Saturday, November 28, 2009

Corporate Governance - NZ Farming Systems Uraguay

Big Bully Approach to Farming outside New Zealand

What are the Corporate Governance Issues involved with NZFSU, and how do they compare with the principals and rules of Corporate Governance and Responsibility?

Issue 1)

Principle: Balance of Board (SEC, 2004)

Issue: The Directors that has been elected, was put in place via biased means. (Gaynor, 4/11/2009)

Why a problem?
Because the old board was re-instated, the existing problems were not addressed and no improvements will be made. It also means that the board of Directors will only change when the directors step down. It could mean that the Directors are being setup as puppets for the board. This directly ties to other issues addressed below.

Issue 2)

Principles: Effectiveness of the Board, Ethics of Directors, Quality and Independence of Auditing and Checking of Processors to Manage Risk (SEC, 2004)

Issue: The board has not pursued a balance between NZFSU and PGG Wrightson (Gaynor, 27/10/2009). Allowing for miss-management of funds between the two. From my perspective this was covered with 'creative accounting'. However, this was eventually discovered during an NZX audit where "Fudge this" (Young, 2009) was left on the copy of the books.

Why a problem?
Due to the board not pursuing irregularities in accounts. This also led to a large public outcry when colloquial terms were used in accounts presented to the NZX (Young, 2009), scaring away new investors from NZFSU.
The recovery of this situation was bad. Chairman Keith Smith was quoted for saying:

“The board has investigated the matter and is satisfied that it is an isolated incident that will not occur again with appropriate checks and controls now in place. Having said that we certainly regret the negative impact the matter caused.” (Smith, 2009)

Clearly stating that he only felt bad for the negative impact it caused externally. And that the incident would not occur due to internal controls not releasing similar information. Very trivial for an issue which involves cash-flow and 'depreciation' according to the reply to the NZX (Young, 2009).
This has accumulated a massive dilution of shares combined with a debt larger than PGG Wrightson. This is discussed later in the article.
Issues 3)
Principles: Boards relationship with Shareholders and Stakeholders

Issue: Purchasing of assets is not being disclosed to the share or stakeholders. (Gaynor, 27/11/09)

Why a problem?
By not disclosing the assets history or nature to their shareholders, investors do not know where the money is going. Land is being purchased via internal channels, with no history of rateable value (Gaynor, 27/11/09) - which due to the nature of the business cannot be considered internal trading, but does leave suspicions on many investors.
This combined with a complete watering down of shares due to reinvestment overseas has left shareholders concerns about what revenues are being made. (Baldwin, 2009)
Stakeholders are also cautious. With slight outrage that NZFSU are based purely in Uruguay, where apparent parent group PGG Wrightson (and their parent PGC), are suppose to be New Zealand companies for the New Zealand farming community.

However this is only the basics of what NZFSU and PGG, under the eyes of the Corporate Governance Principles.
Later we will address if they have Qualitative Governance at all.
As an Investor, what do I think is wrong with the boards and the governance of PGGW and NZFSU?

I think the reasoning behind NZFSU existing has not been fully disclosed to investors (of either PGGW or NZFSU).

Questions have been raised about how NZFSU has allocated its resources. Or what its purpose is. Consistently there have been Management and Performance fee's exchanged between the two firms (Gaynor, 27/10/2009). This with the included costs of purchasing lands between the two firms - I would question who the stakeholders are of the NZFSU.

This issue has been buried consistently with the lack of a new board of Directors. Leaving all new eyes off the existing books and new minds off the company direction. To quote Gaynor (4/11/2009):

"The old boys’ network is firmly in control in New Zealand, even though its performance has left a lot to be desired."

This is reinforced by the NZFSU website which states:

"At each annual meeting one third of the Directors must retire. The Directors who retire are eligible for re-election." and "John Suffield Parker retired and offered himself for re-election. Graeme Henry Wong retired and offered himself for election having been previously appointed by the Board of Directors subsequent to the 2008 Annual Shareholders Meeting. Each was elected by separate motions passed by ordinary resolution of shareholders." (*, 2009)

This means that a significant percentage of shareholding would be required to sway this downward spiral the company is on. It is worth noting also that PGG Wrightson's board members and NZFSU are one and the same - and not even further investment by PGC and Agria could affect the electing of new members in to PGG Wrightson's. (Baldwin, 11/2009)

When prospecting investors have looked into NZFSU, they have found that the operations do not have very sound operations. Duncan McGregor warned investors with this comment:

"What I am saying is if I buy a commercial building to rent out in NZ I can expect a return on capital between 6% to 8% in rent plus a capital gain when I sell. If I buy a farm in any country in this world...I can only expect a 3pc return on capital if I run it myself plus a capital gain when I sell.
To place managers in and run it like a company is a fool’s investment.
That’s only my opinion having been around farms in quite a few different countries. The investors coming into this will be city people I can’t see any practical farmers investing in this." (2007)

So with a board that can't be fixed, operations that are not transparent, expenses that don't add up, stakeholders being ignored and operations that don't make sense - Investment would be the last thing on my mind. The closest thing that comes to mind is a pyramid scheme.
How has the board met and failed to meet its obligations to stakeholders?

Who is the stakeholder?

NZFSU on its own is business set to fail.
- It does not have any links back to New Zealand with the exception of the board (who are also the board of PGGW).
- It is apply New Zealand market dynamics to an international product
- The product NZFSU produces is in direct competition with PGGW's stakeholders
- There is no rational reason to purchase land in Uruguay for a New Zealand based company.
- Re-investment cannot be counted as income.

This leaves the stakeholders as:
- PGG Wrightson’s (customer / owner ???!!!)
- Uruguay farming (customer / supplier)
- The Board (owners)
- Shareholders (owners)

Note that the New Zealand farming community, New Zealand public and New Zealand Government is not a stakeholder in NZFSU.

Stated on NZFSU is nothing about its obligations to the stakeholders. Only the Shareholders are mentioned.
Currently NZFSU has delivered its obligations to PGG Wrightson’s and the Board. It is yet to deliver its potential obligations to the shareholders - expected time for this is 2011. (Baldwin, 8/2009)

2011 is expected to be the first year when NZFSU's figures of income and expenses will break even. However you could question whether this will ever occur, with the ever-increasing annual Management and Performance Fee's being paid to PGG Wrightson. (Gaynor, 27/10/2009).
What obligations do I think the directors have, to ensure that they investors are protected?

Directors, in theory should be able to follow the basic rules of Quantitative Governance. Mervyn King's 8 questions are an easy assessment of Quantitative Governance:

Is there Conflict?
Yes there is conflict.
As stated previously, the board of NZFSU have no degrees of separation between them and the board of PGGW. This has prevented issues to be properly addressed, and has created a loop of money out of investors pockets, into NZFSU, out of NZFSU into PGGW. There also is a conflict in terms of PGGW's stakeholders (NZ Farming) and their relationship with NZFSU who is effectively a competitor to NZ Farming.

Do the Directors have all the facts to make a decision?
Yes they do. They have an excess of information which has given them a competitive advantage to go against the NZ Farming industry (direct competitor).
They have more information than most of their competitors due to operating in 3 different countries. This is due the fact that there are close direct ties between NZFSU, PGGW, PGC and Agria. They are aware of how much shares are required for each step - and they are dictating expenses from NZFSU to PGGW accordingly.

Is this a rational business decision based on all the facts?
Rational - yes, however the ethics could be questions.
With NZFSU, PGGW has a legal money laundering operation. If excess funds are required - they can put a request for shares in NZFSU onto the market - then claim the funds as an expense on NZFSU's accounts. (Gaynor, 10/2009) Likewise if they require to push money out of the PGGW accounts they invest into NZFSU through over-inflated land (which they are not required to declare the history).
However separate PGGW from NZFSU, and the decision to move with NZFSU would not just be irrational, it would be suicidal.

Is the decision in the best interest of the company?
Yes for PGGW, No for NZFSU.
PGGW as stated above has created a legal money laundering process with NZFSU. This however does mean that NZFSU will only exist until either a law makes it illegal - or a principle makes the shareholders aware of the situation they have invested in. Most likely the latter - when NZFSU has to show the true value of the assets on its books.

Is they communication to the stakeholders transparent?
No for both NZFSU and PGGW.
Only expenses are accounted for with NZFSU - and there is no proof what they have proposed with their mission statement and goals is even achievable.

Is the company acting in a socially responsible manner?
No for both
By not disclosing full transparency. They have taken shareholders money and shown no true return for it. This dishonesty towards shareholders is echoed to the stakeholders of PGGW who are now in competition with NZFSU.
Are the directors acting as good stewards of the company's assets?
PGGW - Yes, NZFSU - No
NZFSU is buying assets at whatever price the directors dictate. This is also noticeable in the annual fees NZFSU has in association with PGGW. Shareholders money is being spent not invested.

Would the board be embarrassed if its decision and the process employed in arriving at the decision appeared on the front of the national newspaper?
Yes they would.
This has happened to them before (Smith, 2009). And will continue to happen so long as the system currently in place are allowed to continue. Eventually you can expect that NZFSU will collapse - taking PGGW and Uruguay farming with it.

What options are open to them to meet these obligations?

They need to make NZFSU a completely separate company, if they do not separate it from PGGW and PGC – the collapse NZFSU could backfire on both.

Complete foreign ownership would be the best solution.
What changes are required from the regulators to prevent this happening again?

This is a situation where regulation may not have been the issue. Due diligence has been lost.
Shareholders were willing to invest in a company that promised high returns, without looking at the situation, background or even the parent group.

A warning flag should have been raised at the first signs of the start up. It was started by a director of PGG Wrightson's. It was assumed that because he was working with PGG Wrightson's at the same time of NZFSU - that no conflict would occur. Yet no one considered the concept of who the stakeholders of NZFSU would be, and if their needs would conflict with the stakeholders of PGGW.

The only way they can prevent this is more transparency with reports to the NZX, which hopefully would aid investors from making unwise investments. A similar approach is being trialled in the US.

SEC, (2004),.CORPORATE GOVERNANCE IN NEW ZEALAND, PRINCIPLES AND GUIDELINES - A Handbook for Directors, Executives, and Advisers
Securities Commission (New Zealand)

Gaynor, B (2009),. Old Boys Club remains closed to new entrants
(last viewed 4/11/2009)
Gaynor, B (2009),. PGG Wrightson bills NZ Farming Systems Uruguay for US$62M
(last viewed 23/11/2009)

Young, C, Daly, J (2009),. NZ Farming Systems Uruguay Ltd – Annual Financial Statement ("Fudge This")
(last viewed 23/11/2009)

Smith, R (2009),. NZFSU gets pass fudge comment
National Business Review - Thursday October 15 2009 - 03:25pm
(last viewed 23/11/2009)

Baldwin, L (2009),. NZFSU targets 2011 breakeven
National Business Review - Wednesday August 26 2009 - 04:50pm
(last viewed 23/11/2009)

Baldwin, L (2009),. Chinese Balance - Shift in Power at PGG Wrightsons
National Business Review - Friday November 20 2009 - 02:52pm
(last viewed 23/11/2009)

* (2009) New Zealand Farming Systems Website
(last viewed 23/11/2009)

History of PGG Wrightson
(last viewed 23/11/2009)

McGregor, D,. (2007) - nz farming systems Uruguay
Sharetrader Forums
(last viewed 23/11/2009)

Other Resources (read but not quoted or paraphrased):