There is a huge difference between the current sharemarket downturn and the 1987 crash, particularly as far as New Zealand is concerned.
Most of our large listed companies are now in good shape whereas in 1987 many NZX companies had a strong growth emphasis, were highly leveraged and their expansion plans hit the wall when funding dried up after the sharemarket crash.
In addition there had been a large number of listed property spin offs in the mid-1980s as NZX companies attempted to cash in on the commercial property boom.
PGG Wrightson is the only large company with both of these characteristics in the current downturn.
The farming services group had a big setback this week when its proposal to purchase 50 per cent of Silver Fern Farms was terminated because of funding problems and the share price of NZ Farming Systems Uruguay, which was spun off to take advantage of the dairy boom, has underperformed the sharemarket in recent months.
It will be fascinating to see whether PGG Wrightson Chairman Craig Norgate, who is the driving force behind the group’s ambitious growth plans, will change his aggressive approach in light of the sharp downturn in dairy prices and the company’s inability to fund its Silver Fern Farm acquisitions.
NZ Farming Systems Uruguay (NZFSU) was established by PGG Wrightson in September 2006 to raise equity from the public and purchase dairy farms in Uruguay.
The company believed that it could acquire cheap farms in the South American country and increase productivity by introducing New Zealand pasture management.
The $1.00 shares were initially paid to 50 cents with the remaining 50 cents due one year later on December 14, 2007.
NZFSU purchased three farms from PGG Wrightson for US$11.9 million. These cost PGG Wrightson US$7.6 million although the prospectus stated that these two figures were not directly comparable because of “development that has been undertaken during the period of PGG Wrightson’s ownership”.
Consideration for these farms was a combination of shares and cash, in equal parts. The shares were issued on the same terms as to the public.
PGG Wrightson sold its farms to NZFSU but it acquired the lucrative management contract over the Uruguayan operations. The management fee was 1.5 per cent per annum on the gross asset value of NZSFU until June 30, 2008 and 1 per cent per annum after that.
In addition PGG Wrightson has a performance fee calculated as 20 per cent of the amount by which the total share price plus dividend return exceeds 10 per cent per annum.
NZSFU had a 1 for 2 rights issue at $1.50 per share, which closed on December 14 last, and the company listed on the NZX four days later.
NZSFU’s share price rose steadily to peak at $2.00 on May 28. It closed at $1.74 on the June 30 balance date, a key date in determining the annual performance fee.
The result for the year ended June 30 was substantially below prospectus forecast with NZSFU reporting a loss before interest and tax (ebit) of US$25.9 million compared with a prospectus forecast surplus of US$1.2 million (see table). The June 2008 year ebit is before a US$17.9 million livestock revaluation.
The Uruguayan based company had total revenue of only US$8.1 million in the June 2008 year yet it paid PGG Wrightson an amazing US$16.2 million in fund management fees and an additional US$10.3 million for farm management services.
NZSFU argues that revenue was lower and costs higher than expected because its farm acquisition and development plans were accelerated.
NZSFU’s annual meeting, which was held in Auckland on October 16, was notably subdued. Chairman Keith Smith told the meeting that earnings for the June 2009 year would be below analysts’ forecasts while shareholders asked a number of questions about the low number of animals per hectare, the company’s ability to sell its additional milk supply, the high livestock death rate and the huge performance fee.
One was given the strong impression that NZSFU is performing well below expectations and that Smith and his board should issue more comprehensive updates and guidance, particularly as PGG Wrightson’s performance fee is mainly based on NZSFU’s share price movements.
In addition, one of the lessons from the 1980s is that bull market spin-offs can boost the status and performance of the promoter in the short term but the whole group is adversely affected if a spin-off fails to meet its long-term projections.
On June 30, PGG Wrightson announced that it would take a 50 per cent stake in Silver Fern Farms, the Dunedin based meat processing co-operative, for $220 million.
An evaluation undertaken by the acquirer identified “short-term gains of more than $60 million per year, with longer-term financial benefits ranging up to $110 million per year”.
The deal was subject to approval by 75 per cent of shares cast at a special meeting of Silver Fern Farms shareholders. The meeting was held on September 8 with 75.62 per cent of votes cast in favour of the partnership.
This meant that PGG Wrightson had to pay $145 million by the end of September and the remaining $75 million, plus interest of 10 per cent per annum, by March 1, 2009.
The agreement was unconditional with PGG Wrightson having no ability to renege even if adverse economic or financial conditions developed.
For all intents and purposes PGG Wrightson undertook to complete the transaction on the same basis as Blue Chip investors agreed to fulfil their property purchases.
Immediately after the Silver Fern Farm meeting, PGG Wrightson declared that “it would undertake an equity raising of approximately $100 million” and 18 days later, on September 26, announced that it had “successfully completed” a new share issue that had raised $78.1 million from institutional investors.
PGG Wrightson said that this would be supplemented by a $5000 New Zealand entitlement offering targeting retail shareholders.
Three days later the company announced that this retail share plan had been underwritten for $32 million by an entity associated with Allan Hubbard.
But the following day, which was the last day of the month, PGG Wrightson made a short announcement after the market closed that “the proposed acquisition of a 50 per cent interest in Silver Farm Ferns will not take place today”.
Why was PGG Wrightson unable to complete the deal? Why didn’t it have its bank funding in place at an earlier date? Why didn’t it have an out clause?
This was the type of setback experienced by Ariadne, Euro-National, McConnell Dowell, Kupe, R&W Hellaby and Renouf Corporation after the 1987 crash but investors don’t expect this to happen to the country’s largest rural servicing group.
PGG Wrightson now faces a compensation claim from Silver Farm Ferns, which could be as high as the $220 million acquisition price.
This raises the important issue of whether PGG Wrightson should be able to walk away from a major transaction when individual Blue Chip investors cannot. Does this mean we now have two sets of rules as far as unconditional contracts are concerned, one for large corporations and another for individual investors?
The compensation issue, plus the group’s aggressive expansion plans, will occupy PGG Wrightson’s board a great deal in the months ahead.
NZ Farming Systems Uruguay – June 2008 year prospectus forecasts were way off the mark
Cost of Sales
Farm Working cost
Fund management fee
Fund management performance fee
Earnings before interest & tax(EBIT)*
*EBIT before non-cash revaluations