Brian Gaynor: Questions, dismay over market moves

Kathmandu, popular for its 50-per-cent-off sales, now has 45 stores in Australia and 31 in New Zealand. Photo / Martin Sykes

The two major issues this week were the Kathmandu initial public offering (IPO) and the proposed purchase of 13 per cent of PGG Wrightson by Agria Corporation.

These created a great deal of discussion because Kathmandu is the first major IPO since the recession and PGG Wrightson is a long-standing icon in the agriculture sector.

Two weeks ago this column suggested that investors should ask four major questions in relation to a private equity promoted IPO.

These were: whether the private equity investors were selling all of their holdings; was the management team selling out or retaining a meaningful holding; were any of the IPO proceeds going to the company to enable it to grow; and how much debt will the new listed company have?

The answer to the first question is that the private equity investors can sell all their Kathmandu shares and will probably do so if demand is strong.

Private equity investors bought Kathmandu in 2006 and financed this through a combination of equity and debt.

The borrowings were effectively undertaken by the acquired company and not by the buyers.

It appears that the private equity and employee vendors contributed equity of approximately $96 million and their shareholdings will be worth $301 million and $363 million at the bottom and top end of the indicative IPO price range respectively.

The indicative IPO price range is between $2.01 and $2.32 a share.

Thus the existing owners will make a profit of between 314 per cent and 378 per cent since 2006, when the company was bought from Jan Cameron.

It is worth noting that Kathmandu may have been included in private equity funds with a number of other investments and the other investments may not have performed as well.

The remaining IPO proceeds will be used to repay $85.7 million of debt and issue expenses estimated at $15 million.

The latter is being paid by the vendors and not by the company.

The management team is reducing its shareholding from 2.8 per cent to 1.3 per cent.

There is a huge difference in the approach taken by private equity vendors and more normal IPOs, including Pumpkin Patch in 2004.

The differences between the Kathmandu and Pumpkin Patch IPOs include:

* No new money is going into Kathmandu, whereas $40 million, or 40 per cent, of the Pumpkin Patch IPO-raising went to the company. The remaining $60 million went to original shareholders.

* Pumpkin Patch had no debt after its IPO while Kathmandu will have $70 million.

* Kathmandu will have intangible assets of $244 million and total equity of $218 million, including intangible assets, whereas Pumpkin Patch had minimal intangible assets and total equity of $65 million.

* In 2004 Pumpkin Patch had 64 stores in Australia and 37 in New Zealand whereas Kathmandu has 45 stores in Australia and 31 in New Zealand.

* Pumpkin Patch was forecasting EBIT (earnings before interest and tax) of $23 million, on sales of $247 million, for its July 2005 year, whereas Kathmandu is forecasting EBIT of $51 million, on sales of $240 million, for its July 2010 year.

These figures don't mean that Pumpkin Patch was a better proposition than Kathmandu, or vice versa, but it is much more likely that vendors who continue to have skin in the game will leave more on the table for new shareholders than vendors who completely sell out.

Pumpkin Patch's existing shareholders retained a 51 per cent shareholding in 2004 and the company's shares went from the IPO price of $1.25 to a high of $4.95 in January 2007.

Kathmandu's existing shareholders wouldn't be selling out if they thought that the company could achieve a similar capital appreciation as a listed company but new Kathmandu shareholders will be happy with a more modest, albeit positive, post-listing performance.

The announcement that Agria proposes to take a 13 per cent stake in PGG Wrightson, at 88c a share, was greeted with dismay for a number of reasons, including:

* Agria is a new and unproven company.

* It is incorporated in the Cayman Islands and operates through British Virgin Islands and Hong Kong into China.

* The company listed on the New York Stock Exchange in November 2007 following an IPO at US$16.50 a share. Its shares were trading at just US$2.19 before the PGG Wrightson announcement.

* The company had a sharemarket value of only US$138 million ($184 million) at the time of the announcement, compared with PGG Wrightson's $205 million.

* Agria has not filed its annual report for the December 2008 year and its last quarterly announcement to the NYSE was for the three months ended September 2008.

* The company is subject to a class action under the Securities Act of 1933. This includes claims that it has transferred US$18 million cash and 22 per cent of the company to a number of employees.

These concerns gathered momentum because PGG Wrightson, and its related party companies, have made a huge number of blunders in recent years and board governance has been particularly weak.

In addition Keith Smith, PGG Wrightson's chairman, has been involved in a large number of disastrous overseas transactions.

He was chairman of The Warehouse and Tourism Holdings when they went into Australia and is chairman of the poorly performing NZ Farming Systems Uruguay.

PGG Wrightson has gone on the offensive over the past three days and claims that the Agria deal will be great for the company.

It reports that a number of offshore parties did due diligence on PGG Wrightson and Agria was clearly the best.

The New Zealand company has done extensive due diligence on its proposed new partner, including visits to China, and is convinced that the class action will be dismissed.

Agria has all its money intact, according to PGG Wrightson, and the $36 million required to invest in New Zealand is already in the country and is held in escrow.

PGG Wrightson also believes that the company's 2008 annual report will be published shortly.

PGG Wrightson considers that Agria, which specialises in seeds, will give the New Zealand company access to the state-owned Chinese Academy of Agriculture Sciences (CAAS), the country's major agriculture research organisation.

CAAS's products, particularly its seeds, can be commercialised and exported to South America through PGG Wrightson.

In addition, PGG Wrightson believes there is scope for it to export livestock to China through Agria, to introduce New Zealand farming methods into China and to help China establish a rural stores network.

There is also scope for Wrightson Finance to expand into China.

But the main reason PGG Wrightson seems to be so keen on Agria is its new chief executive, Xie Tao.

Tao is a PricewaterhouseCoopers partner in China and a member of its executive board. He was also lead adviser to the Beijing Olympic Organising Committee and has had a long-standing relationship with the New Zealand company.

But surely the issue here is that PGG Wrightson can do better than this. It can do better than sell a cornerstone shareholding to a small company incorporated in the Cayman Islands, which has experienced an 80 per cent decline in its share price over the past two years and hasn't produced any financial figures since the September 2008 quarter.

We should only be selling major shareholdings in our icon companies to the world's best and at the highest price.

Instead the board of PGG Wrightson is selling a major stake to a small and unknown company at a bargain basement price.

It will be fascinating to see how chairman Keith Smith, who is standing for re-election, explains this transaction and his company's annus miserabilis at next Thursday's annual meeting, which will be held in Auckland.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management and a PGG Wrightson shareholder.