China venture fraught with peril

Photo: Grahame Cox

Chairman Keith Smith and PGG Wrightson have a lot at stake in the performance of Agria chief executive Xie Tao.

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OPINION: Believing that PGG Wrightson is making a sensible decision in welcoming Agria, a Chinese company, as a cornerstone investor takes two leaps of faith.

First: that Agria today and into the future is a very different and better company than the troubled one revealed over the past two years in New York Stock Exchange announcements, SEC filings and US court documents.

Second: that Wrightson knows what it wants to do with Agria. Ask two very senior people at Wrightson and you get two very different answers.

The only simple thing about all this is the basic logic of a deal: China is a large agricultural producer; it is already something of an agricultural science powerhouse; it needs to grow a lot more food; it will manage to do so only through new technology and much better farming practices; New Zealand in general and Wrightson in particular have science and management skills that can be put to use profitably in China, here and elsewhere in the world.

But the deal will work only if Agria and Wrightson live up to the claims they make for themselves.

Up to now, Agria hasn't. In every press release it claims it is "an innovative China-based agri-solutions provider". And indeed it has operations in sheep-breeding, new-seed commercialisation, seed growing and distribution, plant sales and the like.

Selling this story, it floated on the New York Stock Exchange in November 2007, raising $US282 million ($371m) at $US16.50 a share. The shares are currently trading at $US3.

The prospectus included 16 pages of potential risks Agria might face. Some were obvious such as drought, disease, volatile prices and other perils of the primary sector or of doing business in China. But many were specific to the company, its structure and relationships.

For example:

By far the largest part of its current business is contracting farmers to grow corn seed, which it then on-sells to other farmers. The growing is done through a network of 54 village collectives and seed production companies. While the villages typically enter into 12-year contracts with Agria, the company says it has little recourse if they choose not to plant corn in a given year because other crops might pay more.

It currently produces new corn varieties through traditional cross-breeding. Currently genetic modification of corn seeds is not allowed in China, although the country is a very large planter of other GM crops such as cotton. "The advent of the genetic modification of corn seeds in China could adversely affect our business, causing us to lose opportunities, market share and revenues."

Agria is also developing a new breed of sheep it calls Primalights III. But it admits there is ambiguity in its relationship with Shanxi Agricultural University. If the university "were to dispute our exclusive rights to use, further develop and commercialise these technologies, we may lose our ability to continue to employ such technologies".

The Chinese government strictly forbids the selling for breeding purposes of a new variety of animal until it has declared it a new breed. Agria is currently selling them as just hybrid sheep for general purposes rather than as breeder sheep. "If the sale is considered by relevant government authorities to constitute the sale of breeder sheep, we may be ordered to stop selling Primalights III and be subject to other penalties."

"Our limited operating history makes it difficult to evaluate our future prospects and results of operations. Our consolidated affiliated entity, P3A [Agria's main operating entity in China which is owned not by Agria but by principals of P3A] commenced operations in 2000 and first achieved profitability in 2002."

"Our senior management team has worked together for a short period of time, which may make it difficult for you to evaluate their effectiveness and ability to address challenges."

"Failure to achieve and maintain effective internal controls could have a material and adverse effect on the trading price of our ADSs (American Depositary Shares)."

"The shareholders of P3A may breach our agreements with them or may have potential conflicts of interest with us, and we may not be able to enter further agreements to derive economic benefits from P3A, which may materially and adversely affect our business and financial conditions."

In the two years since the float, some of these risks have eventuated. Agria's announcements to the NYSE consist almost entirely of news of departing board members and executives; of a dispute with P3A and subsequent settlement with its principals that cost Agria $US102.4m and the sale of 17.4% of Agria to one of them; a profit forecast revised sharply up then down; and financial reporting delayed. It has yet, for example, to publish its results for the year ended December 2008.

As a result, Agria is facing four class action suits from US investors over the P3A settlement and related matters.

But, says Wrightson, that is the old Agria. It is dealing with a very different new Agria, it believes from the due diligence it and its advisers have done over recent weeks.

Wrightson is putting a lot of trust in Xie Tao, Agria's new chief executive. Xie was until a month ago, a partner of PricewaterhouseCoopers in China. Among other things, he was the Chinese government's chief financial adviser on the Beijing Olympics and has helped on a string of takeovers in China by foreign companies, including Fonterra's purchase of its 43% stake in San Lu.

Tim Miles, Wrightson's managing director, says Xie is working fast to sort out Agria and he has a good relationship with Guanglin Lai, Agria's founder, chairman and main shareholder, a Singaporean investor who collected $US82m in the float.

Wrightson is convinced that Agria has the scientific, political and commercial relationships needed for the two of them to prosper together.

Their co-operation agreement, which will be cemented by Agria taking a 13% stake in Wrightson for $36m, outlines potential areas such as seed commercialisation, livestock trading, farm development and funding for Wrightson's finance arm here in New Zealand.

But, says Miles, the plan is for Agria to learn from Wrightson's expertise here and elsewhere in the world and to apply the knowledge itself in China. Wrightson will not invest in large operations there or second large numbers of people, as it has in recent years in Uruguay.

But ask a senior board member of Wrightson how the deal will work and you get a different picture. He says Agria is very interested in Wrightson's Uruguayan model.

This has two parts: its own fast-growing and profitable seed, rural services and livestock business; and NZ Farming Systems Uruguay, the company it started and spun off to outside shareholders but still manages for a large fee. This has lost money so far because it over-invested in land and under-invested in developing the farms. But it is now on a somewhat more hopeful medium-term track to profitability.

Any Wrightson direct investment in China in dairying or other activities would be modest and take time to build scale and profitability, the director added.

There's good sense in doing that. But only after Wrightson has got its operations in New Zealand and Uruguay and its global seeds business operating far more effectively and profitably.

So, when Wrightson asks its shareholders to stump up money in a rights issue next month, it is asking them to take a great deal on faith: that Xie can shift the relationship between Agria and P3A to a normal, transparent and non-conflicted one; that he can make Agria a transparent and effective company; and that Wrightson has the skills to handle the relationship and the investment.

If Agria and Wrightson let down their shareholders on any one of those, they will repeat the expensive, disastrous mistake Fonterra, enmeshed in all the same Chinese complexities, made with San Lu.