A Leading sharebroking firm has lent its support to PGG-Wrightson's proposal to invest $220 million of equity in meat processor Silver Fern Farms, but warns there are risks associated with the deal.
ABN Amro Craigs described PGG-Wrightson's (PGG-W) plans to invest $220 million in the Dunedin meat processing and marketing co-operative as "a bold attempt to rectify some of the longstanding structural problems that afflict the New Zealand red meat industry".
"While cognisant of the risks involved, we view the proposed transaction with cautious optimism. Its timing could prove astute given improving underlying market dynamics and, if management can deliver the promised synergy gains, there is scope to add material value to the group's investment," ABN Amro Craigs analyst David Oxley said.
Benefits would be magnified if the deal encouraged further industry consolidation, but Mr Oxley said there was much to be done before then, with the first obstacle getting the support of SFF shareholders.
Mr Oxley saw three main risks for PGG-W in the deal.
The proposal aims to change the way SFF does business by moving from a seasonal supply of stock based on spot-market procurement, to supplying a premium quality branded product to new markets all-year-round.
He said that meant changing farmers' habits to supply that type of stock when it was wanted, which could prove challenging.
It relied on SFF getting markets prepared to pay premium prices for stock supplied outside the traditional season so it could pay more to farmers.
"Failure to achieve such changes would mean the group has invested a substantial amount in an industry that historically has not generated attractive returns."
PGG-W had not achieved the promised synergy gains from the Wrightson-Pyne Gould Guinness merger, and it was crucial that it did so with the SFF deal to get material value from the investment.
The final risk to PGG-W came from borrowing $145 million to fund the deal.
"The PGG-W balance sheet is already reasonably leveraged, with total net debt at the year-end expected to be around $470 million, with around $155 million of this contained within the Finance Company."
Despite these reservations, Mr Oxley said he was cautiously optimistic about the merger, adding that prospects of improved meat prices meant the timing was "shrewd."
A merger would address industry issues of a lack of vertical integration, excess processing capacity and competition for stock.
But it would not rectify an imbalance between New Zealand sellers and concentrated international buyers.
For that to happen, further industry consolidation was needed, which Mr Oxley said both SFF and PGG-W supported.
A merger would strengthen SFF's balance sheet, an obstacle for a proposed merger with Alliance Group earlier this year.
He valued SFF at $500 million, based on $440 million in equity and post-deal net debt of between $50 and $60 million, with PGG-W effectively taking on the company's debt.
ABN Amro broker Peter McIntyre said there was no plan B for SFF or the meat industry.
"My viewpoint is that this should be attractive to SFF shareholders because they are running out of options. If there is a plan B, I would like to see one. This is the only well thought-out plan that has been presented."
Farmers appeared unable and unwilling to inject capital into SFF, and by giving up control of 50% they would have a stronger company with options.
"To me it's a win-win. They still retain 50% ownership, but debt is transferred to PGG-W."
