Eyes out for a PGW cockroach or two

From the Independent Business Weekly

With the permission of the publication’s management we enclose the entire article by Chalkie dated July 30.

The Independent, Page: 12

Thursday, 30 July 2009

Ref: 54874053

Craig Norgate stepping down as chairman of PGG Wrightson (PGW) was appropriate and necessary.

Appropriate because the "buck stops here" sign resided on his desk for the stuff-up over the failed Silver Ferns Farms (SFF) purchase, which cost the company more than $40 million in settlement and costs.

Necessary, in Chalkie ’s opinion, because PGW must fix its balance sheet fast and Norgate, with his heavy financial involvement, would have had a strong personal aversion to swallowing the bitter medicine, and forking out the cash needed to get the company back on track.

The table (below) has a restated and rearranged PGW balance sheet as at December restated for the $25m SFF cash settlement and rearranged to show the finance company assets and liabilities as a one-line deconsolidated "net assets in finance business" (geared at an appropriate 10:1).

The first thing to note is that the biggest item on the PGW balance sheet is goodwill resulting from all the mergers and takeovers that formed this dominant rural player.

Is this market position worth $329m? The sharemarket doesn ’t think so, valuing the company at about $300m against a stated adjusted equity value of $389m.

The second thing to emphasise is that, under this presentation of the balance sheet, there is $143m tied up in investments which already have their own gearing sitting behind the investment in net equity.

Chalkie and others often comment it ’s not a good idea to gear a geared asset something colloquially referred to as "pork on pig".

Pointy-headed analysts have a way of looking at companies like this by "attributing" 1:1 an amount of shareholders ’ funds to the geared investments and asking the question: what level of "free", or residual, shareholders ’ funds is left to support the debt on balance sheet? For PGW, this calculation gives $389m of equity, less $143m in geared investments, leaving $256m of free equity supporting $435m of net debt.

In the best of times, having debt more than your equity was considered poor form; these days net debt to free equity of 170 per cent is unsustainable.

These issues are interesting, but they aren ’t the only problems facing PGW. There are a few other messes left to clean up. Firstly, New Zealand Farm Systems Uruguay (NZS) is yet to pay US$10.3m (NZ$15.7m) in performance fees to PGW from 2008.

The fee has been accrued through the profit and loss and into equity, but the amount has been converted to a subordinated loan because it is uncollectible, given NZS ’s own cashflow and debt problems.

And remember Norgate announcing in May 2008, with great flourish, how PGW had sold its wool operations into a joint-venture with a farmer-owned company called Wool Grower Holdings? The sale appeared to be slapped through the profit and loss in the period to December 2008 for a gain of about $15m.

All well and good, but Wool Grower Holdings, some 14 months after the announcement, has yet to raise any shareholder capital from farmers. The $37.5m "paid" by a jointventure company, Wool Partners International (WPI), has been financed by a $l0m equity injection by PGW, a $17.5m preference share issue by PGW and a $l0m loan by PGW to Wool Growers Holdings (still a $100 company), which used the money to "buy" half the ordinary shares of WPI. No-one bar PGW has injected money of substance into WPI, yet PGW has shunted it off the balance sheet and booked a large profit. Nice accounting if you can get away with Press reports have suggested a prospectus from Wool Growers Holdings was due in July but there is nothing on the Companies Office website. Given PGW ’s wool operations made only $3.1m in earnings before interest and tax in 2008, the purchase price should make the targeted farmer shareholders relatively cautious and, of course, many of the potential shareholders are currently being asked for money by Silver Fern Farms.

If Chalkie was doing PGW ’s audit, he would make the company reverse the interim transaction and account for the wool operation as an "in substance subsidiary", reducing shareholders ’ funds by an estimated $15m and probably putting about $20m of debt on the balance sheet that resides inside WPI.

A popular investment rule lithe "cockroach theory" once yon have seen one cockroach within a company you can be sure there will be more hiding somewhere. New Zealand Farm Systems and WPI certainly look like vermin in the PGW accounts and it will be interesting to see if the cockroach theory applies.

PGW recently renewed its debt facilities to the equivalent of $500m against the balance sheet presented.

The problem is that, of this amount, $125m is an amortising facility, with $57.5m to be paid in instalments up to December 2010, and then $67.5m being paid as a bullet payment on that date.

Roughly speaking, with $30m per annum of retained profits for two years and $65m in head room currently enjoyed, it is theoretically possible for PGW to repay this facility without selling assets or resorting to an equity issue. But in practice no company can afford to run this close to the debt facilities ceiling.

Chalkie was surprised that, whilst Pyne Gould Corporation was playing pass-the-parcel with its assets (which include a 20 per cent stake in PGW) last week, Marac didn ’t end up buying PGW ’s finance company. Maybe later, when Marac is in a better space.

PGW is so over-geared one could argue it is good that the SFF investment did not go ahead more pork on pig, given PGW intended to use mostly debt for this transaction.

PGW needs a rights issue. Norgate, with his sponsors, the McConnon family, own 28 per cent of the company through holding company Rural Portfolio Investments (RPI), which was set up with $40m of capital.

They appear to have put in another $45.9m to repay the first mature preference shares issued by RPI. The joint company ’s investments are today worth just over $90m, offset by remaining debt of $58m.

The unrealised loss inside the company looks to be about $50m, although the McConnons and Norgate may have made some level of profit shovelling the PGW shares into RPI.

So, how would Norgate/the McConnons feel about stepping up with $44m for a 1:1 cash issue at 50 cents, which Chalkie calculates would right-size the balance sheet? Norgate ’s personal balance sheet cannot look that flash given his losses on PGW. And Norgate and the McConnons are not the only shareholders without the appetite for a rights issue. Pyne Gould Corporation, with 21 per cent, and SFF, with 3 per cent, have their own capital concerns.! What is needed is a strong chairman withont any personal agenda to tell major shareholders and their board representatives that a capital raising is happening.

Keith Smith is picking up the chairmanship, but many see this as an interim move ahead of a review of board composition. Might Chalkie suggest that Henry van der Heyden will have some spare time after resigning his NZX directorship? Sorting out PGW ’s capital structure, with all the vested interests around the table, would be good practice for what will eventually need to be done at Fonterra.

Fonterra chairman Henry van der Heyden will have some spare time after resigning his NZX directorship. Sorting out PGW ’s capital structure would be good practise for what will eventually need to be done at Fonterra.

Questions that woolgrowers should be asking before voting on the levy are: 

Meat & Wool chairman Mike Petersen has consistently said he has nothing to do with WGH and WPI – although he has previously been a director of both companies.  Now, we discover (because he certainly hasn’t said so) he owns the shares in WGH – the majority shareholder in WPI – jointly with Mark Shadbolt from the South Island.  Will he now concede he has something to do with those companies? When was Petersen going to volunteer the fact that he and Shadbolt now own the shares in WGH – before he gets the levy money paid into WPI, or after?

Who decided that WIN – which was, at least, an industry body – should transfer its shares in WGH to Petersen and Shadbolt? Now that Petersen does have something to do with WGH, can he tell us whether his company is meeting its payment obligations to PGG Wrightson in respect of the $10 million loan – and what the total amount of that loan now is?

Levy money is not permitted to be applied to a commercial or trading activity – so how can MWNZ justify paying $5 million of wool levy money to WPI?  Does MWNZ not have a concern that asides from PGG Wrightson, it appears to be the only party putting money into WPI?  Is MWNZ satisfied that WPI is in a sound financial position, and that levy money will not simply be used to keep it going?

Why is Petersen prepared to tell journalists/newspapers that MWNZ plans to hand over levy money to a private company, WPI, when MWNZ wasn’t prepared to say so in its consultation document or the proposal sent to growers?  One can only assume MWNZ did not want growers to know who would actually be getting the benefit of their levies.  How can growers be expected to make an informed decision on the [support referendum] without this vital information?

Does Petersen see any conflict in his promoting, as Chairman of MWNZ, the payment of levy money to WPI, while being a joint owner of WPI’s majority shareholder, WGH ? 

MORE QUESTIONS AND ANSWERS WOOLGROWERS SHOULD THINK ABOUT WHEN VOTING FOR OR AGAINST THE LEVY

From consultation 09

By working with companies who share our vision of partnering to improve returns from the market, we will facilitate greater co-ordination in the marketplace and achieve the growth we are seeking.

There is only one wool marketing entity that “shares the vision” and that is Wool Partners International. Does this suggest Meat & Wool NZ is seeking a grower mandate to fund Wool Partners out of levy funds? So far WPI has been highly divisive, rather than facilitating greater co-ordination.  

From Consultation 09

Meat and Wool signalled that following the Wool Industry Network (WIN) strategy development, we would review the need for a levy on wool. It is our view the industry has not transformed and there remains a case to support limited market development.

Does this mean that in spite of several million dollars funding the WIN strategy does not work and that it is flawed?

From Proposal 09

Market Development could include projects focused on limited investment in Wool Market Development, for the next two years to help transitioning the industry into a commercial marketing model.

This suggests Meat & Wool NZ has consulted and got a mandate from a majority of growers and it’s a fait accomplis that levy money is headed to Wool Partners International? 

What is a “commercial marketing model” mean? At the moment competition exists in the buying and marketing, but WPI wants to become a dominant monopoly player and do away with the open forum of the auction and thus competition.

From NZ Farmer July 27

Farmers have sprung a surprise by calling for Meat & Wool NZ to do more in wool marketing. Mike Petersen says “half the farmers” backed him in giving $5 million to market development over the first two years of the new levy period.

Did half the farmers really back Mr Petersen and does he have quantifiable evidence of this backing? Isn’t it most likely we will never know how many farmers were actually consulted and what percentage of all woolgrowers they represent?