Outlook for Silver Fern Farms deal looks bleak

The last minute hold up of the first instalment of PGG Wrightson’s (PGW) payment for 50% of Silver Fern Farms (SFF) was, in Craig Norgate’s words, ‘bloody disappointing’. More than that, it is a major obstacle to what had seemed to be a done deal, having overcome what everybody thought was an even bigger challenge – getting more than 75% of eligible SFF shareholders to vote in favour of giving up half their co-operative to an outside investor.


The global financial meltdown will claim more scalps before it recovers, indeed it has already caused the Mataura Valley dairy factory and AgInvest’s $30 million Canterbury farm conversion to be put on the back burner. But this was the big one, because it was widely seen, by many sheep farmers at least, as the salvation of their industry. It was the first sign of the meat industry actively considering a new business strategy of integrating livestock production to specification, procurement, processing and international marketing.


There will be some disagreement from other processors and their shareholders about how successful the PGW/SFF strategy might be, but they deserve credit for taking a new approach to the thorny question of how to match livestock supply to market demand. Keith Cooper, CEO of SFF, told me last week the deal was always about strategy, not the money, so the original plans are still in place, with the procurement amalgamation programme being launched this week. The money would have been helpful because the company could have moved more quickly on some initiatives, as well as cutting the interest bill, but it won’t be a show stopper.


It’s just as well the relationship can be consummated without the money, because getting six banks to approve the credit lines necessary to provide $125 million looks harder with every day of uncertainty. Banking syndicates are notoriously more difficult than one lead bank to negotiate with. SFF must be thanking its lucky stars it has moved on from its horrendous 2007 result, having succeeded in renewing its banking facilities till September 2010 including repayment of listed bonds which mature next March. At the same time its 2008 result, due to be announced at the end of October, is clearly much improved on last year, judging by the positive remarks about performance and the $100 million debt reduction.


I have an uneasy feeling the deal with PGW may be one of those that gets further away as time passes, although I would be pleased if my gut instinct was wrong. The obstacles are likely to arise on both sides of the deal, not because of lack of desire, but the financial climate is likely to become increasingly risk averse. The meat industry will be a lot tougher this season than last, with lamb, sheep and prime beef numbers significantly reduced, so even if there isn’t a procurement war, there won’t be the plant throughput needed to sustain profitability. Right sizing and debt reduction are both positive factors, but they won’t make much if any improvement to processors’ balance sheets, while improved returns will only make farmers happier.


On the other side of the coin PGW will also be facing less favourable trading conditions with the positive impact of dairying less of a factor than in the previous year. This is against a background of higher percentage increases in PGW’s debt and liabilities than assets for the year ended 30 June 2008. The ratio of total liabilities to liabilities plus equity was below 33% at year end compared with 36.2% the previous year, neither of which is considered dangerously low, but the downward trend, combined with the added debt needed to buy half a meat company, may have tipped the balance against the deal in the current environment.


The meat industry hasn’t exactly been a bed of roses for investors, particularly big corporates, so it’s probable PGW’s banking syndicate may have viewed the big strategic vision behind the proposal with initial enthusiasm. But as the debt market tightened, it looks as if at least one of the banks had second thoughts about investing any more in the meat industry without insisting on a set of belt and braces closely resembling a strait jacket.


The big vision remains in place for the time being at least, with the intention of living together which each partner will try to make work, but it won’t be the same as getting married and sharing their assets.


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