Brian Gaynor: Hopes for Uruguay dairy farms sour

NZS chairman Keith Smith is also chairman of management company PGG Wrightson. Photo / Greg Bowker

The NZ Farming Systems Uruguay (NZS) annual meeting, which was held on Thursday, was a sombre occasion.

It was depressing because it was clear that a number of investors have lost a lot of money, including farmers who believe they were encouraged to borrow against their New Zealand property to invest in the Uruguayan company.

It was also clear that the company's poor performance is primarily due to the board because they were far too optimistic and didn't anticipate the risks associated with investing in a foreign country.

The dismal performance of NZS is particularly frustrating for shareholders because they have had all the downside while the management company, which is owned by PGG Wrightson, has done particularly well.

These related party agreements, conflicts of interest and poor board governance issues continue to be the bane of the sharemarket with shareholders in the PGG Wrightson, Pyne Gould Corp and NZ Farming Systems Uruguay group of companies suffering particularly badly.

In the past 12 months these three companies have destroyed a huge amount of shareholder wealth as their combined sharemarket value has plunged by $880 million or 68 per cent, from $1140 million to $360 million.

Over the same period the benchmark NZX-50 Gross Index is up 9.9 per cent.

Even though the Uruguayan company's performance has been dismal, shareholders re-elected two existing directors with over 96 per cent of the votes each while only 4.3 per cent of votes were cast in favour of a credible outside candidate, with farming experience, who was not supported by the board.

When are New Zealand shareholders going to wake up and vote against directors whose main credentials are that they are members of the cosy old boys' network?

NZS issued its first prospectus in November 2006, which coincided with the visit of nearly 60 potential investors to Uruguay.

The prospectus and the Uruguayan visit presentations were extremely optimistic and the company managed to sell 115.6 million new shares at $1 each.

Chairman Keith Smith wrote in the prospectus: "NZ Farming Systems is a unique investment opportunity. The board considers that PGG Wrightson has an unmatched combination of knowledge, experience and demonstrated capability, and the infrastructure to be able to put in place the comprehensive package of skills and resources necessary to create a profitable farming business in Uruguay".

NZS bought three PGG Wrightson owned Uruguayan farms for US$11.9 million and gave the New Zealand company an extremely lucrative management contract.

The company listed on the NZX in December 2007 following a successful second capital raising. This was a one for two rights issue at $1.50 a share.

The original plan was to buy the 2686ha farms from PGG Wrightson and then purchase a further 4000ha in the immediate future. Over time the company planned to purchase additional farms with a total area of 24,000ha.

However as the equity funding flowed in, and dairy prices soared, the directors decided to accelerate its farm purchase progress and by June 2007, just seven months after the initial equity raising, it owned 26,523ha and by June 2008 this had grown to 36,300ha. This was far in excess of the original prospectus forecast.

The problem with this strategy was that the company was using up all its money buying dry land and failed to recognise that it would have to incur large expenditure on irrigation. It was also paying top dollar for its land, as demonstrated by the following figures:

The average cost of its first 26,523ha purchased up to June 2007 was US$2300 per ha. The average cost of the 9777ha bought in the June 2008 year was US$4600 per ha.

Uruguay is on the eastern side of South America and looks more like Hawkes Bay in February than Taranaki in the spring. Climate statistics indicate that the country gets plenty of rainfall but it is often far drier than New Zealand and dairy farms have to be well irrigated.

The figures in the accompanying table, which contain the 2006 prospectus forecasts for the June 2008 year and the actual results for 2008 and 2009, show how NZS got it so horribly wrong.

The company had property, plant and equipment worth $165.4 million as at June 2008, compared with the prospectus forecast of $48.3 million, yet it had revenue of just $7.8 million, compared with the forecast of $12.3 million.

At this week's meeting one shareholder asked whether NZS was in the asset accumulation/appreciation game or was it trying to establish a profitable business that paid dividends.

Smith, who is also chairman of PGG Wrightson, fudged his reply. This is not surprising as there are huge potential related party and conflict of interest issues between NZS and PGG Wrightson.

PGG Wrightson's management fee was based on the gross asset value of the company's assets and the fee was 1.5 per cent up to June 30, 2008 and 1 per cent after that.

In other words the bigger NZS became the better it was for the management company in terms of fees. In addition the more farms NZS has, the more it will spend and most of its farm supplies are provided by PGG Wrightson.

Thus the three important figures as far as the management company is concerned, namely the gross value of the company, farm expenses and the management fee, are well above the prospectus forecast, whereas the figures that are most relevant to shareholders, namely revenue and earnings before interest and tax (ebit), are substantially below forecast.

The other big issue is the huge performance fee of US$13.6 million for the June 2008 year, which was based on the company's share price performance for that period.

The performance fee formula was outlined in the original prospectus but why did the company change from a slow and steady farm acquisition strategy to an accelerated purchase approach when the performance fee would have to be paid out of earnings?

This fee has yet to be paid and when asked by a shareholder whether PGG Wrightson would forgive it, Smith turned sideways and said nothing.

The question and answer session was revealing and indicated that NZS was ill-prepared for Uruguay and did not understand the risks.

Directors claimed that New Zealanders had not been a great success in Uruguay and the last New Zealand manager, who has just left after two-and-a-half years, had never learned Spanish.

Smith wrote in the original prospectus that "PGG Wrightson has an unmatched combination of knowledge, experience and demonstrated capability ... to create a profitable farming business in Uruguay" yet its main man on the ground was not fluent in Spanish and English is almost non-existent in the country's rural areas.

They now argue that the key to success in Uruguay is finding and keeping the right staff, whereas the earlier message was that the company would be successful because it was introducing our farming methods to Uruguay.

But the most lasting impressions from the sombre meeting were from NZS director John Roadley and an elderly shareholder.

Roadley said "a fire is burning fiercely at our feet right now" while the shareholder, who had been invited to go on the original Uruguay trip, told directors "I have been conned".

It is difficult to decide which of these two statements represents the best description of NZ Farming Systems Uruguay.

* Disclosure of interests: Brian Gaynor is an executive director of Milford Asset Management.