On October 31, 1994, Jaroslav Lizner, the head of the Czech Republic’s Coupon Privatization Center, was arrested after accepting a briefcase con-taining Kˇc8.33 million in cash. The money, 166,000 50-koruna notes, was allegedly a bribe for making sure that shares of Mlekarna Klatovy, a West Bohemian dairy, went to TWI, a local privatization fund interested in pur-chasing the stake from another fund. TWI had won the right in a tender to purchase 34% of Klatovy for Kˇc220 million. Several competing investors wondered why TWI was willing to pay so much.
In the summer of 1994, Klatovy’s management had filed a complaint with its owner – the National Property Fund – saying that the terms of the tender were not being met. In the dairy’s estimation, TWI’s liquidity was questionable, and its commitment to helping the dairy tackle its own liquid-ity problems was suspect as well. TWI, it seemed, had proved unable to come up with the Kˇc65 million required as a down payment, causing speculation that the buyer was less than whole. After looking into the complaint, the Fund judged the claim unfounded. Later, a rehearing reversed the decision after the Fund Supervisory Board focused “on whether or not the company really needed the money to be gained through the sale of shares. We found that they didn’t,” said Fund Director Roman Ceska, “and that’s why we allowed the tender to be dissolved.”
The dairy desperately needed the money. In 1990, Klatovy had pur-chased modern milk-processing equipment worth Kˇc500 million. By the summer of 1994, Kˇc100 million on the loan remained to be paid. In addi-tion, the firm’s equity, at Kˇc263 million, was and is inadequate. More new equipment – particularly for saving energy – is needed. Now that the dairy has offered 96% of its shares – the maximum amount permissible – through coupon privatization, its more than 8,000 shareholders will decide what hap-pens next. General Manager Sekyrka says the firm hopes to increase equity next spring, probably through a rights issue of Kˇc150 to 200 million.
When Klatovy was still available during the tender, however, the dairy did not lack suitors, either domestic or foreign. Karel Pech, a local investor heavily involved in the food-processing industry, showed interest in the firm last August, but when the Fund announced a competitive tender for the 34%, Pech backed off. He did not even participate in the tender held later.
France’s Lescure Bougon was to purchase that same 34%; the firm withdrew its interest in October, before the Lizner affair began.
What was it about Klatovy – the fifth largest producer in an over-crowded, contracting market – that was so appealing? Some thought the
answer lay in the products which the dairy manufactures, its relatively mod-ern assets, and the structure of the firm’s – and the country’s – milk-product exports.
Dairy processing, like several sectors in the food-processing industry, in-volves slim margins and stiff competition. There are more than 100 dairies operating in the Czech Republic. According to executives at Klatovy an
“economically reasonable” number of dairies is nearer 25 than 100. “There is too much capacity,” says the General Director, “and [the dairies] are them-selves too small.” Overcapacity is reckoned by the local dairy association to be as much as 40% countrywide. A typical West European dairy can process 500,000 liters of raw milk daily. Klatovy has the the same capacity, thanks to modern equipment. But the typical Czech dairy is far smaller, able to process only 50,000 liters daily. In late 1994, Klatovy was profitable – just – at a throughput of 100,000 liters per day. The firm was trying to process about 130,000 liters a day.
Klatovy employs 450 people at its complex, more than other dairies, according to the General Director. The firm’s main products are processed cheese and milk powder. The soft, spreadable white cheese which crowds local grocery shelves (and comes in a bewildering variety of fat contents and flavors) is big business both at home and abroad. Czechs consume more of the stuff per capita than any other country in the world. And a special type of processed cheese called Akavy is a major export to countries of the Middle East. Czech dairies have been producing and exportingAkavycheese for 30 years, and according to the director, the Czech Republic produces more Akavy cheese than any other country (smaller amounts are produced in Bulgaria, Lebanon, and Syria). Customers in the Levant and Middle East consume from 6,000 to 8,000 tons every year. There, the cheese figures prominently as an ingredient in sweet delicacies. Customs figures show that Czech dairies export more cheese to Lebanon (40% of their total) than any other country.
Skimmed milk powder is an even bigger export product. In late 1994, world market prices were around $1,600 per ton, and the firm produced roughly 3,000 tons of skimmed milk powder annually. Klatovy’s 1993 rev-enues totaled Kˇc600 million, meaning that exports of skimmed milk powder accounted for nearly one-quarter of all revenues. The dairy’s 1993 profit was Kˇc5.6 million. According to officials, Klatovy earns a 5–7% margin on exports of skimmed milk powder or about Kˇc7.2 million.
There are more advantages to dried milk production. Skimmed milk powder can earn generous subsidies from the Ministry of Agriculture’s mar-ket regulation fund (the agricultural fund established to prop up farm prices).
In the second quarter of this year, only 200 tons of processed cheese exports were subsidized by the fund. In comparison, 5,400 tons of dried milk were
subsidized – and those subsidies are increasing by about 25% per quarter.
Akavy cheese is not subsidized.
Following the shares-for-favors scandal, one respected local paper fixed on processed cheese as the real impetus for interest in the dairy, weaving a plausible but ill-substantiated tale hinting at shadowy Middle East connec-tions. But the numbers don’t add up. Klatovy wants to produce five times more skimmed milk powder over the next three years – a sensible policy, given current world market prices for dried milk. Although Klatovy officials say “too much” milk powder is being exported, this is a reflection on the firm’s market share, not the profits to be had in the market. On a unit basis, producers can expect a margin of from 5 to 7%. The General Director says he would like to increase production of milk powder by as much as five times.
Selling skimmed milk powder may not be as easy as it at first appears.
When asked exactly who his customers for skimmed milk powders are, the General Director laughs. “We don’t know,” he says, describing an intricate sales system which begins in Klatovy and flows from Prague to Hamburg to Senegal and then – maybe – to other markets. “Once something gets to Hamburg, you can never tell where it’s going,” he says. The Director also notes that German exporters receive generous government assistance for exporting such products to less developed countries. (So do Czechs.) Klatovy exports 15% of its production to two markets: the Middle East and North Africa.
Processed cheese poses an even riskier bet. Imported cheeses will soon make up about 30% of the domestic market, and a typical Western dairy can produce up to 150,000 tons per year. Even if Klatovy can increase target production to 25 tons a day (about 7,500 tons per year), it will remain well behind the potential of foreign producers, not to mention rival local dairies such as Jihoceske Mlek´arny and Plzenske Mlek´arny. Moreover, the Gen-eral Director expects domestic consumption of processed cheese to decrease.
“Consumption is relatively high right now,” he says. “I suppose it can’t get any higher and will slowly decline.”
Other Klatovy products, such as white (hard) cheese, are being rethought. The firm commands a market share of 10%, but according to the General Director, it produces white cheese at a loss. Klatovy’s hard cheese line operates at only 45% of capacity. A surplus of white cheese on international markets means prices are low. Too, foreign governments are protecting their own producers. (Asked about trade relations between the United States and the Czech Republic, officials at the Ministry of Industry and Trade immediately complained of high tariffs on Czech white cheese.)
Executives worry about a lack of working capital. They would like to increase equity by between Kˇc150 and 200 million but the shares would be a
tough sell to a public skeptical of the food-processing industry. Management may decide on a rights issue. Nor is debt an answer: the Director says his firm cannot qualify for favorable interest rates, and without a restructuring of existing debt, new payments could break the company’s financial back.
Klatovy’s early 1990s purchase of new equipment through high-interest bank loans now seems suspect: the equipment is idle far too often, and the firm is having trouble carrying the interest expense.
Klatovy suffers from a severe receivables problem. Two-thirds of all receivables, about Kˇc125 million, are past due. To combat the problem, Klatovy has restructured its sales force and has focused on working only with reliable (i.e., paying) suppliers.
Several large dairies are now splashing out expensive marketing and promotion campaigns. Klatovy has not yet, and at the end of 1994, mar-keting accounted for between only 1 and 2% of total costs. This matters in a market crowded with local and foreign products, many of which possess better packaging and smarter positioning than Klatovy’s offerings. Klatovy brought bar coding to some of its products in 1994 and introduced technolo-gies to improve shelf life. On the whole, however, the products do not have a progressive, modern image.
Wholesale milk prices increased slowly during the first half of 1994, be-fore a rapid rise in fall 1995. Countrywide, prices are up about 5%. But the firm has little room to increase prices to consumers, which are being pres-sured from decreasing demand and cheap imports. Domestic consumption of milk and milk products fell from 256 kg per capita in 1990 to 190 kg in 1993. Cheap milk products from heavily subsidized EU countries are staples on Czech grocery shelves, and competition from the West will not abate.
As the firm decides on its production strategy for the near future, it will have to face the unpleasant fact that consumption of its products will in all likelihood decrease over the next several years.
Mlekarna Klatovy Exhibit 1. Balance sheet in 1994 (in thousand Czech
Deposits on tangible fixed assets 60
Financial investments 20
Other assets, prepayments, and deferred income (1,050)
Total liabilities 676,542
Mlekarna Klatovy Exhibit 2. Income statement in 1994 (in thousand Czech korunas).
Sales of purchased goods 56,831
Cost of goods sold 52,980
Gross margin from trade 3,851
Sales of own products and services 564,560
Revenues from own products and services 493,022
Changes in inventory and work in progress 14,180
Own work capitalized 57,358
Production costs total 476,901
Raw materials and energy costs 439,084
Services 37,817
Value added 91,510
Personnel expenses 31,457
Wage expenses 23,193
Social security expenses 7,918
Other social expenses 346
Taxes and fees 1,103
Depreciations of intangible and tangible fixed assets 26,021
Revenues from the sale of fixed assets 1,463
Remaining revenue from previously sold fixed assets 863
Addition to reserves 1,575
Corrections to operating expenses 10,500
Other operating revenues 50
Other operating expenses 614
Operating profit 20,890
Revenues from the sale of securities and deposits 38
Revenues from interest 103
Interest expense 20,538
Other financial revenues 318
Other financial costs 1,451
Profit from financial operations (21,530)
Income tax from the ordinary income – due (270)
Profit of the ordinary income – due (370)
Extraordinary revenues 989
Extraordinary costs 180
Income tax from the extraordinary income – due 340
Extraordinary profit 469
Profit of current period 99