also increase its workforce in China to support its increased size. That made investors nervous about future earnings.
But Cook, Babidge and Nathan are still pinching themselves about getting this far in the first place.
“To say nothing of the money that the original shareholders and those who have bought in along the way have made, Geoff and Peter have really created a millionaires factory for so many people, and I did pretty well along the way too,” Cook says.
Just ask the McLachlan family, who heeded Cook’s advice and went on the journey with A2. One of Ulrike’s daughters decided to look Cliff up and say thanks. “They finally sold some shares and the mother decided to give her kids part of their inheritance early,” Cook says.
I ask him if he knows how much.
“I think the three kids got $19 million each,” says Cook. “Now that’s not bad for a bankrupt little milk company.”