Brian Gaynor: Contested takeover great for shareholders

The takeover battle for NZ Farming Systems Uruguay is an absolute ripper.

It is a fantastic development for shareholders because contested bids, whether for companies or residential properties, ensure that owners are more likely to receive a fair and full price.

This column has been highly critical of New Zealand shareholders because they have been quick to accept low priced offers. This is mainly because most takeover offers have been uncontested; there has been only one bidder.

Many original NZFSU shareholders will be unwilling to accept Olam International's 70c a share bid because it is well below their original purchase price.

This is a natural reaction, but the 70c offer should be given careful consideration because non-accepting shareholders will probably have to contribute more cash as NZFSU's capital requirements are far from over.

The NZFSU concept is soundly based but its execution and management have been very poor.

The company has been racked by conflicts of interest and far too many related party transactions while its revenue and profit performance has fallen well short of forecasts, as indicated by the accompanying table.

The original prospectus, released at the end of 2006, predicted that the company would be in profit for the June 2008 year, its first full 12 months of operation.

But there was a huge difference between the prospectus projections and the results for the 2007-08 year. The main differences:

* Revenue was (all figures in US$) $8 million instead of the prospectus projection of $12.3 million.

* Costs were $16.1 million, well above the predicted $10.4 million.

* The company reported an ebit (earnings before interest and tax) loss of $8 million compared with an expected profit of $1.9 million.

* It had properties, plant and equipment of $165.4 million at year end compared with a predicted $48.3 million.

* Livestock values were $40.4 million compared with a prediction of just $11.6 million.The Uruguay-based company went on a mad spending spree and bought far more farm land than it intended at per hectare prices well above those indicated in the 2006 prospectus.

The situation deteriorated further in the June 2009 year and this week the company reported revenue of $22.5 million for the June 2010 year and an ebit deficit of $10.4 million.

Less than two years ago broker analysts were forecasting a positive ebit of nearly $20 million for the June 2010 year on revenue of $65 million.

Chairman John Parker told the NZX this week: "Significant achievements have been made to further improve performance and move towards the targeted production levels. We expect, subject to funding, to further reduce our operating loss in the current 2010-11 year, establish profitability by the 2011-12 year, completing development of our dairy operations over the upcoming two years, before achieving steady state production in 2015-16."

One of the most important phrases is "subject to funding".

Shares were originally issued to New Zealand investors at $1 each in December 2006 and this was followed by a one for two rights issue 12 months later at $1.50 a share. The latter capital raising helped finance the company's frantic farm acquisition strategy.

The board and management team continued to make positive predictions throughout the first half of the 2008 calendar year and NZFSU's share price reached an all-time high of $2 on May 28, 2008.

But from there it was steadily downhill, with the stock hitting an all-time low of 37c on March 31 this year.

The takeover battle for NZFSU began on July 19 when Singapore-based Olam International announced it would make a full takeover bid for the company at 55c a share. The offer was conditional on Olam reaching 50 per cent. The Singapore company already owned 18.4 per cent of NZFSU and had a lock-up agreement with PGG Wrightson to acquire a further 11.5 per cent at 55c a share.

NZFSU's share price closed at 53c on the day this offer was announced.

Olam is a processor of agricultural products and food ingredients with a Singapore Stock Exchange value of $5.5 billion. This is more than 20 per cent larger than Fletcher Building, the NZX's largest listed company.

Olam, which listed in February 2005, reflects the strong growth of the Singapore bourse. The total value of all companies listed on this stock exchange rose from US$153.1 billion to US$481.2 billion between December 1996 and December 2009, whereas the total value of all NZX companies declined from US$36.9 billion to US$35.5 billion over the same period.

On August 16 NZFSU received notice from Uruguay-based Union Agriculture Group of its intention to make a takeover offer at 60c a share.

NZFSU's share price closed at 58c after this announcement. On Monday NZFSU said it was in discussions with another party to provide it with extra capital. It told the stock exchange it needed about US$60 million in funding to complete development on the farms, purchase livestock for initial stocking and repay money owed to PGG Wrightson.

It noted "with hindsight, initial estimates of the speed of productivity growth and profitability were ambitious, even allowing for drought and a lack of capital".

NZFSU recommended shareholders should not accept the 55c offer from Olam, because it was well below the independent adviser's valuation of 65c to 79c a share, or sell to Union Agriculture Group pending further information. This compares with the company's net tangible asset backing of 92c a share. The company's share price closed at 62c after this announcement.

On Tuesday Olam said it had increased its offer from 55c to 70c a share and noted that the NZFSU proposal, announced the previous day, was likely to be dilutive to existing shareholders and the Singaporean company "would expect to support a capital raising" if its 70c a share offer was successful.

On the same day the Accident Compensation Corporation said it would accept Olam's latest offer giving the Singapore company a 37 per cent foothold. This includes its original holding, the PGG Wrightson stake and ACC shares.

Union Agriculture Group pulled out yesterday, saying it had decided against making a bid higher than Olam's offer, putting Olam in an even stronger position.

Under the Takeovers Code Olam has to acquire at least 50 per cent of NZFSU. If Olam doesn't reach 50 per cent it will be forced to return acceptances and reduce its shareholding to under 20 per cent of the Uruguayan farm owner.

The contest for control of NZFSU is arguably the most interesting takeover bid since the battle for control of Montana nine years ago.

Lion Nathan first bought 20 per cent of the wine company at $2.30 a share. It then made a partial offer at between $3.20 and $3.80 a share but was finally gazumped by Allied Domecq at $4.80 a share.

Olam's 70c a share offer for NZFSU is light compared with the initial IPO price of $1 a share and the subsequent rights issue at $1.50 a share.

But the farm-owning company is still reporting huge losses, it has capital expenditure requirements and too much debt.

New Zealand investors have to decide whether they take the 70c or stay on board and contribute to NZFSU's next round of capital raisings.

This is a difficult decision, particularly for original shareholders, but the ACC, which held 9.2 per cent when NZFSU listed on the NZX in 2007, has decided that the 70c a share offer is good enough as far as it is concerned.

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