Why we invested in MRG in the IPO
The trend of growing demand for natural and organic foods has been well entrenched for many years, and we believe provides strong tailwinds for over the long term:
MRG’s prospectus forecasts suggested the company was listing at an EV/EBITDA of 11x versus the global average for listed organic and differential food stocks of 13.2x, and the multiples would drop off materially in the coming years as MRG’s vines mature:
In addition to the industry tailwinds MRG appeared well positioned to take advantage of the current global under-supply of organic raisins:
What happened next…
“The FY17 pro-forma revenue is expected to be down by $10 million, with approximately half of this reduction being attributed to the previously communicated 5-6 week delay in harvest season caused by an unusually cool and wet spring, coupled with more recent wet weather. The other half of the reduction is attributable to slower than anticipated uptake in sales following delays to the refurbishment of the Company’s Sunraysia processing facility, during which dried vine fruit could not be processed, as well as a lower contribution from Cluster sales following the previously communicated write-down of some Cluster inventory.”
“The reduction in sellable dried vine fruit from the 2016-2017 crop, due to the recent and previously announced cold and wet weather experienced in the Sunraysia region, has resulted in the Company revising its estimated FY17 pro forma EBITDA to be in the range of $6.5-7.5 million and pro forma FY17 NPAT in the range of $0.1-0.8 million.”
What we got wrong
This is the most humbling mistake for us to own up to since we are so focused upon identifying management teams who are honest, competent, shareholder friendly and motivated. The great thing about investing is that everyone is faced with mistakes upon occasion, and thus has a choice how they deal with them – we can all chose to either learn a lesson or not to.The background to our experience with MRG’s management dates to the pre-IPO presentations when we saw them present. We thought the CEO came across as competent, honest and knowledge-able, and were of the opinion he would be a great leader for the business looking forward. We then met him again at a conference a few weeks after the IPO and were again impressed for the same reasons. We were reassured that everything was on track and the company’s prospectus forecasts would be achieved. This meeting was the week before the company announced its first major profit warning. Yes, you read that right. Management were presenting to investors the day before the profit warning with the message that everything was on track.
This is why this job can be so humbling. We clearly misjudged management on all levels. We don’t want to dwell on the negatives about MRG’s management in this article but it is clear they didn’t tick any of the boxes we were aiming to tick.
b) Our assessment of weather risk
Weather risk will always be a key consideration when investing in an agricultural exposed company like MRG. We did indeed consider this risk in depth before investing. At the time we took comfort from management and broker reassurances that the prospectus forecasts already factored in short term risks including weather. This was a big mistake on our part as poor weather ended up being a primary contributor to MRG’s subsequent profit warnings which made it painfully clear that weather risk had not in fact been factored into the company’s prospectus forecasts.
c) Our assessment of the company specific risks
Beyond the challenging weather conditions, the company mentioned the refurbishment delays at the company’s Sunraysia processing facility as being a major problem since dried vine fruit could not be processed as a result. In addition, there was as a lower contribution from Cluster sales following the previously communicated write-down of some Cluster inventory.
Both of these issues have had a significant impact on the company’s sales and earnings in MRG’s brief listed life, and we clearly under-estimated both of these risks. We both issues relate to our judgement of management as there was an underlying assumption that management were on top of these logistical issues ahead of listing. MRG certainly has revealed an unusually long list of problems to the market in its 6 months on the ASX.
d) Investing in the IPO rather than awaiting some listed trading history
Arguably most of our mistakes in this example would have been avoided if we had avoided buying MRG in the IPO and had awaited some listed trading history, preferably at least a few years. By watching the stock as a listed entity for a period we would have had a far clearer picture of the company’s key risks.
e) Under-estimating the implications of the company’s unusually short escrow period
This was an unusual one. MRG had a very short escrow period for pre-IPO shareholders which meant there was a massive increase in the supply of stock hitting the market at exactly the wrong time, into bad news. In hindsight we should have asked ourselves why the management team and brokers would support such a short escrow period. We are not suggesting that management were aware of all of impending problems when they wrote the prospectus but it does look as if there was pressure from some pre-IPO shareholders to create an exit point as soon as possible. This is the opposite of what we are normally aiming for; a long term and committed shareholder base.
Lessons learnt:
- Only invest in IPOs where we have a history of following and understanding the business and management – Our MRG investment experience has reinforced in our minds the benefits of investing in companies with a long term trading history which reveals the ins and outs of how a business works and evolves.
- Avoid agriculture exposed companies unless we are certain weather risk is mitigated – The reality is it is almost impossible for agricultural companies to mitigate against weather risk and when poor weather hits it will generally impact upon earnings far more than any financial model will predict.
- Make sure all your research is independent – do not rely on broker research – When we invest in a company it is our responsibility to get it right and we cannot rely on external research in any shape or form. MRG’s lead brokers got the company’s financial forecasts very wrong just a few months before the end of FY17 but we should not have factored their analysis in as much as we did.
- Be careful of IPOs with short escrow periods – This is the first time we have encountered such a short escrow period and it has highlighted to us that this is a warning sign which should not be ignored.
- Your first loss if your best loss – selling on the first profit warning was absolutely the right strategy despite feeling “wrong” at the time – We sold our entire MRG stake at between 63c and 65c after the first profit warning. This was a remarkably hard and humble step to take but in hindsight it was the right step.
