Olam sees higher costs, cash call and potential land shift for NZFSU

Singapore's Olam International, which has launched a takeover bid for the shares in New Zealand Farming Systems Uruguay (NZFSU) that it doesn't already own, says the Kiwi company is on to a good concept but has executed poorly highlighted by it developing dairy farms in the wrong part of Uruguay. Olam also says NZFSU's farms are likely to be more expensive to run under its lead given a need for supplementary feed.

Vivek Verma, Olam's managing director for coffee & dairy products, told interest.co.nz if his company secures control of NZFSU it will evaluate reallocating capital to central Uruguay from eastern Urugauy where the company chose to develop New Zealand style dairy farms in a warmer climate than New Zealand has and on traditional rice cropping land. The east of Uruguay, Verma said, doesn't have the good, free draining soil of the traditional dairying lands in central Uruguay.

In a Double Shot interview with interest.co.nz Verma said Olam viewed the concept behind NZFSU as a good idea but the company had executed poorly.

"It was a new concept that was being tried out in a new geography and I think the company was too aggressive in terms of land acquisition when they went in," Verma said. "They planned to acquire initially about 24,000 hectares. They ended up acquiring close to 36,000 hectares with the result that they ran out of funding and didn’t have enough money to take the project to completion."

"A little bit more conservatism would have probably helped the company."

NZFSU was floated on the NZX by PGG Wrightson in late 2006 at NZ$1 a share raising NZ$115.6 million. Managed by PGG Wrightson, it had a one for two rights issue at NZ$1.50 per share a year later.

Olam is now offering 55 cents per share in cash for all the shares in the loss making NZFSU it doesn't already own. The offer price, Olam says, is a 38% premium over NZFSU's 3-month average trading price of 40c.

Olam is already NZFSU's biggest shareholder with a 18.45% stake after buying in initially last September and topping its stake up in May. It has also secured backing from the second biggest shareholder, PGG Wrightson, which has signed up to a “lock-up” agreement to sell its 11.5% stake to Olam.

The Offer is subject to Olam securing a minimum 50.1% NZFSU stake and gaining Overseas Investment Office approval.

Verma said Olam would be happy with 50.1% of NZFSU or up to 100%.

If successful in gaining control, it will review NZFSU's operating model. Much of the company's problems stemmed from it trying to transplant a carbon copy of the New Zealand dairy farming model to Uruguay.

"The idea was to transfer the New Zealand intensive pasture based dairying system into Uruguay but the fact is Uruguay is not New Zealand," Verma said.

"It has got a slightly different climate, it’s in a different latitude zone. We believe that while the model is right it has to be adapted to Uruguay conditions."

To succeed in the slightly more tropical Uruguay conditions, a significant amount of supplementary feed is needed.

"It’s still a pasture based system, but there has to be much more supplementary feed than what you would have required in New Zealand," Verma added. "Which basically means costs are definitely going to be higher and if you do not implement a hybrid system of more supplemental feed, then you are not likely to get the results that you are looking for."

Given this Olam viewed NZFSU's financial forecasts as "extremely ambitious" and isn't confident they can be achieved even in the long-term.

NZFSU reported a US$6.9 million loss for the six months to December 2009, down from a loss of US$8.9 million in the same period of 2008. Its results for the year to June are due out on August 23. The company forecasts a loss before interest and tax of US$10 million for the year based on forecast milk production at the lower end of an 80-85 million litre range.

Based on milk production of 100 to 110 million litres it expects a "small" loss before interest and tax in the 2010-11 year and positive earnings before interest and tax in the 2011-12 year. If its full scale production target of 940 kilograms of milksolids per hectare per year is achieved by 2014-15, NZFSU expects earnings before interest and tax of US$35 million to US$40 million.

NZFSU, which has debt of about US$57 million, says it needs a further US$60 million to complete its plans. Verma said Olam would support the company in whatever form was required to finish its project.

"I it is possible that, as the company states, there could be a capital call. If there is it’s likely to be on a pro rata basis and we will definitely be willing to support the company in any way possible."

Olam describes itself as a global integrated supply chain manager and processor of agricultural products and food ingredients, sourcing 20 products from 64 countries and supplying them to some 10,600 customers. The company also owns a 25% stake in Open Country Cheese’s parent company Dairy Trust and interest.co.nz understands it kicked the tyres of Cedenco Foods when that company was on the block recently. 

A publicly listed company, Olam's major shareholders are the Kewalram Chanrai Group, Singapore government affiliated Temasek Holdings and Olam's management.

US$1 billion warchest

Olam recently said it had raised about US$1.8 billion through bond issues, bank syndication transactions and an equity placement in the space of a year. It had spent about US$800 million on acquisitions and working capital in that period, meaning it had a further US$1 billion for more acquisitions. In May Olam reported a 30.1% increase in net profit after tax to S$267.2 million (NZ$270.5 million) for the nine months to March with sales revenue up 19.1% to S$7.3 billion.

Verma said Olam's recent acquisitions included ones in spices, dehydrates, tomato paste, and Australian almond orchids.

"We are continuing to look for value opportunities which are synergistic with our business."

This included looking at selective "upstream assets" in countries that offer cost of production advantage. Although New Zealand offered such advantages in dairying, it wasn't Olam immediate objective given there were other countries where the cost of dairy production and investment could be lower such as Uruguay.

Although Olam currently has no operations in Uruguay, it has a significant presence elsewhere in South America.

"We are very large in Brazil with coffee, cotton and cashew operations, (have) a large farming operation in Argentina where we farm soya and peanuts, plus (we have) operations in Peru, Honduras, Colombia and Mexico. So we are pretty familiar with the territory and know the continent quite well," Verma said.

"Our contextual knowledge will definitely aid in being able to turn the company (NZFSU) around."

'Opportunistic bid'

Macquarie analyst Brooke Bone suggests Olam's offer could be viewed as opportunistic given a plethora of problems NZFSU has had over the past year including a drought, slower than expected farm development rates and volatile dairy prices. Bone has a net tangible asset (NTA) value on NZFSU of 73c per share.

However, she notes the company is still losing money at an operating level and needs US$60 million to complete development of its farms. She says the US$60 million represents 65% of NZFSU's market capitalisation based on a 53c share price.

NZFSU's shares were trading at 56c yesterday.

NZFSU has appointed Grant Samuel & Associates to prepare an independent adviser’s report on Olam's bid for its directors. It has also named a response committee to address its obligations under the Takeovers Code which consists of directors John Parker, Graeme Wong and Craig Norgate.

NZFSU also says it's well advanced in negotiations with PGG Wrightson about buying back its management contract and entering into a long term preferred supplier agreement.

PGG Wrightson received US$2.5 million for managing NZFSU in the year to June 2009. Last October the companies announced the management fee percentage had been reduced to 0.75% from 1% for gross asset value above $US400 million. As of June 30 last year gross asset value was about $US215 million.

NZFSU's also owes PGG Wrightson about US$9.6 million left over from its management fee due for the 2008 financial year, which had been converted to an interest-bearing loan carrying an interest rate currently of 9 to 10% per annum.

NZFSU has advised shareholders to hold fire on whether to accept Olam's offer or not. The offer's due to open on August 3, running through until September 1.

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