Cheese dream that turned sour Now 130 workers wait for the inevitable

constituency of the Scottish Secretary Ian Lang. Some said it was a

scandal in the making. The focus for all the talk was unexpected: that

humble commodity, Scottish cheddar cheese.

On Thursday evening the timebomb finally blew. The directors of the

Galloway Cheese Company, based in Stranraer, having received demands for

immediate repayment of borrowings of some #22m from their bankers,

demands they could not hope to meet, asked for receivers to be

appointed. In stepped Ian Rankin and Frank Blin of Coopers & Lybrand, at

the behest of those bankers, the Royal Bank and the Cooperative Bank.

The 130-strong workforce now face agonising days of wondering how long

their jobs will survive. The receivers will try to keep the plant going

in the short-term, but that means securing supplies of milk and

retaining the loyalty of customers for the cheese. Critical talks were

ongoing yesterday to ensure that happens. But no one is placing any bets

on the outcome.

The cheese plant is by far the biggest in Scotland, taking some 17% of

total Scottish milk supply and producing 18,000 tonnes of Galloway

cheddar on an annualised basis at present. It is ultra-modern, the

fruits of a #12.5m investment commissioned in 1991. And it had

guaranteed buyers for its entire cheese output, in the shape of its

three shareholders, the Scottish Milk Marketing Board (60%), the

Cooperative Wholesale Society (20%) and Unigate (20%), who took cheese

in proportion to their interest in the business.

There had been a creamery on the Stranraer site since 1899. The SMMB

took it over when the board was created in 1933. The facility was

upgraded in 1966 and again in 1974. But the 1990 joint venture, which

involved the closure of two other small cheese-making plants, at

Mauchline in Ayrshire and at Sorbie near Newton Stewart, projected the

Galloway company into a quite different league. With a 1992 turnover of

#46.9m, it ranks 319th in the Insider 500 listing of Scotland's largest

companies.

Some in the dairy trade believe there were motives, other than simple

rationalisation of cheese-making in south-west Scotland, behind the

1990/91 changes. The SMMB retained a controlling interest in the cheese

company. That left it with a massive processing sink for its milk, a

sink it could use as a powerful bargaining weapon when agreeing milk

prices with independents in the dairy trade. ''They could always tell

us: If you won't pay our price, we'll send the milk to Stranraer'' said

one independent yesterday.

But, although the SMMB effectively controlled the Galloway Cheese

Company, it was never consolidated into the board's own commercial

processing arm, Scottish Pride. It shared Scottish Pride's computer

system. It sold most of its cheese to Scottish Pride. But it remained an

independent company, and an extremely heavily geared one at that, thanks

to the chunky 1990/91 investment programme.

As the SMMB chairman Andrew Howie put it in a letter to milk producers

after this week's shock news broke, ''This company was funded by

property transfers from the three partners and by bank facilities. No

fresh money or capital contributions from producers were used.''

One can wonder why the banks, principally the Royal Bank, should

sanction such generous borrowing facilities (which recently peaked at

some #22m) to a business turning over #47m and, in 1992, making no

profit at all. Royal sources say they took comfort from the fact that

the cheese company's principal shareholder and customer was a statutory

board. ''The security for our lending was that established trading

relationship'' said one source.

But that old trading relationship comes to an end on November 1.

Scottish Secretary Ian Lang approved a scheme on July 7, under the 1993

Agriculture Act, to deregulate the Scottish milk industry. The SMMB

eases to exist from November 1. In its place will be Scottish Milk, a

producer cooperative handling wholesale milk distribution, and a major

independent processor, Scottish Pride Holdings, in which individual milk

producers will be given shares in proportion to their production

volumes.

But Scottish Pride is currently undergoing a root and branch

restructuring of its own. In April a tough new chief executive, Jim

Hosea, was recruited to sort out its mess. One of the first impacts of

the new regime was #6m worth of write-offs and provisions in Scottish

Pride's side of the Milk Board's latest accounts.

In a letter to producers in June SMMB chairman Andrew Howie explained

why an operating profit of #4.1m from Scottish Pride was being

transformed, thanks to exceptional items, into a loss before tax of

#1.99m. ''A high milk-for-cheese price during the first half of the year

combined with a fall in the market price for cheese when the production

of that period was mature enough to sell severely impacted on the

performance of our cheese business'' he wrote. Scottish Pride ended the

year with excessive cheese stocks whose value had to be written down to

reflect the prices which could realistically be achieved in the

marketplace.

Faced with huge stocks of unsold, overvalued cheese, Scottish Pride's

new chief executive was, apparently, beginning to talk tough about the

prices he would be prepared to pay for Galloway's output in future.

Meanwhile the first auction of Scottish milk under the new deregulated

system triggered considerable interest from England and secured prices

nearly 3p a litre higher than the Galloway cheese plant currently pays.

Higher milk supply prices and lower cheese prices spelled big problems

for the Galloway company's commercial viability. The banks began to

sense that they were being left hanging out to dry, their #22m exposure

no longer secured to anything like the extent it was under the old

regulated arrangements. Crisis talks commenced, involving the banks, the

company and its directors, the SMMB and the other shareholders, and the

Scottish Office. But the talks proved abortive.

According to Mr Howie's letter to producers, ''neither of the board's

successor bodies could, taking into account the best interests of their

members, provide'' the new guarantees or funds being asked for by the

banks. The banks, having seen the basis of their lending security

removed at a stroke of the Scottish Secretary's pen, when he approved

the deregulation scheme in July, now began to sense that the Milk Board,

or more precisely Scottish Pride, was, in effect, daring them to walk

away from Galloway Cheese and take a #22m hit in the process.

One other thing happened over the summer which changed the odds more

in the banks' favour. In the words of one banker: ''The cows did a noble

job this summer.'' The mild weather and good grazing combined to produce

exceptional milk yields. Galloway was producing cheese at levels way

above budget. When the receivers moved in, they found maturing cheese

stocks at the Stranraer plant worth #8m.

Assuming the modern plant and machinery at Stranraer could be worth,

say, another #5m, the banks were well on their way -- even if no buyer

can be found for the operation -- to recovering their liabilities. One

other item could clinch that position. The receivers were sent in on the

day Galloway was due to pay the Milk Board for all the milk it receieved

in July. That bill has not been paid. Nor has any money changed hands

for the milk supplied so far in August. The total could be another #6m

to #7m.

But equally, as an SMMB source was keen to point out yesterday,

Scottish Pride has not paid for cheese supplied over the same period. So

the Milk Board's net exposure may be relatively small, assuming, of

course, that the receivers fail to recover that money owed by Scottish

Pride for that cheese. There are, apparently, set-off arrangements in

existing supply contracts which may turn this part of the story into a

legal minefield.

There is certainly no doubting the anger felt within the banks at the

way they have been treated, both by government's deregulation measures

and by the Milk Board and Scottish Pride. They clearly believed they

were being set up as the fall guys, unable to extricate themselves from

Galloway Cheese because of the size of the financial hit that would

involve.

Yesterday the Scottish Office minister Sir Hector Monro was

desperately seeking to distance the government from the whole sorry

saga. ''The deregulation of milk marketing has not caused this'' he

asserted. ''It was the banks, not the government's decision to withdraw

overdraft facilities.''

According to all the statements from those involved in the

receivership issued on Thursday, the government's deregulation measure

did, in fact, lie at the heart of what has happened. Sir Hector and his

advisers are alone in thinking differently.