Ceres (TSX:CRP) is in Play
Ceres Global Ag Corp (TSX:CRP) is in the news because New York hedge fund, VN Capital is unhappy with the fee arrangement between Ceres and a management group from Front Street Capital. VN Capital owns ~7% Ceres and their belief is that Ceres is trading below breakup value because of an outdated "2 and 20"fee structure.
Ceres was a pick of mine several years ago as a way to play the agriculture sector. Initially they were trading on the abilities of Front Street Capital's braintrust to plough money into agriculture related investments.
Investing in big picture themes, like agriculture, it can lead to outsized gains. It helps to have strong fundamentals but if enough fund managers raise enough capital, a sector can become overheated. There are only so many real small/mid cap businesses to invest in. Multiples expand and everybody makes money...sometimes.
Ceres was set up with a typical "2 and 20" hedge fund compensation/incentive system for management. Management is paid 2% of the asset value annually and 20% of any gains or outperformance compared to a relevant benchmark. Unfortunately for Ceres' investors the company launched just before the 2008 crash and was never able to completely recover. Management abandoned the fund model and decided to purchase Riverland Ag in 2010. More recently, they have announced construction of a logistics hub in Saskatchewan (for trains of grain and Bakken oil). Ceres never made money for its initial investors so there have been no incentive fees paid to management. However, they've been collecting their 2% of Net Asset Value fees even after the acquisition of an operating company.
VN Capital Management is making waves. Here is an excerpt from their latest salvo...
The management agreement structurally misaligns Front Street’s financial interests from those of Ceres’ shareholders. To illustrate, since the company’s inception, Front Street has collected $15.4 million of fees plus $2.3 million of additional expenses which has more than offset any losses on Front Street’s equity stake in Ceres while the non-Front Street shareholders have lost a collective $58 million.
Ceres has a market cap of of ~$100 million and it has been higher in the past so that 2% fee certainly adds up over the years. One key question is, are the guys at Front Street earning their keep? Had they done nothing would shareholders be better off? On the surface, it sounds like VN Capital may have a valid grievance.
Ceres shareholders would have been better off holding an agriculture related ETF.
The very important wrinkle in this corporate battle is that Front Street management is a significant shareholder of Ceres Global Ag Corp. On December 8th 2012 they announced a purchase of $9.4 million worth of shares. At that time they owned 3,093,091 common shares of Ceres (Ceres has just over 14 million shares outstanding). On March 18, 2013 Front Street principals announced that they owned or controlled approximately 20% of the outstanding shares of Ceres. Less honourable management would have bailed as soon as their 20% incentive fee seemed out of reach. I've seen it happen.
Sometimes these hedge fund gambits work (Canadian Pacific Railway TSX:CP NYSE:CP) but other times they completely destroy shareholder value (Baja Mining - TSX:BAJ).
I attended the Berkshire Hathaway AGM this year and one of my big learnings was how beneficial investment in long term businesses is to the economy compared to say, hoarding silver bars. It looks like Front Street is trying to create a business that will create jobs and make money for shareholders over the longer term.
I also learned that Warren Buffet pays himself $100,00/year.