Owen Hembry: PGG breathes easier but questions remain

Investor tension about the health of PGG Wrightson eased this week with news of improved operating profit and agreement with ANZ, BNZ and Westpac to refinance a $475 million loan facility.

As a long-held breath was exhaled across the market, the share price, which took a hammering the previous week, losing more than half of its value, continued to recover. It gained 32c last week to reach 91c on Friday.

The refinancing includes a $275 million loan repayable at September 30, 2011 and a $125 million amortising loan repayable at the end of 2010. The company expects to repay the amortising loan through improving operating cashflow by targeting a nil cash dividend and a number of cost savings.

PGG has dropped 150 employees during the last few months through people leaving and contractors not being rehired.

Costs are also being reduced through working capital changes, including inventory reductions, a focus on arrears and potential asset sales such as surplus properties.

The company hopes to trim $10 million from its rural supplies business through inventory cuts, although it was difficult to know whether the asset sales would go ahead in the present environment.

Revenue for the six months ended December 31 was up 32 per cent to $738 million, with operating profit after tax also up by 32 per cent to $22.1 million.

The company said trading had been consistent with guidance given in December for likely full-year earnings of $39 million to $45 million.

However, the company did post a net loss of $32.8 million for the period, including fair value adjustments of $35.2 million relating to the value of the company's shareholding in NZ Farming Systems Uruguay.

Macquarie Research Equities says the probability the company will need to undertake an equity capital-raising has declined - a view that will also help the share price recover.

The result will have answered questions that have dogged the company, including concern about debt facilities and trading performance in the global environment.

But there are questions still to settle, including how much the failed deal with meat processor Silver Fern Farms will eventually cost and why PGG went unconditional without total certainty on the finance.

A cost of $17 million was linked to last year's failed $220 million deal to buy half of Silver Fern Farms, of which $10 million was put aside as a provision for the Dunedin-based co-operative. Silver Fern's farmer shareholders approved the deal but it failed after PGG missed the first instalment because it had been unable to finalise bank credits.

Chairman Craig Norgate is the most recognisable face of the company but he is only one part of a team of directors and executives.

Surely someone should have put a hand up and said: "Hang on a tick, we don't have the money sealed yet."

PGG Wrightson had planned to fund the $220 million purchase through a mixture of capital-raising and debt.

Norgate has said approval was needed to change details related to the equity-raising and while in principle nobody had any problems with the change it gave an opportunity to review the whole deal. The failure was a function of the extreme financial market conditions, he said at the time.

Perhaps now is the time to put a hand up and admit it was a mistake as well as misfortune because to not do so could suggest the lesson has not been learned.

CAPITALISATION

While the probability of PGG raising new equity capital recedes, erstwhile partner Silver Fern Farms says it needs to re-capitalise.

Chairman Eoin Garden says the PGG Wrightson partnership proposal was going to recapitalise the balance sheet anyway.

"Our shareholders have the decision whether they in fact allow or encourage equity partner or shareholder into the co-operative or make the effort to recapitalise themselves," Garden says.

"In the current environment there's unlikely to be any major equity partner or shareholder interested in this industry and so the current environment also gives us a real sense of a need to protect ourselves or de-risk ourselves from, if you like, the global impacts on the banking fraternity."

The co-operative will start talking to shareholders in the next few months.

Garden says that no number has been set.

In its annual report for the year ended August 31 last year, Silver Fern said total borrowing was $238.6 million, down from $329.5 million the previous year and the company had cut debt levels by $150 million since February, 2007.

"Notwithstanding the fact that we took $150 million worth of borrowing off our balance sheet ... there are huge risks out there, even with our stronger balance sheet because of the global economic situation," Garden says. The $220 million deal with PGG Wrightson would have been used principally to reduce debt but also for working capital and capital expenditure, although when it fell through Silver Fern said it was comfortable with its position regardless of the deal.

"In September was the very start of the meltdown and we saw the consequences of that meltdown actually deliver to [PGG Wrightson] an inability to fund their partnership deal," Garden says.

"It was all occurring at that stage and I think we've got to be wise enough to acknowledge that even since September the conditions have changed."

LET'S HAGGLE

PGG Wrightson wants to give Silver Fern Farms compensation of $10 million for the failed deal, including $3.5 million for costs, plus a settlement it says is based on delivering the benefits that would have been achieved.

In response Silver Fern says $10 million is totally unacceptable, although chief executive Keith Cooper says the $3.5 million for costs is fair.

Haggling usually begins with gambits both parties know they will not get.

So we have PGG starting with $10 million plus a package to deliver benefits, although they would argue it is a fair final result, but what is Silver Fern's starting point?

Silver Fern starts from the stronger position because PGG went unconditional before missing the first payment and last year Silver Fern referred to the deal as unconditional and enforceable.

The strong language from the past and the reaction to last month's PGG offer suggests they are starting considerably higher - but could we be talking $20 million or $220 million?

Haggling goes well if both sides start from a defendable position, within cooee of each other and with a mutual understanding they will shake hands somewhere in the
middle.

But how wide or close is the gap between the parties and how well can PGG defend its position given they went unconditional?

PGG Wrightson wants mediation before a retired High Court judge, while Silver Fern say PGG is being antagonistic, has not yet named a price, at least publicly, and has talked about the possibility of litigation.

The fear that $10 million is well wide of the mark played a part in the recent share price crash at PGG, which will want a speedy resolution to stop speculation.

Unlisted co-operative Silver Fern has arguably been under less pressure to hurry the negotiations along but PGG has now eased the pressure on itself with commitment from its banks, and Silver Fern's farmer owners will also want some certainty before opening their chequebooks to refinance the co-operative.

Silver Fern starts from a stronger position and will likely want that reflected in any settlement but how much pain do they want to inflict on PGG for the monetary gain, and how important today is last year's original idea of partnership as the road to prosperity?

More pain now means more scars to heal later.