Monday, October 12, 2015

Brian Gaynor: Silver Fern Shareholders risk being shanghaied


The Notice of Meeting and Independent Report for the acquisition of 50 per cent of Silver Fern Farms by Shanghai Maling are revealing. The documents clearly show that the banks are playing a major role in the transaction and the shareholders’ agreement has a number of features that could be extremely disadvantageous to New Zealand shareholders.

First, a recap.

Silver Fern Farms Limited, which is 100 per cent owned by Silver Fern Farms Co-operative, is New Zealand’s largest livestock processing company with turnover in excess of $2 billion per annum.

The company was formed in September 1948 as Primary Producers Co-operative Society, mainly to counter the pernicious grip of British multinationals over the domestic meat processing sector.

Under the proposed new structure Silver Fern Farms Co-operative will own 50 per cent of Silver Fern Farms Limited and Shanghai Maling will acquire the other 50 per cent.
The latter will acquire its 50 per cent stake through the purchase of $261 million of new shares.

The limited liability company will distribute $57 million to the co-op and $35 million of this will be allotted to the co-op’s 16,000 shareholders as a dividend.

The following comments clearly indicate that the banks are encouraging the transaction:
  • Silver Fern Farms’ chairman Rob Hewett wrote “if the proposed transaction is not approved … some or all of the members of the banking syndicate could elect not to provide debt facilities to the Co-operative beyond 31 October 2015″
  • The Financial Implications section of the Notice of Meeting states: “It is possible that some or all of the Co-operative’s lenders may elect not to provide facilities and … the Co-operative will be faced with adverse consequences including potential insolvency”.
The Grant Samuel independent report had a large number of references to the bank loans including:
  • The banking syndicate advised that “in the absence of an injection of new capital they may not renew the current facilities beyond the current expiration date of 31 October 2015″.
  • If the proposal is approved the company “will no longer be subject to rigorous oversight by the banking syndicate”.
  • “The existing debt syndicate … has sought a resolution to (the company’s) capital structure involving a substantial (greater than $100 million) reduction in debt through the introduction of new capital”.
The banking syndicate comprises Westpac, Rabobank, Hongkong and Shanghai Banking Corporation and Commonwealth Bank of Australia, all 100 per cent overseas owned.

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Silver Fern Farms’ annual report for the year ended September 30, 2014, showed that bank borrowings were $287 million compared with $387.1 million at the end of the previous year.

The annual report revealed that its average interest rate on secured loans, which represented 95.4 per cent of total loans, was 6.01 per cent and 11.02 per cent on its overdraft facility.

Silver Fern Farms’ peak season overdraft must be huge as its 2013/14 interest-rate costs were $37.4 million compared with a theoretical $18.7 million based on its average interest rates and year-start and year-end debt figures.

The interest costs of $37.4 million suggest that Silver Fern Farms’ peak season bank overdraft funding could be as high as $500 million.

It would be easy to claim that overseas-owned banks take a particularly tough stance against the country’s agriculture sector but this is not the situation.

Reserve Bank statistics disclose that the country’s registered trading banks have outstanding loans of $57.9 billion to the agriculture sector, representing 14.8 per cent of total bank lending.

By comparison the largest New Zealand-owned banks, Kiwibank, TSB Bank, Heartland and Southland Building Society, have just 0.1 per cent, 4.0 per cent, 16.5 per cent and 11.4 per cent of their lending to the agriculture sector.

The Government-owned Kiwibank, which is the largest NZ-owned bank by a wide margin, has only $25 million of agriculture loans compared with $18,212 million lent to individuals, mainly in the form of residential mortgages.

Thus, it is incorrect to argue that overseas-owned banks are less willing to lend to New Zealand’s agriculture sector.

The problem is that meat-processing companies have low levels of profitability, particularly compared with their gross revenue, and have extremely high peak season financing requirements. Banks are becoming more and more reluctant to fund these companies in light of the significant downturn in commodity prices.

Corporate governance is another important issue as far as the Silver Fern Farms/Shanghai Maling deal is concerned. When the deal is completed Silver Fern Farms will have ten directors, five of them appointed by the co-operative and five by Shanghai Maling. There will be two “Co-Chairpersons”, one appointed by the co-op and one appointed by Shanghai Maling.

The partnership agreement contains a “Casting Vote Matters” clause whereby the Shanghai Maling appointed Co-Chairperson has a casting vote. This casting vote will apply in the following situations:
  • On the approval of the annual business plan.
  • On the approval of the annual budget.
  • On the approval of the annual financial statements.
  • On the appointment or dismissal of the chief executive and determination of the chief executive’s compensation arrangements.
  • In relation to the dividend policy and the quantum and timing of dividends.
The Notice of Meeting stated that “the Casting Vote Matters will apply when the board has been unable to achieve a majority of directors supporting one of these matters. The Casting Vote Matters are necessary to allow Shanghai Maling to consolidate its investment for accounting purposes under the financial reporting standards applicable in China”. This was a pre-requisite for Shanghai Maling’s investment in Silver Fern Farms.

This casting-vote agreement is a concern and could lead to serious problems in the years ahead.

Joint ventures arrangements are challenging, particularly when they involve two different cultures with one representing producers and the other owning distribution facilities in another country.

There are likely to be differences of opinion between the two parties but Shanghai Maling will be in the box seat because it has been granted a casting vote on major issues. This casting vote effectively disenfranchises the co-operative’s 16,000 shareholders in relation to these issues.

The Notice of Meeting tries to soften this casting-vote facility with the comment that “the senior management of Silver Fern Farms is responsible for the preparation of the annual business plan and budget”. The catch to this is that the Chinese company has been granted a casting vote regarding the appointment or dismissal of the chief executive.

In effect, Shanghai Maling has been given the opportunity to acquire a controlling interest in New Zealand’s largest meat export company for just $261 million.

Why didn’t Silver Fern Farms offer Shanghai Maling only 25 per cent at a cost of $130 million?

Silver Fern Farm’s financial situation has improved with chairman Rob Hewett telling the media that its debt would be reduced by approximately $140 million, to just under $150 million, by the end of September 2015.The company will also report a much-improved profit figure for the 2014/15 year.

Grant Samuel’s report also indicated that the banks were looking for a capital injection of just over $100 million instead of the $261 million Shanghai Maling is providing.

There has been speculation that the additional $161 million war chest could be used to crush Invercargill-based Alliance Group in a livestock procurement war and eventually take it over.

However, the simple answer to the question above is that the Chinese company demanded a 50 per cent stake with a casting-vote facility. This indicates that Shanghai Maling drives a hard bargain and will be firmly in the box seat if the partnership deal is approved.

Brian Gaynor is an investment analyst and the Executive Director of Milford Asset Management. 

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