Carving up Affco

By Andrea Fox

Monday 1st March 2004

"Big turnaround for Affco". Yeah, right.

The hard men of the meat industry reckon the headlines about Affco's financial result in the dying days of last year qualified for a Tui billboard.

The big meat exporter, which probably also put steaks on your barbecue this summer, has had more "turnarounds" than a dog settling down for the night. It just about went bust in the early 1990s (though it wasn't alone in the meat industry there). In 1995 it got a blood transfusion from share sales after its fed-up bankers pressured it to list on the Stock Exchange. By 1997 it had gone through all that cash and was in trouble again. In 2000 it declared a "turnaround", but within 10 months of that had fired its chief executive and was going broke.

Then, in November last year, up popped the "turnaround" word again after Affco chairman, Otorohanga farmer Sam "put away that chequebook" Lewis declared a $16.2 million profit for the September year, compared to the previous year's $12.3 million loss.
What's a bloke to think?

The fact is, Affco is falling into the hands of fishermen and that, even the hard men concede, could mean the headline writers may have to ditch the "t" word (as in, turnaround) for the "s" word (as in, sustained), when they record Affco's next few financial performances.

Just before Christmas, Motueka family company Talley's, processors of seafood, vegetables and ice cream and regarded by the fishing industry's tough men as New Zealand's most efficient processor, became 40% owner of Affco. Just what has possessed the conservative Talley family to take this walk-on-the-wild-side of an industry with razor thin margins, high fixed costs, constant stock procurement pressures, low equity, and with its throat constantly exposed to the cyclical ravages of drought, plague and the Kiwi dollar, is anyone's guess. And Affco, which turns 100 years old this year and is one of New Zealand's big five meat companies, is hardly the sexiest proposition, with its unsavoury history of huge losses interspersed with scant profitable years.

Alas, the deeply private Talley family doesn't talk about its plans and hopes - except to other Talleys. But this Yugoslavia-rooted fishing family is already showing it's as capable of ruthless strikes on livestock supply sources in this procurement-frenzied industry as Affco's South Island meat industry rivals, PPCS and Alliance. As these Southerners invade the North Island in search of stock to feed their plants, and the odds grow that the blood of one or more of the $5 billion industry's big players could soon spill as livestock supply shrinks, Talley's has shown it is ready to join in the slaughter. Using Affco as its vehicle, it is to build a $30 million processing plant at Invercargill, right in the Southern men's backyard - a move seen by some as retaliation for Invercargill-based Alliance's decision to develop a plant in Dannevirke, Affco's territory.

Four meetings and no takeover
So, we have South Island fishers turned meat poachers now embedded in a company which is seen as a bit of a sharemarket dog, with more lives than a cat. Providing an extra twist to the Affco tale is another tough man of few words, Peter Spencer. Believed to be New Zealand's biggest corporate meat farmer, he is said to spend much of the year in Britain, and in the past couple of years has taken an increasingly active role on Affco's share register.

When Talley's increased its stake to 40% in the week before Christmas, Spencer's share of the company also increased - to 23.5%. The two parties seem to be playing some sort of cat and mouse game (hard to judge, given that Spencer refuses interviews), but the upshot is that Spencer has put himself in a good position for when Talley's eventually gets around to making a full takeover bid for Affco.

And one thing is for sure - together, Talley's and Spencer's money has saved Affco's hide. The way they've gone about it is yet another story.

A special pre-Christmas shareholder meeting, which allowed both Talley's and Spencer to increase their shareholdings, was the fourth in 20 months for Affco's long-suffering other shareholders. It's been seven years since Affco paid a dividend and its share price has seesawed from 52c on listing day in 1995, to a miserable low of 15c in December 2002, at press time hovering in the low to mid 20s.

Respected sharemarket commentator Brian Gaynor caned the company over the special meetings, calling them repetitive and monotonous and demanding to know why Talley's just didn't make a partial or full offer to all shareholders. Good question. Probably because 60% of Affco is a big bite for one family to take on when there is still a lot of downside.

Talley's softly-softly approach to mopping up Affco started in October 2001 when it bought 10% of the company for 29.6c a share. Affco was Talley's second choice of meat processing investment: it was beaten in 2000 to a stake in Hawkes Bay's Richmond by Dunedin meat cooperative PPCS (later caned by the High Court for "gross commercial misconduct" in the way it had conducted its hostile takeover of Richmond).

On-market buying and Talley's partial underwriting of a December 2001 rights issue swelled its stake to 19.9%. Then things started to get really interesting - but rough on small shareholders. A special meeting was called in April 2002 to ask shareholders to approve a proposal to buy corporate farmer Hugh Green's 10.5% stake at 38c a share. Approval was needed under takeovers law because Talley's didn't want to make the offer to all shareholders.

Amazingly, shareholders said no. Amazing because no special meeting - these events aren't cheap - would have been called if the major shareholders had not already agreed among themselves to support the proposition.

Enter meat industry puppet master, Peter Spencer. Through his company Toocooya Holdings he owned, at that time, 10% of Affco, having sold most of his shareholding in Richmond to PPCS. Green said at the time that it was Spencer who told him to sell to Talley's, but then at the eleventh hour the puppet master withdrew his support, to everyone's bewilderment.

Later that year, shareholders agreed to let Talley's and Spencer underwrite a one for one rights issue at 10c a share. This raised Talley's shareholding to 26.4% and Spencer's to 20.8%.

Last year Green again got the itch to sell to Talley's, only this time his stake had grown to 11.6% and he was only going to get 25c a share for it. At a special meeting in July, shareholders approved the deal. But, oddly, at the same time they said no to Talley's and Spencer buying Dairy Meats' (a dairy calf processing company) 4.7% stake in Affco for 26c a share. The upshot was yet another special meeting, the pre-Christmas approach to shareholders. Talley's emerged from that with 40% and Spencer, now on Affco's board in person instead of having a shadow director, with 23.5%.

Gaynor proved to be dead right when he grumped that these in-house deals had allowed a select number of Affco shareholders to quit the company and capture the premium for control, with apparently no restriction on them buying back at a lower market price. After selling 60 million shares in-house, Green, who's been selling cattle to Affco for 35 years, turned round and bought 8 to 10 million shares at an undisclosed price.

Why? "Because they were cheaper than I sold them for, and I still have to have a finger in the meat business and I think it has a chance of being a successful company," says the guileless Irishman, head honcho at the Hugh Green Group, which sends 10,000 cattle to the knife each year, about 8000 of them to Affco.

Gaynor scoffed at an independent report from Deloitte Touche Tohmatsu's last year that offered an explanation for Talley's not simply making a partial takeover offer for 50% to all Affco shareholders on a pro-rata basis. Deloitte said such an offer could result in the elimination of Affco's $108 million of tax losses (tax effect $35.6 million). Gaynor called this claim "spurious", saying tax losses were carried forward if there was a 49% continuity of shareholding.

Affco chairman Lewis says Gaynor is wrong. "They (Talley's) only have to get 42- 43% for tax continuity to become a problem for us. And with $135 million of losses before this year's result, which decreased it by about $16 million, that was pretty critical as far as we are concerned."

Back to bloody basics
So, Green has faith in an Affco renaissance, the Talley family has banked heavily on it, and the canny Spencer is confident enough to get on board for the ride. But even 37-year-old chief executive Tony Egan, Affco's fifth chief executive in just over a decade, admits one profit doesn't make a turnaround. Events that occurred one day in the week before Christmas show how quickly a positive outcome can be eclipsed, and why few in this tough trade are yet prepared to use the word "turnaround" and Affco in the same sentence.

Less than two hours after Talley's and Spencer got the okay to up their stakes, Affco paid $20 million to Farmers Mutual Group, wiping out its $55 million indebtedness to this lender. Good reason for a beer, if not a champagne.

That afternoon Affco issued a profit warning. Echoing an earlier warning by rival Richmond, the company said disappointing trading in the first two months of the 2004 financial year meant profit expectations for the first quarter were behind last year.

Difficulty getting livestock, particularly lambs, would be worsened by increased (both actual and planned) processing capacity in the North Island, mourned the company in a notice to the market.
One step forward, two steps back.

But Lewis, who became executive chairman in early 2001 after firing upbeat chief executive Ross Townshend just five days after a bullish annual shareholders meeting (the share price was then 42c) is having none of that. Affco has not come close to falling over in his 13 years on the board, he says, and he's confident the improvement is not a flash in the pan. (Industry watchers suspect it hasn't gone bust because its bankers were in too deep to let it).

But Lewis is also cautious. "We are influenced by other things - like [the fact], one little company can go out there and wreak havoc [in the stock procurement market]. We probably have about another year to year and a half of hard work to do."

Unlike Townshend's smoke-and-mirrors, razzamatazzed financial turnarounds, the Lewis method of pulling Affco back from the brink has been a simple, even dull, back to basics approach. Plenty of blood was spilt in the process.

While Lewis is credited by some commentators as being the unsung hero of its recovery, Talley's business style can also be detected. During Townshend's short tenure - he was appointed in 1998 to restructure Affco (its last good profit had been in 1996) and his goal, as he said often, was to save the company $50 million a year - 73 staff were on $100,000 a year or more. By 2002 that number had been slashed back to 57; in 2003 it was just 21.

Townshend himself earned $870,000, more than twice that of his counterpart at Richmond, and was paid $1.25 million for his last five months work. Affco's latest annual report suggests Egan is on a more modest $390,000 to $400,000.

After Townshend's shock exit, Lewis helped 11 top managers to the door, remarking that the company had been "brought to its knees by extravagance". An army of consultants was axed. Lewis was to tell farmers later that year that $9 million had been carved from costs in seven months.

Next, Affco's headquarters were moved from Auckland city, home for 98 years, to the company's processing works at Horotiu, north of Hamilton, where a certain pong serves as a daily reminder to the greatly shrunken management team of what their core business is. The move would save $1 million a year, Lewis said at the time.

Townshend's "internationalisation" drive, which saw Affco disastrously invest in a joint processing venture in China - the plant has been starved of stock since it was commissioned and is now officially "in recess" - has been taken off the road and trashed.

Lewis indicates there's more to come yet in this seemingly never-ending tale of restructuring. This is because Affco's real challenges could be just beginning as the industry itself shakes down in the wake of PPCS's long drawn-out takeover of Richmond, and the commissioning of new meat processing capacity. There was also a worrying splash of red ink in the much-improved 2003 result - operating revenue was down to $892 million from $993 million the year before.

The youthful Egan, appointed in mid-2001 as chief operating officer and eased into the chief executive role under Lewis's flinty eye, remembers being bluntly told at his interview to keep his nose out of anything that did not involve bricks and mortar in New Zealand.

Egan also says a lot of work has yet to be done before Affco is no longer at risk. "If you take last year you have to read it in the context of a better season, there's no doubt about that. One swallow doesn't make a summer, but having said that, some of the fixed cost savings in particular that have flowed through in the company have been a fundamental improvement."

He is upfront that there's a lot of teamwork in managing Affco: read Egan, Talley's and Lewis. Affco management answers to Motueka, make no mistake, industry watchers say. The Talley operating style is to run low cost businesses efficiently. The aim is to be a smart processor. The family treats its products as commodities, and the focus is squarely on the cost of production. Curbing costs and back to basics is the rule.

And it's a strategy that could well work, say the watchers. One day Talley's will buy Affco, but in the meantime having control of management without having to put up the money for 100% is not silly.

Dangers aplenty
But there are perils ahead, and not everyone is convinced that Affco's latest result is as solid as it looks. Some suspect the profit is bolstered by extraordinary gains on the sale of assets, a common ploy in the meat industry's books. Egan responds that, sure, there was an $11.5 million cash gain from the sale of shares in associated companies New Zealand Holdings in the UK and Auckland Meat Processors, but the money helped repay a net $24 million of borrowings in line with the board's new policy of retiring long-term debt.

Canterbury University senior accountancy lecturer Alan Robb could see no evidence of creative accounting in the annual report to September 2003. He too was inspired to use the "turnaround" word, saying it would be "very pleasing" to shareholders and Affco's bankers, HongKongBank, Bank of New Zealand and Rabobank, which got involved about four years ago. Robb notes the company's debt to equity ratio has fallen from 72c of debt for every $1 of equity to 43c. This has helped to cut the interest bill in 2003 to $3.4 million from $7.1 million in 2002. He also notes that seven of the 21 executives on more than $100,000 no longer work for Affco, so the total salary cost will shrink further.

"Since 1997 the company has lost $43 million but has generated net operating cash flows of nearly $22 million ...the trend is in the right direction but there is still a way to go before its cumulative profitability catches up with its operating cash flows," says Robb.

But easy does it. Even Egan - whose beef processing background could make him a liability in a sheepmeat focused company, according to one industry hard man - acknowledges the lurking dangers for Affco in an industry racing to rationalise itself. With too much killing space and not enough stock, he says there is the danger that the industry will revisit those dark days of 1993 and 1994 when apparently-thriving meat companies Fortex and Weddel New Zealand crashed spectacularly, throwing thousands of people out of work.

"Look at the Weddel crash - back then you could process all the [sheep and lamb] in the North Island in 19 weeks. We are down to 25.3 now."

Strewth. What was that they said about a turnaround?

Affco in brief

The basics

One of two listed meat companies (the other being Richmond)

Exports 150,000 tonnes of beef and lamb a year

Operates nine processing plants

Employs 2800 workers

Market capitalisation $119 million

The big shareholders
Talley's Fisheries - 40%
Peter Spencer's Toocooya Nominees - 23.46%

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